Pre-opening Comments for Tuesday November 3^rd

U.S. equity index futures are lower this morning. S&P 500 futures are down 8 points in pre-opening trade. Traders are responding to news that the Bank of England has provided another equity infusion to Royal Bank of Scotland and Lloyd in order to ensure their continuing operation. Another big loss by UBS, another European based bank also contributed to weakness. UBS is down 8% after reporting a third quarter loss of $542 million.

Weakness in U.S. equity indices is happening despite news that Berkshire Hathaway has offered to acquire Burlington Northern at $100 per share. The deal is worth $44 billion and consists of 60% cash and 40% stock. Burlington Northern jumped 27% to $97. In addition, several major U.S. railway stocks such as Union Pacific, Norfolk Southern, Canadian National Railway and CSX are trading 10% higher in pre-opening trade. The Dow Jones Transportation Average is expected to surge at the opening.

Berkshire Hathaway also announced a 50 for one split of its Class B shares.

Traders are waiting for news from the Federal Reserve’s Open Market Committee. It meets today and tomorrow to determine interest rates offered to major banks and releases results of its meeting tomorrow at 2:15 PM EST. Consensus is that the Fed will maintain an easy money policy, but may hint about the timing of an eventual change in policy.

Gold added $6 U.S. per ounce on news that the Reserve Bank of India has purchased 200 tonnes of gold from the International Monetary Fund. The sale takes out about half of the 403 tonnes of gold that the IMF has pledged to sell. China is rumored to be interested in purchase of the remaining 203 tonnes.

Third quarter earnings reports continue to exceed expectations. Companies that reported higher than consensus third quarter earnings this morning include Viacom and Master Card.

Morgan Stanley reduced its rating on the semiconductor sector from Attractive to Cautious and downgraded all stocks recommended at Outperform to Equal Perform. Downgraded stocks included Intel, Micron, Altera and TLA Tencor.

Stanley Works and Black and Decker have agreed to merge though a share exchange. Stanley Works added 3% in pre-opening trade. Black and Decker rose 20%.

Technical Action Yesterday

Technical action by S&P 500 stocks was quietly bearish yesterday. One S&P 500 stock broke resistance (Clorox) and five stocks broke support (Amerin, Dean Foods, Denbury Resources, Pinnacle West and Southern Companies). The Up/Down ratio dipped from 2.21 to (288/131=) 2.20.

Technical action by TSX Composite stocks also was quietly bearish yesterday. No TSX stocks broke resistance and two stocks broke support (Imperial Oil, TransForce). The Up/Down ratio slipped from 2.38 to (129/55=) 2.35.

Forest Product Stocks

They were notably stronger yesterday thanks to analyst upgrades, a blow out quarter by Domtar and higher lumber prices. Seasonality studies show that most forest product stocks on both sides of the border bottom at the end of October and peak either in early February (with the seasonal peak in lumber) or at the end of April (when strong first quarter earnings are released).

Chart courtesy of StockCharts.com www.stockcharts.com

Lou Schizas’ Comment

Looking for a comment on a junior forest product stock? Check out Lou Schizas’ comment posted yesterday: http://www.happycapitalism.com/2009/11/growing-wealth-one-tree-at-a-time/

Thackray’s Market Letter

The November edition focuses on seasonality in North American equity markets as well as seasonality in several sectors including Technology, Retail merchandising, gold, Canadian Materials, Consumer Discretionary and Canadian Banks.

Price for the letter is right. It’s free. To subscribe send an email to subscribe@alphamountain.com with SUBSCRIBE in the subject line. Also, please state your first and last name, city and country.

Seasonality in Small Cap Stocks

Thackray’s 2010 Investor’s Guide identifies the optimal period to invest in the small cap sector each year. Optimal dates are December19th to enter the trade and March 7^th to exit the trade. Mark Hulbert wrote an article yesterday that explains why the seasonal trade works. Preferred investment vehicles are ETFs that track the Russell 2000 Index.

Mark Hulbert

Nov. 2, 2009, 12:01 a.m. EST

Pay to play?

Commentary: Fund managers’ incentives affect stocks they buy

By Mark Hulbert, MarketWatch

ANNANDALE, Va. (MarketWatch) — It’s somehow fitting that as traders focus their sights on November, our political leaders are focusing on compensation reform.

