Right out of the gate, the markets hit the skids yesterday, as the above chart clearly shows.

One supporting actors in this drama causing this sharp selloff was a disappointing report on the Chinese economy as their leading indicators were downwardly revised. Adding fuel to the fire was a drop in the consumer sentiment index to the lowest level since March.

Despite a rise in U.S. home prices and a three-month extension of the home buyer tax credits, the markets were solidly entrenched in a downward move and never looked back.

Technically speaking, the S&P; 500 dropped intra-day below its strong support level of 1,040 (see chart above) but managed to close above it. If this level gets broken, you may see downside activity gain momentum.

The selloff was not enough to push our Domestic Trend Tracking Index (TTI) into bear market territory, but we are within striking distance—again. As of yesterday’s close, the TTI has moved to with +0.35% of breaking its trend line.

Any follow through selling, which is likely to happen, especially if the 1,040 level of the S&P; is violated, will end this domestic buy cycle and change our investment stance from bullish to bearish. Since you may use this break as your final exit point, I will post this event, as soon as it happens, based on the closing prices of the day.

Wall Street traders’ anxiety may very well increase somewhat over the next couple of days not only in view of yesterday’s drubbing but also because of the impending jobs report on Friday.

More uncertainty about the economy will derail this market further and life below the S&P;’s 1,040 level may very well be financially hazardous for those hanging on to outright long equity positions.

Aimless meandering describes best how the markets drifted through the day yesterday and ended up with slight losses.

As this month comes to an end, we may see more of the same with the major indexes completing what looks to be their worst quarter since the beginning of 2009.

Volume was light and may continue along the same path until Friday when the ever important nonfarm payroll employment numbers will be released. While the G-20 nations vowed to cut their deficits substantially over the next two years, the market showed no reaction one way or the other.

It looks that this quarter will end on a negative note with the Dow being down -6.6%, while the Nasdaq and S&P; 500 have given back -7.4% and -8.1% respectively. Most of that damage occurred during May’s correction.

Our domestic Trend Tracking Index (TTI) recovered slightly from last Friday’s close and has now moved to +1.49% above its long-term trend line.

Reader Steve followed up with a comment to last Sunday’s post titled “A 2-year Anniversary:”

It appear this market is declining much like the initial decline in 2008, a little each day until it hits panic levels and selling really takes off. Do you see the same pattern?

Yes, I see the same pattern, although much smaller in size. However, it does not mean that the markets will crash again once we break through the trend line and move into bear market territory. We may very well see a slow but consistent decline in prices, which can become very painful for those who continue to hang on to equities (remember 2001?).

No one knows for sure, but it’s imperative that you make plans to move your portfolio to the safety of the sidelines, whether the eventual outcome will be in form of a crash, a slow decline or even a whip-saw.

In these times of economic uncertainty, being cautious and defensive will very likely prove to be the best course of action.

I found an interesting article discussing “Can You really Accomplish Everything You Need With One Single ETF?”

The story focuses on a new ETF (ONEF), the purpose of which is explained as follows:

Our firm wants to give small investors (under $100K in investable assets) access to the same professional portfolio management that high net-worth investors receive from their dedicated advisors, but at a fraction of the cost, packaged in a way that is easy to understand and buy and which follows the time tested approach of passive index investing.

Obviously anyone who buys this fund is still on their own for fixed-income exposure. U.S. One hopes to also launch similar ‘one-and-done’ bond and balanced ETFs to provide a full range of investment solutions to small investors.

The idea here is to come up with an ETF for all seasons to find a solution for the buy-and-investor so he no longer has to worry about diversification. For the most part, diversification for the purpose of better weathering out bear markets is a useless endeavor.

Sure, having a bond portion in such a portfolio can protect some of the downside. Doug Short of http://www.dshort.com said it best: Diversification works, until it doesn’t…

Doug’s chart makes it very clear that diversification in a typical Vanguard portfolio during a down market does not make much sense since all equity/international/emerging funds took at hit during the 2008 market massacre. While the bond portion saved the day, significant losses were still incurred.

As I posted yesterday, the far better solution is to not participate in the downdraft to begin with. For those following the trends, the sell date was 6/23/08, which you can easily identify in the above chart.

Back to the discussion. Can an investor with under $100k in assets use just one ETF? I believe so, but I don’t think ONEF is the one. It’s tiny with low volume and has no long term track record yet.

I don’t think there is any fund that can simply be held; any holding needs to be tracked and sold prior to bear markets developing. The last decade should have made that abundantly clear. Those investors looking for that one ETF that fits all circumstances will have a rude awakening at some time in the future.

I have found one no load fund, which I have featured before, that comes close to being held most of the time. However, in 2008 it also took a licking, but held up far better than the S&P; 500. Nevertheless, stepping aside would have been the right course of action.

