MarketWatch had a feature story titled “Some managers know how to let you sleep at night,” which identified 5 no load funds that allegedly capture much of the gains in good times without suffering devastating losses in down markets. It’s likely you have heard of most them, and I have even used some when appropriate. They are good performers, not necessarily in the top, but very solid when used at the right time. The article makes you believe that these 5 can be held without regards to market direction, which, of course is a fallacy. Additionally, some have not been around during the past bear market, so they are not necessarily battle tested. Take a look at a long term chart: As you can clearly see, the performance varies widely with FAIRX leading the pack. My point is that these funds could be worthy of your consideration (neither I nor my clients have currently any positions) when the market gets out of the doldrums and the trend heads back up. However, if we are crossing into bear territory, I suggest, as I always do, that you get out of your positions and move to the safety of the sidelines (money market). The simple fact is that in a bear market all equity funds will decline, some more some less. As many have learned during the 2000 to 20003 disaster, there is no safe haven other than cash

The Subprime pig strapped on his wings this week and feasted at different troughs in a variety of countries. While the countryside varied, much to the pig’s delight, the food was identical: Same old leftover slop from irresponsible subprime lending procedures primarily designed to feed somebody’s corporate bottom line no matter what the long-term outcome might be. Affected countries, besides the U.S., included Australia, Germany and France. Yes, even the French saw their culture invaded by having to interrupt their wine and cheese desert to come to grips with the fact that some of their own U.S. exposed hedge funds stopped redemptions. The European Central Bank injected some $130 billion into the financial system to provide liquidity, a step which was followed by the Fed a day later. Once the subprime pig is on the move, there is no way of knowing where it might stop and feast next. And that is a big problem because there is no transparency as to which financial institution has how much exposure. There is a good chance that far more companies have invested in these loans through a variety of schemes, and fear of redemptions may keep them from disclosing their true risk exposure until the heat is really on. If this trend continues, it will be an absolute certainty that the stock market rally of the last 10 months will come to an end. And don’t kid yourself into believing that there are asset classes that will resist the subsequent downdraft. The only safe position will be in money market—until the subprime pig has found its last meal.

Bloomberg had an article titled “Soft-Dollar, Trading Costs Devour Fund Returns,” which describes the effect of various expenses and trading costs on overall mutual fund returns. The story goes on to look at a fund manager’s turnover rate, which is the amount of trading expressed as an annual percentage of fund assets. For example, a turnover rate of 100% tells you that the value of the entire portfolio was traded in a year. Yes, this does happen; in some fund orientations more than in others. That in itself is an irony, because the fund manager obviously feels that, in order to increase performance he needs to discard losing stocks and add more on the winning side. While this makes good business sense to me, there is a double standard here. Why are you, as a fund investor, not supposed to (or only with a penalty) to do the same thing by dumping underperforming funds and replacing them with better ones? Makes it pretty clear whose interests are priority and whose are not. The gist of the story is that all fund expenses decrease the shareholder’s return. However, keep in mind that this is only an issue for Buy & Hold investor, who will not only be paying these expenses in good times, he will also be paying them as his portfolio suffers in a bear market. Following trends, I never concern myself with a fund’s expense ratio. I want to be invested in a good performer and will only stay in it long enough until my sell stops, or a major trend reversal, takes me out of the market. While the entire mutual fund community hates this selfish profit motivated approach, it allows you to stick to the basis of investing, which is to make your money grow and not be loyal to a fund company that has absolutely no loyalty towards you. Speaking of selfish and profit motivated, always remember, a mutual fund company’s main goal is the same as the one for any corporation, including the one you work for: To make money for the company; nothing else. If you happen to grow your portfolio along the way, that’s great, but not necessary for the fund company to survive. Here’s a more humorous way to look at it: “Fall in love with your wife,” but “fall out of love with your mutual fund,” and focus only on those that can help you grow your portfolio.