That’s because pay incentives are also key to determining which trading strategies are likely to be most and least profitable this month.

To be sure, the pay incentives of greatest interest to traders are not those for bank CEOs, which are the focus of the current political debate. Instead, the ones most relevant to traders are those that prevail for mutual fund managers.

TRADING STRATEGIES: NOVEMBER

With earnings behind us and the holidays ahead, investors are looking for an easy sprint to the end of the year. But this year has shown us surprises around every corner. Let our experts guide you through the last leg.

I concede that the relationship between November’s trading strategies and fund managers’ compensation is not at all obvious. But that relationship nonetheless exists, and shrewd traders may want to try exploiting it.

The key to understanding this otherwise inscrutable relationship is an appreciation of what needs to happen for a fund manager to earn a year-end bonus. In most cases, earning that bonus depends on outperforming a pre-determined benchmark, and by far the most commonly used benchmark is the S&P 500 (INDEX:SPX) .

Believe it or not, the seemingly innocuous decision of which benchmark will be used to judge their performance has profound consequences for how managers behave.

Consider first a manager who right now is ahead of the S&P 500 for year-to-date performance. Even if he is behind the Russell 2000 for year-to-date performance, this manager knows that if he can hold on to his lead above the S&P 500 for another two months — until December 31 — he probably will earn a decent bonus.

He thus will have an incentive to make his portfolio look more and more like the S&P 500, which will have the effect of locking in his lead. That means he will tend to be a net seller of secondary stocks that are not part of the S&P 500.

Money managers who currently are behind the S&P 500 also will have an incentive to reorient their portfolios to be more like the S&P 500. That is because their desire to take on more risks in order to possibly rise above the S&P 500 by year’s end will be outweighed by the fear of losing their bets and lagging the S&P 500 by a large margin — in which case even their jobs might be in danger.

One implication of this reduced appetite for risk as the year progresses is that the beginning of the year will be a lot different than the end of the year. That’s because, once Jan. 1 rolls around, managers’ compensation slates will be wiped clean. Their willingness to take risk, which often manifests as an eagerness to bet on secondary stocks, will be at the highest point it will be all year.

That in turn means that managers in January will likely be net sellers of the large caps they increasingly will be purchasing over the next several weeks, while being net purchasers of the secondary stocks that they will be selling in the near term. Because of this tendency, large caps are likely to outperform small caps in November and December, while just the reverse is likely to be the case in January. (This latter tendency, by the way, is the source of the well-known year-end seasonal pattern that is known as the January Effect.)

This isn’t just theory, by the way; it has been documented by any of a number of academic studies. One that provides a good summary of the data supporting the theory was authored by two finance professors, one of whom is also an economist at the Federal Reserve Bank of Atlanta. Click here for a copy of the study.

What would a trading strategy look like that tries to exploit this tendency? A particularly aggressive one would be to simultaneously buy an exchange-trading fund that reflects the S&P 500 index (such as the SPIDERS S&P 500 (NYSE:SPY)) and sell short an ETF that reflects the small-cap sector (such as the iShares ETF that is benchmarked to the S&P Small Cap 600 index (NYSE:IJR) ). Notice that such a strategy makes money regardless of whether the overall market goes up or down — provided that the S&P 500 does better than secondary stocks.

A more conservative strategy would be to reduce your holdings of secondary stocks now and replace them with stocks that are part of the S&P 500 index. Such a strategy doesn’t require selling short, though it is vulnerable to a decline in the overall market.

The Latest SPIVA Report on Performance of Canada’s Mutual Funds relative to their Benchmarks

Following is a comment released by Standard & Poor’s yesterday.

S&P: Fewer Active Funds Beat their Benchmark in Q3 2009

S&P Releases Q3 2009 Index Versus Active Fund Scorecard (SPIVA) for Canada

Toronto, November 2, 2009 – Fewer active funds posted higher returns than their benchmarks in the third quarter of 2009, according to the latest results for the Standard & Poor’s Indices Versus Active Funds Scorecard (SPIVA) for Canada released today. SPIVA is produced by Standard & Poor’s, the world’s leading index provider.

Between July and September 2009, only 36.0 per cent of Canadian Equity active funds and 31.8 per cent of active funds in the Canadian Small/Mid Cap Equity category beat the S&P/TSX Composite Index.