It’s PRPFX, and in my advisor practice we use it all the time. It has been very steady, and, during the last year, never once came close to be stopped out via our trailing 7% sell stop discipline. While it will never be a top performer, the lack of volatility makes it an ideal candidate for the conservative investor. Since June 2008, it’s up over 16%, and it’s well suited as the only fund in a small portfolio—of course, subject to trend tracking and sell-stop rules.

While ONEF has to prove itself in the future, PRPFX is here now and has a long track record to boot.

Disclosure: Holdings in PRPFX

While June 23, 2010 passed quietly last week, it nevertheless marked the 2-year anniversary of our last domestic sell signal on 6/23/2008, which provided a safety net for those who followed its call and moved their portfolios out of the market onto the sidelines.

Here’s a look at the blown-up domestic Trend Tracking Index (TTI) chart covering the past two years:

[Double click on chart to enlarge]

I have on several occasions posted as to how avoiding a big drop relates to performance when compared to the S&P; 500, which stood at 1,318 on 6/23/08 and closed last Friday at 1,077.

Despite the enormous stimulus induced rally of 2009, the S&P; 500 still needs to gain another 22.40% just to reach the point we sold at in 2008. While that is possible, given the current economic backdrop, it’s highly unlikely at this time.

If you follow chart patterns, it becomes obvious that a huge double top was formed in 2008 leading to the subsequent crash. If you look closely, you’ll notice that we’re in the process of forming a double top again, although smaller in size.

Unless we break out to the upside by making a new high for the year, it’s more likely that a pullback will occur, which eventually will break the trend line (red) to the downside and move us back into bear market territory. As close as we’ve come recently, I would assume that this will happen within the next few weeks/months—that’s as close as I can guess.

Looking at this chart confirms again the importance of avoiding bear markets, while it is not necessary to participate in every upturn in order to outperform the S&P; 500. That’s an important point that I want to elaborate on since several readers have commented on it.

One widely held argument is that “if you’re out of the market, you will miss the big rebound rally.” Sure, you may miss some or all of it but the above chart speaks volumes. If you had just sat on the sidelines after 6/23/08, staying in money market, you would have missed 100% of the rebound totally and be still way ahead, as I pointed out above.

This supports my long-held view that it is more important to avoid bear market drops than participate in every rally.

Some readers have a misconception about trend tracking I want to clarify. They erroneously assume that during a bullish period, such as the last 10 months of 2009, trend tracking will outperform or at least match the gain of the S&P; 500. Expecting that is missing the point.

To be clear, during such bullish periods, you will lag performance more often than not. There are several reasons for that:

1. A buy signal may not be generated until a later point in time, thereby shortening the investable time span.

2. Depending on client risk tolerance, we may ease into the market with less than 100% of portfolio value.

3. We may use funds/ETFs with a lower beta than the S&P.;

4. We may experience a whip-saw signal, which will reduce returns.

Having pointed out these limitations, it’s important to look at the overriding benefit, which is not participating in major bearish periods. Since markets go down a lot faster than they go up, this should always be priority one.

Here’s the important point I am trying to make: Only when you combine bull AND bear markets will you have a chance to outperform the S&P.; Again, you very likely will not be able to do so during bullish periods alone, as pointed out above, unless you are extremely aggressive.

That means you have to keep the big picture in mind and not just focus on what happened during the past year, as the market rebounded, but be aware of the fact that only when you combine the good with the bad, you will come out ahead a winning investor.

When the markets zig, you hope to have a component in your portfolio that zags to offset or minimize any drawdown. While that is not always easy to do, during May’s market meltdown, I noticed one ETF (IIH) that definitely bucked the trend.

Take a look at the 6-months chart, comparing IIH with the SP 500 (SPY):

Not only has it bucked the trend, but during the most recent correction, it has held up remarkably well and sits in the number 1 spot in the technology sector out of the 48 I track.

So what’s wrong with it? For one, it’s a tiny ETF with net assets of only $22 million. Second, the average daily volume of $284k makes it suitable for only a small investor.

You won’t find any professionals involved with IIH, so if you are in the market to deploy small amounts of money to a technology sector, this one deserves further investigation. Despite its recent fine performance, you need to work with a trailing stop loss to protect yourself from downside risk.

Disclosure: No holdings in IIH

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The bulls gave back last week’s hard fought gains and then some as the bears ruled.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains above its trend line (red) by +1.19% (last week +2.46%) keeping the current buy signal intact. The effective date was June 3, 2009.

The international index has now broken below its long-term trend line by -1.84% (last week -0.49%). A Sell Signal was triggered effective May 7, 2010. We are no longer holding any positions in that arena.

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.