Mark Twain said it best in this quote: “When you find yourself on the side of the majority, it’s time to pause and reflect.” To my way of thinking, this certainly holds true when it comes to handling your money. There are few advisors and others who don’t believe in the Wall Street induced herd instinct type of investing. It has proven to be one a sided “win” situation with the masses of investors usually being left stranded on the street licking their wounds after another failed attempt to stay fully invested during a bear market. If you are new to investing, these words may not mean much to you because you haven’t lost enough money to appreciate them. If you’ve been around the block for a while (translation: a severe bear market), you should have learned (hopefully) how to adjust your investment approach. One of the books I referred to in a recent post to on this subject was Al Thomas’s “If It Doesn’t Go Up, Don’t Buy It.” While Al covers a variety of investment areas, the book is easy to understand and contains words of wisdom from over 40 years of exposure to the financial industry. He has no ax to grind and no allegiances. He calls it as he sees it, which is very rare, nor does he care if anybody is offended, which makes him my kind of a guy. I have gone through his mutual fund section, which advocates trend tracking, and picked out a few gems that you might consider adapting: 1. Mr. William O’Neil, on of the market technicians and found of Investor’s Business Daily, did a study that found that between 1953 and 1993, 67% of the move upward in any stock can be credited to the positive advance of the Industry Group of the Market Sector to which it belongs. A more recent study shows 49% of the move of any stock is due to the industry itself, 31% to the general market movement and 20% to the company itself. This is ‘proof’ that research is nonsense. Just because the research report on a company is good doesn’t mean it’s going up unless the entire industry group catches fire. Birds of a feather flock together. 2. You leave the picking of the individual stocks to the mutual fund manager. That is his job. You want the best mutual fund manager on the street “at that time.” You can find him not by name because his name is unimportant, but by performance of his fund. You want the fund that is outperforming all the other funds. You want get on the ‘up escalator’ with him and follow him to the top. When he doesn’t seem to be able to go any higher, you get off. Take the next escalator to the higher level following another fund manager. I have no idea who is managing the funds I own and, you know what—I don’t care. That is the way I want you to picture the stock market—you riding gently, easily and steadily up to a level where you get off one mutual fund which has leveled off and choosing another one for the ride to the next higher level. That’s what rotation is all about. 3. Another great fallacy of the mutual fund gurus is “expense ratios.” They tell you not to invest in any fund that has expenses over 1-1/2%. Who cares what the expense ratio is if that fund makes 40% or more annually? The same for 12b-1 expenses. Who cares? Show me the bottom line. That’s all that counts. Basic rule: Follow the money! Even though Al’s book was written years ago, his wisdom gained by years in the trenches is simply timeless. It advocates exactly what I have been saying in my weekly updates and in my blog: Focus on being invested only during up trends in the markets, avoid the bear at all costs and disregard Wall Street’s self serving stories.

In a recent post I talked about the dangers of using leverage when investing and how it has helped this market to continue its run toward record highs. Front page news at MarketWatch tells us some more details about the subprime debacle and its effect on two of Bear Stearns hedge funds, one of them which is down an amazing 91% for this year. Minus 91%? Hmm, I guess using sell stops to protect investor capital would be out of the question. Makes you feel kind of glad that you and the size of your portfolio aren’t qualified to participate in these kinds of ventures, doesn’t it? To make their investors feel better, the company stated that “in light of these returns, we will seek an orderly wind-down of the funds over time.” Oh yeah, that sounds great. Be sure to hurry up, the investors could use the left over money to gas up their cars. The High-Grade fund had $1 billion in assets while the Enhanced Leverage fund had about $600 million and via leverage they controlled more than $10 billion in mortgage related securities and other derivatives. I can see why they would name one of their funds the “Enhanced Leverage” fund. What I don’t understand is how the other one can be called “High-Grade Structured Credit,” because of the involvement of subprime mortgages, which are anything but high-grade. The article further states that “the losses partly reflect unprecedented losses in the valuations of several securities with top AAA and AA credit ratings.” I don’t get that. Either they did not really own AAA rated securities or the ratings were incorrect. On the other hand, maybe they simply misread the label “subprime” loans to mean “supreme” loans? We may never find out but the smart guy in this transaction has to be the hedge fund manager on the other side of these trades who made a killing for his clients. I am sure the investors will get the obligatory “thank you and come again letter.” After some passage of time, Bear Stearns will come out with a “new and improved” hedge fund and solicit the same investors with promises of great fortunes. It’s business as usual.

This week’s sharp downside market activity has left a lot of investors somewhat breathless and wondering if a repeat of last year’s Many/June debacle could be on the agenda again. Or, could it be just a one week correction that can be overcome within a 6-week period just like at the end of February 07? While no one has that answer, there are a few things you can do to handle any market correction without the usual emotional impact. Rather than seeking psychological treatment, or finding the nearest “mixologist,” as shown in the picture, here are some that I have found helpful: 1. Reduce your news intake sharply. There is no need to listen to the talking heads on CNBC and other financial channels. Their hyped up views will do nothing to calm your nerves; besides, they don’t know any more than you do as to what the market will do next. 2. Make sure that you know where your sell stops are supposed to be and enter your orders "after" the points have been clearly penetrated. Remember, even if you use ETFs, for sell stop purposes I recommend you only work the with day-end closing prices. 3. View your portfolio with the right mindset. Say, the current value of your holdings is $100k. That is not really correct, isn’t it? Unless, of course, you had liquidated all of your holdings at that very day. A more realistic view of the view of the value of your portfolio would be to deduct your allotted sell stop percentage. For example, if you use my recommended trailing sell stop of 7%, then your $100k portfolio would be worth, in the worst case, only $93k. You may not like looking at it that way, but it is realistic when the market stalls or retreats. It will help you to always focus on the “real” value instead of on a number that is not only subject to change daily but also totally out of your control. If you can incorporate these 3 things into your day-to-day investing life, you will be able to keep your emotions at bay which, knowing that you have a plan to deal with uncertainties, will allow you to sleep better at night. And if that doesn’t work, go ahead and visit the nearest “mixologist.”