This quarter has been challenging for active funds with exposure to markets outside of Canada. Almost 70 per cent of the Canadian Focused Equity funds that outperformed the blended S&P/TSX Composite Index in Q2 posted returns below the index in Q3. While 61.0 per cent of U.S. Equity funds were able to outstrip the S&P 500 in Q2, results diminished in Q3 with less than half, 40.3 per cent, posting returns above the index.

“More and more Canadians have shown interest in passive investment and the index funds and ETF products available to them,” says Jasmit Bhandal, director at Standard & Poor’s Canada. “Every investment decision comes with an element of risk and SPIVA is designed to help investors do their homework.”

As the average holding period for most investors is well beyond three months, a look at SPIVA’s long term numbers will be most relevant for Canadians. Across all categories, the majority of active funds have been unable to exceed the returns of their respective benchmark. In three-year and five-year periods, only 12.1 per cent and 5.9 per cent, respectively, of actively-managed Canadian Equity funds have outperformed the S&P/TSX Composite Index.

For a comprehensive, visual explanation of the results, including an interview with Jasmit Bhandal, click here.

SPIVA reports the performance of actively managed Canadian mutual funds corrected for survivorship bias, and shows equal- and asset-weighted peer averages.

Tech Talk comment: The full report is available at http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Canada_Q32009_Report.pdf

ETF News

An ETF tracking the VIX Indicator is available for trading. Symbol is VXX.

Chart courtesy of StockCharts.com www.stockcharts.com

IndexIQ Engineers Two Innovative Anti-Inflation ETFs

October 29, 2009 at 10:48 am by ETF.com

IndexIQ has been a leader in creating new models for exchange-traded funds. Its newest two offerings will feature anti-inflation components, which are designed to help investors protect assets while producing a profit should inflation return to the US economy.

The two new funds, IQ CPI Inflation Hedged ETF (CPI: Quote, Profile, Advanced Chart, News) and IQ ARB Global Resources ETF (GRES: Quote, Profile, Advanced Chart, News), launched earlier this week on the NYSE Arca exchange. The IQ CPI Inflation Hedged ETF will track a similarly named IQ index that will seek to provide a real return greater than changes in inflation as measured by the Consumer Price Index, according to Reuters.

IQ ARB Global Resources ETF will carve a different path, opting to invest in commodity producers to achieve exposure to monetary inflation. CPI and GRES will launch with a .48% and a .75% expense ratio respectively.

Exchange-Traded Funds-ETF Assets and Net Cash-Morgan Stanley

October 30, 2009-Highlights: There were 27 new ETFs listed in the US and three providers entered the market in the third quarter of 2009. There was only one liquidation this past quarter bringing the total number of US-listed ETF liquidations to 92 since 1/01/08. In 2009, 74 ETFs have been launched and 48 have been closed resulting in net new issuance of 26 ETFs. As of October 26, 2009, there were 789 ETFs listed in the US. Six providers have exited the business as the challenging market environment has limited traction for many of the newer, more narrowly focused ETFs based on less well-known indices

Inflows into US-listed ETFs were $26.4 billion during the third quarter of 2009. While this was down from the $37.8 billion in net inflows in the second quarter, it remains in line with the average quarterly net cash inflows of $24.5 billion from 2004–3Q09.

The largest net cash inflows occurred into ETFs tracking fixed income and international indices as well as Sector & Industry ETFs.

We note that Leveraged/Inverse ETFs had net cash outflows of $1.9 billion in the third quarter, some of which may have occurred in response to recent regulatory commentary.

US ETF industry assets have recently touched an all time high and are currently $718.8 billion. US ETF assets have rebounded by roughly 33% so far this year and by 53% since the end of the first quarter of 2009.

This is a result of a strong rally in global markets and a rebound in ETF net cash inflows after a weak first quarter of the year. Two providers and 20 ETFs still account for roughly 68% and over 51% of industry assets, respectively.

Jefferies Launches Highly Desired Agricultural and Metals ETFs

October 29, 2009 at 11:14 am by ETF.com

Jefferies exhibits no delay when it comes to releasing funds in the height of their demand. Two new issues, launched on October 27, provide investors exposure to agriculture and metals, two popular anti-inflationary investments.

