A Trend-Follower Positions for 2009

by: David Fry

At ETF Digest I provide to our subscribers ten mantras that I’ve respectfully named ETF Digest Sacred Cows (available here). ETF Digest Sacred Cow IX is a self-explanatory quote from economist Edgar R. Fiedler: “If you have to forecast, forecast often.”

Further, while I maintain strong opinions about overall conditions, as a technically based trend-follower the prediction business isn’t relevant to my work.

With those two observations as the lead, I’ll offer what we continue to focus on now and in 2009.

As trend-followers, we look for markets that “trend well.” That may seem obvious, but it bears more scrutiny. There are many new ETFs that have and will enter markets with most based on either well-known indexes or newly created quantitative indexes. We would continue to exclude so-called “actively managed” ETFs unless I personally know and respect the manager.

Many new ETFs sound seductive and that in turn could suck you in. Yet any new index should come with historical data. This is an analytical requirement for trend-followers. If you can’t get the index with adequate history (say, five years at least) then you’re working blind and going with only “coolness” as your guide. This isn’t for me.

There are many new ETFs, such as in alternative investments like commodities and currencies, that are linked to existing products with lengthy data. These can and have performed well.

But if you can’t get the data, forget about it. And if the data you get doesn’t lend itself well to a trend-following system, forget about it.

That said, I continue to believe the best opportunities will remain in those sectors that trend well either from a long or short perspective.

In general, these will include Emerging Markets and overseas ETFs - whether in regional products (ILF, EFA, EEM, etc) or in single country funds (EWA, FXI, EWZ, etc). These products and their associated indexes trend well and, for the most part, have inverse or leveraged issues to utilize.

In US markets, bond sectors offer potential opportunities, problems and risks. Spreads between direct Treasury obligations and corporate issues have never been wider. All these markets trend well and there should be opportunities for arbitrage. Given the advent of some inverse issues in Treasurys (TBT and PST), along with high yield issues (NYSEARCA:HYG) there can be a narrowing of spreads. Perhaps that time will come in 2009.

In fixed-income markets, there is a problem with obtaining historical data from Lehman-linked issues. As you may know, most fixed-income products are linked to Lehman Indexes. Barclays has purchased these indexes from the now defunct firm, but has decided to charge quote vendors for their use. Many vendors have balked and in a self-destructive way are preventing others from getting the data. It seems silly, but what will happen is hard to say.

Remaining in the fixed-income area, many understandably believe the extensive money printing and bailouts from the Bernanke/Paulson era will lead to inflation. If so, then opportunities should remain in inflation-indexed bond ETFs TIP and WIP. But trend analysis will determine when or if investments there make any sense.

Naturally, if future inflation becomes a problem then commodity issues should rally including commodity tracking indexes (NYSEARCA:DBC), gold (NYSEARCA:GLD), base metals (NYSEARCA:DBB), grains (NYSEARCA:DBA) and currencies (FXE, FXY and others). The good news here is twofold. First, these markets trend well in both directions, and secondly, all have inverse or leveraged issues available. This area will continue to offer investors, whether long or short, opportunities.

In US sectors, investors should remain focused on the major index-related ETFs (VTI, SPY, RSP, MDY, IWM, QQQQ and so forth) since they offer great liquidity, trend well and have inverse and leveraged issues available. In addition, various sector ETFs (IYR, XLE, XLB, XLY and so forth) will also offer opportunities, and no surprise, also have inverse and leveraged issues available.

As we end 2008, markets are oversold from a long-term perspective and clearly in a bear market. These conditions can last longer than many expect or wish. Nevertheless, as 2009 begins a new administration takes office with the economy in disarray and markets as described.

I believe in 2009 investors should stick to the areas mentioned above and avoid new investment schemes when possible - especially if reliable historical data is hard to find and analyze. Our mission as trend-followers is to identify trends in markets that normally exhibit reliable patterns and seize on those opportunities, whether long or short. Finally, managing risk is always paramount which means standing aside in cash when volatility is too high such as during the last quarter of 2008.

Good luck in 2009!