Reader Nitin sent me an article from BusinessWeek called “Five Reasons to Sell, Sell, Sell.” It lists five of the biggest threats to the current stock market rally, which include: 1. Earnings 2. Consumer spending 3. Inflation 4. Subprime and housing 5. Shiny happy investors All of these are items which I’ve discussed in various posts and comments, and every one them has the ability to derail the current bull market. Some have actually contributed to last week’s sharp pullback. If you are a casual reader of these types of articles, you may be prompted to liquidate your entire portfolio, and possibly watch the major indexes resume their upward march for another 6 months. And that is the problem with these stories. They may be correct in outlining all of the culprits that will always affect markets to the downside, but that does not mean such an event is imminent. This is why I continuously harp on the fact that these stories have no value when it comes to actually making a decision regarding your investments. At the risk of sounding like a used car salesman (no offense), stick to watching the major trend and follow your trailing sell stop points. Those are real numbers you can use to improve your decision making process.

With the constantly expanding offerings of ETFs, I have been planning on improving the weekly StatSheet. While this is a work in progress, you will see come changes already in this Friday’s issue and from hereon forward. In its current format, the StatSheet contains some 30 pages of graphs and no load mutual fund/ETF data. One of the major planned changes is the presentation of the momentum tables. They will be expanded where appropriate and posted as a link to a downloadable PDF file. This will allow you to better print out only that information which is of interest to you. Due to the reference to the tables as a link, the overall size of the StatSheet will be reduced, which will allow for faster loading when accessing. As mentioned above, new ETFs are being added rapidly, and currently there are almost 450 being offered with more in the works. I believe that ETFs should be an important component of everybody’s portfolio, and I will set up tracking for all of them as time goes on. In this week’s StatSheet, you will notice how the ETF Master list already has grown to some 250 funds. While ETFs originally started out covering the most well known indexes, they are now being sliced and diced and are representing many micro sectors. While not everyone of them may be a good investment choice, our momentum figures will weed out the weak ones and show those worthy of your attention. More importantly, having all of these choices will put us in a position to improve selections by (hopefully) having some “zig” in our portfolios when the markets “zag.”

Reader and client Nitin pointed out an article in the NYT called “Is It Just A Strong Market, or The Bubble, Part 2?” The story goes on to compare the differences between the events of 2000 and the market in 2007. Several academic studies suggest that current sentiment isn’t likely to be low enough to prevent another bubble form forming. Professor Porter pointed out that a typical pattern for a burst bubble (2000) is to be followed by a somewhat less extreme version of the original—something he refers to as a “bubble echo.” He said that this pattern has appeared so consistently in psychological experiments that “you could almost set your clock according to it.” There are some interesting points he makes, but he also admits that his research can’t be used to predict when a bubble echo might burst. Too bad, I thought I had something of value here that could be used to somehow improve my investing prowess. I guess it’s back to tracking trends and monitoring sell stops.

The recent roller coaster ride in the stock market was caused by a variety of events, one of them which was a rise in interest rates. If you held any income producing bonds, bond funds or municipal closed end funds, you undoubtedly have seen the values head south as they always do when rates are rising. Personally, I have watched the tax-free income portion of my portfolio go from about +1.50% to -3.00%. This is a normal occurrence within an economic cycle, and you need to look at the income generating process with the right frame of mind. If you invest for income, and your funds/ETFs/CEFs pay monthly dividends, then that’s what you need to focus on. After all, the income is what will support your lifestyle and not the value of your portfolio. Interest rates will always fluctuate and, in times of lower rates, you’ll have some potential for capital gains, while, during times of higher rates, you may see the value of your portfolio head south. Whether rates rise or fall has no effect on the underlying issuer to pay your monthly dividends, so don’t get too emotional about it. Here’s another way to look at it. I have a friend who prefers generating monthly income from his real estate holdings. He owns several single family rental homes, which provide him with regular monthly income that he collects from his tenants. In his area, real estate prices have come down some 20% off their highs. Translated, that means that the value of his real estate income portfolio has gone down by several hundred thousand dollars. I asked him if he was worried about that kind of price drop but his response was that he was living well off the generated income and that the value only mattered if he were to sell. Obviously, even if he wanted to, he couldn’t just turned around and liquidate his real estate holdings overnight as you can with a bond fund. However, maybe there is lesson to be learned here, which is to focus on the purpose of your investment. If it does what it was designed to do, why worry about things that are beyond your control anyway? However, I believe that no matter what you invest in, there should be some kind of ultimate safety net, in case the world goes haywire. Just like using the Trend Tracking Index (TTI) for growth investments, I will draw a line in the sand when I will sell my income portion. After all, I am old enough to remember 21% mortgage rates and 16% money market interest in the early 1980s. While we may never experience that again (hopefully), my line in the sand for my income portfolio is a drop of -7%—just in case.