The Jefferies TR/J CRB Global Agriculture Equity Index Fund (CRBA: Quote, Profile, Advanced Chart, News) and the Jefferies TR/J CRB Global Industrial Metals Equity Index Fund (CRBI: Quote, Profile, Advanced Chart, News) are the names of the two new funds. The Jefferies TR/J CRB Global Agriculture Equity Index Fund will seek out investments in companies that produce primarily agriculture and derivative products, including grains, livestock, seeds, fertilizers, etc, according to Reuters.

The Jefferies TR/J CRB Global Industrial Metals Equity Index Fund will invest in companies centered in the production of base metals, which are most in demand for infrastructure and global stimulus efforts, as well as for anti-inflation investments. Both funds will trade with a .65% annual expense ratio.

AdvisorShares Takes the Lead in Actively-Managed Funds

October 29, 2009 at 10:56 am by ETF.com

The otherwise smaller exchange-traded fund issuer, AdvisorShares has taken an early lead over the actively-managed ETF competition. Its new product, the Dent Tactical ETF (DENT: Quote, Profile, Advanced Chart, News), is already the fastest growing actively-managed fund on Wall Street.

The Dent Tactical ETF has been launched for only four weeks, but investors are already flocking to the fund. In the first four days, more than one million shares were traded, according to a press release. Based upon these numbers, the fund is on the same track as the largest fund on the exchange, SPDR S&P 500 ETF (SPY: Quote, Profile, Advanced Chart, News), when it was first launched in 2004.

It remains to be seen whether actively-managed funds will be able to gain investor traction, but with AdvisorShares’ success, more firms may be willing to build on their actively-managed brands

Expensive Hedge Fund ETFs: An Oxymoron or the Future?

October 27, 2009 at 1:50 pm by ETF.com

Hedge funds and ETFs reside on two different spectrums of the industry. Hedge funds are high cost and require a high initial investment, while ETFs sell inexpensively and can be purchased for a fraction of the initial investment a hedge fund requires. Interestingly, Aramid Asset Management and Thomas Funds think they can merge the two together.

The new offering, the All-Asset Capital Preservation fund, will launch with a 2.5% annual expense and a 25% performance fee, which is unprecedented in an industry with expenses as low as tenths of a percentage point. The hedge fund anticipates a very expensive trading system that hopes to pin losses down to no greater than 5% during poor economic climates, FTAdviser reports.

The ETF will be open to all investors, but will trade on the little known Channel Islands Stock Exchange. The fund, which is a pioneer in expensive ETFs, could open the door for big name investment banks to court typical hedge fund clientele with an exchange-traded liquidity driven model.

iShares Files for Six Target Maturity Municipal Bond ETFs

October 27, 2009 at 1:42 pm by ETF.com

iShares continues to expand its collection of exchange-traded funds by mixing municipal bonds with popular target date funds. The newly filed ETFs would buy muni-bonds with differing maturity dates, offering investors the ability to quickly and easily target certain holding periods in a variety of bonds.

The six new funds are as follows:

1. iShares 2012 S&P AMT-Free Municipal Series
2. iShares 2013 S&P AMT-Free Municipal Series
3. iShares 2014 S&P AMT-Free Municipal Series
4. iShares 2015 S&P AMT-Free Municipal Series
5. iShares 2016 S&P AMT-Free Municipal Series
6. iShares 2017 S&P AMT-Free Municipal Series

Each fund will buy municipal bonds to hold until maturity, at which point the bonds would be sold and the proceeds divided among investors. The funds will seek to track the S&P AMT-Free Municipal Bond Index Series, which selects investment-grade municipal debt that matures between June 1 and August 31 of specific years, according to the SEC filings.

The funds will feature regular distribution dates, akin to municipal bonds, and offer investors the ability to buy into a larger selection of bonds for diversification

Ken Norquay’s Column

The second wave: H1N1 and DJII

Canada is on red alert: the swine flu is back with vengeance. The so-called “second wave” is upon us. Children have died. Vaccinations are being distributed. Everyone is paying attention and trying to defend against the attack of this virus.

The H1N1 virus was first detected in Canada earlier this year. Then it went away. Medical professionals predicted that it would come back, perhaps in a more deadly form: this phenomenon was referred to as “the second wave.”

Why do they call it “the second wave?”

Doctors who follow the spread of disease through a population observed that it sometimes occurs in two surges or waves with an intervening period when the disease seems to abate. The sequence is: Wave #1, abatement, Wave #2. And the second wave is the deadly one.

