I’ve written several times about market cycles and about how if we know where the markets are within a specific cycle, it increases the possibility of knowing what its next move will be. Obviously everything around us has cycles. Some are natural, like a heartbeat or lunar phases. Others are contrived, like the hum of an engine or the recurrence of a scheduled event. Careful periodic examination of these cycles can be revealing. For example, when a heartbeat changes, that is a reaction to something that is going on with the body.

The past two weeks many of us have intently watched the events of the Winter Olympics in Turin, Italy. Four years ago the Games were unfolding in Salt Lake City. Both events have greater meaning for people here in Utah because of our involvement with the Winter Games. Because it was such a significant event, I can remember clearly standing in lines four years ago waiting to clear security to attend Olympic events. I remember the crowds, the smells, the banners and signs. My memory of what was occurring in the financial markets at that time is murkier, so this week I took a few moments to review where the markets were four years ago and what has happened since.

Just for your information, since Feb. 10, 2002 until now, the Nasdaq has advanced 25.5%, for an annualized return of about 5.8%. Over the same period, the Dow is up 14.3%, for an annualized gain of 3.4%. The markets actually showed some strength during the 2002 Winter Olympics, but collapsed after the games ended. The remainder of 2002 turned out to be a horrible year for most investors. Fortunately, all the losses of 2002 were erased in 2003. Unfortunately, since the end of 2003, Neither the Dow nor the Nasdaq has made much progress. Since then the Nasdaq has gained 14% and the Dow is up just 6.5%.

Below is a chart that illustrates the situation. Notice that since the big moves of 2002 and 2003, these two averages have traded in a fairly tight range that has narrowed further in the past few months. I added the yellow arrow just to make it easier to see the level where the averages where in February 2002 compared to today.

The past couple of years have been quite discouraging for traditional buy-and-hold investors and there is no indication that the situation is going to improve in the near future. Unless there is a dramatic change, it appears that major market averages will continue to move mostly sideways in narrow trading channels.

Fortunately, exchange-traded funds (ETFs) offer investors an opportunity for hope. During the 2002 Salt Lake Winter Olympics, ETFs were relatively unknown. Only a few dozen existed and few investors had ever heard of them. That’s too bad because some of those early ETFs have earned remarkable returns over the past four years. For example, Merrill Lynch Oil Sv HOLDRS (OIH) has gained 153% during the same period as illustrated on the above chart. IShares Cohen & Steers Realty Major Index Fund (ICF) is up 142% during that same period.

But those aren’t even the top-performing ETFs during that time! The gold medal winner would be iShares MSCI - Austria Index Fund (EWO), up a scorching 309% in four years. The sliver medalist would be iShares MSCI - Brazil Index Fund (EWZ), up 291%. And the bronze medal goes to iShares S&P Latin America 40 Index Fund (ILF), with a return of 226%. I’ve included these on another chart so you can see the comparison.

I hope these funds and sectors seem familiar to those who have been reading this report for the past year. These have been the same sectors and funds that have been among the leaders throughout 2005 as well.

So while major market averages have generally failed to provide investors with great returns over the past four years, many ETFs have offered solid opportunities for profit. In fact, there are 52 ETFs that have returns of more than 50% during that period. There were 79 ETFs that outperformed the Nasdaq over that time.

At some point, these leading sectors will fall out of favor as the business cycles shifts to reward other sectors of the economy. When that occurs, other funds will will emerge as the place for investors to keep their money. When that happens, we hope to provide you with accurate, timely information.

Several years ago I was discussing market trading strategies with one of our most faithful clients. This gentleman was trading stocks before I was born. He witnessed the development of mutual funds and options markets. He mentioned that in his experience, the markets made many of their biggest gains in relatively short periods of seven to 14 days. Although this seasoned trader believed in the validity of being invested during long-term trends, he noted that even in sustained uptrends the markets would have short, steep advances.

I’ve never forgotten that observation, primarily because in the years since I’ve found it to be true. Partly as a result, when reviewing investments I normally look closely at both short and long-term performance. In most instances, funds I consider for investment will be among the leaders in both categories.