This wave phenomenon was first observed by an accountant in the late 1920s in the stock market. Ralph Nelson Elliott noted that stock market sell offs, bear markets, often occur in two waves too. [In fact, Elliott outlined his Wave Theory before medical scientists observed the same wave phenomenon in the spread of disease.] From an investment point of view, here’s how the waves look: this is a chart of the Dow Jones Industrial Average.

The first down wave started in October 2007 and ended in March 2009. The market dropped just over 50%. The abatement wave started in March 2009; when it ends, the second wave of selling will begin.

The same thing happened earlier this century. The US market dropped 45% in the two years from 2000 to 2002. Wave one went from February 2000 to Oct 2001; the abatement ended in March 2002 and the second wave of selling ended in October 2002, shortly after 9-11.

Canadians are seriously alert to the health risk, the second wave of H1N1. But we seem oblivious to the economic risk, the second wave of sell off in the stock market. Why isn’t Canada on red alert about our investments?

The answer to this mystery lies in the law of cause and effect. In the H1N1 wave count, viruses are the cause of the disease: human beings [our sickness] are the effect. In the stock market, human beings are both the cause and the effect. Our selling causes the stock markets to go lower and the effect is the declining value of our investment portfolios. When physicians advise us to wash our hands and get inoculated, they are trying to prevent the effect: trying to curb the spread of the disease by neutralizing the cause. When investment professionals tell us not to sell, they too, are addressing the cause: trying to prevent the selling that drives the stock market lower. If they succeed in preventing a serious sell off, the effect [lower portfolio values] will be avoided.

In the medical profession, the spirit is that we should all cooperate, wash our hand a lot and get the inoculation. Cooperation will help us all.

In the investment profession we have proof that cooperation doesn’t work. In 2007/9 the US stock market dropped over 50% in 17 months. In 2000 to 2002, it dropped 45% in 2 ½ years. Cooperation doesn’t work. The effect – a sharp drop in portfolio values, cannot be avoided by not selling. In my book, Beyond the Bull, Taking Stock Market Wisdom to the Next Level, I try to help investors understand the importance of this concept. Investment industry leaders sincerely try to keep the financial markets stable. 45% declines are not good for anyone. But the stock market is not a co-op formed for the benefit of everyone. Big declines do happen. And when those big declines occur, whoever sells first wins. There are winners and there are losers. It’s like a pandemic: not everyone survives.

The investment world is more like a theatre of war. In order to win, we have to behave like generals, conserving our resources, avoiding high risk times, retreating and fighting another day. In the financial world, we have to act like the physicians are telling us to act in the medical world. We have to defend ourselves.

The irony is that our financial defence [selling off our stock portfolio] will help cause the demise of those who do not sell. It really is like war. Massive selling drives stock prices down. The cumulative effect of many investors selling in a short time is what causes the down wave. But, if you sell early in the decline, other investors selling later will drive the stock market down to where it will be a bargain – time for you to buy back. There are winners and there are losers.

Defending against the H1N1 second wave helps you and it helps the rest of us. Defending against the DJII second wave helps you, but it could hurt the rest of us. It’s a tough decision for an individual investor.

But imagine how tough it is for a giant financial institution like Royal Bank’s mutual funds or the Teachers’ Pension Plan. They are so big that they can’t sell off all their stocks. Their selling [the cause] depresses the stock market and results in lower values for their portfolios [the effect]. Because they are so big, they are stuck. They can’t get out of the market. In big sell offs like the 2007-9 decline, they are doomed to experience portfolio loses. They can’t win.

What kind of advice do you think comes from the managers of these large pools of money? For them, defence is futile. Why should they advise you to defend yourself by selling off your stocks when they can’t sell theirs.

Our advice? Go to red alert. Defend yourself and your family against the second wave of both H1N1 and DJII.

Ken Norquay, CMT Oct 28, 2009.

Financial Philosopher

Chief Market Strategist,

CastleMoore Inc.

Ken@CastleMoore.com

Links to Beyond the Bull.

Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
UK
http://www.amazon.co.uk/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228245979&sr=8-1

Disclosure: Mr. Vialoux does not own securities mentioned in this report.

Disclaimer: Comments and opinions offered in this report at www.timingthemarket.ca are for information only. They should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.

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