The financial news media focuses a lot of attention on short-term market or sector advances. For most investors, short-term rallies need to be part of a longer trend in order to have much importance. Most custodians (the company where your money is held) have so many restrictions and penalties associated with short-term trading that it becomes impractical. Investors end up forced to trade intermediate and long-term cycles.

Differences between long-term and short-term leaders can sometimes be an indication of economic changes that will result in a rotation among industry sectors. This can signal a possible change in longer-term trends. Recent weeks provide a good example.

Over the past month, the top sector ETF has been Merrill Lynch B2B Internet HOLDRS (BHH). It is up more than 14%. The telecommunications sector has also seen a recent surge and the top fund in that group, Merrill Lynch Telecom HOLDRS (TTH) is up more than 7% in that time. IShares Dow Jones Transportation Index Fund (IYT) has risen more than 6% in the past month and iShares MSCI - Brazil Index Fund (EWZ) is ahead by 5%. Given the recent weak market conditions, these are all respectable returns and many investors would put money in these funds based on their one-month gains. The chart below illustrates their performances since mid-January.

The red line is BHH. Notice that the bulk of its gain came in a three-day period in January. Since then it has actually given back some returns. The other funds on the chart are TTH (green line), IYT (yellow line) and EWZ (purple line). Below are the same funds on a one-year chart. Obviously the longer perspective changes the picture. Now the top fund is EWZ, which has gained more than 70% over this period. But the gains were not always steady. There were sharp, short advances as well as some periods of correction. Now we can see that the past month has actually been a weak period for this fund and that it is still in a sustained advance. This would make it a good candidate for purchase.

Compare that to BHH, which is up 23% over the past year. While that seems like a good return, a glance at the red line shows that in addition to the three-day rally in January, the rest of its gains came during a sharp one-week rise in October 2005. The fund exhibits no sustained trend. Purchasing it at this point would appear to be nothing more than a gamble. There other two funds are a little more difficult to judge. Notice that the green line, TTH, has made a nice gain since mid-October. But its total gain over the past year is just 8.5%–basically the same as in the past 30 days. This fund could be at the start of a long-term advance, but I’d want to do some more fundamental research into the telecommunications sector before I would commit money to it. Finally, IYT is up about 22% over the past quarter. Whether or not the transportation sector continues to trend upward is largely dependent on what happens with the price of crude oil. If oil prices begin rising again, chances are this fund and the entire transportation sector will falter.

If you click the Internet link to view this report on our web site, I’ve included a table that shows the returns of all ETFs over the past month. Basically it shows that if you randomly chose an ETF for investment over the past four weeks your chances of losing money would have been about equal to your chances of making a profit. As a group, international funds are still dominating the funds that are in the black. Energy funds have taken a beating for the past month, but it is too early to declare an end to the bull market in oil prices.

Have a wonderful weekend. I hope you are fortunate enough to have good weather for enjoying the holiday on Monday.

Several years ago I was discussing market trading strategies with one of our most faithful clients. This gentleman was trading stocks before I was born. He witnessed the development of mutual funds and options markets. He mentioned that in his experience, the markets made many of their biggest gains in relatively short periods of seven to 14 days. Although this seasoned trader believed in the validity of being invested during long-term trends, he noted that even in sustained uptrends the markets would have short, steep advances.

I’ve never forgotten that observation, primarily because in the years since I’ve found it to be true. Partly as a result, when reviewing investments I normally consider both short and long-term performance. In most instances, funds I consider for investment will be among the leaders in short and longer-term performance.

Differences between long-term and short-term leaders can sometimes be an indication of economic changes that will result in a rotation among industry sectors. Recent weeks provide a good example.

Over the past month, the top sector ETF has been Merrill Lynch B2B Internet HOLDRS (BHH). It is up more than 14%. The telecommunications sector has also seen a recent surge and the top fund in that group, Merrill Lynch Telecom HOLDRS (TTH) is up more than 7% in that time. IShares Dow Jones Transportation Index Fund (IYT) has risen more than 6% in the past month and iShares MSCI - Brazil Index Fund (EWZ) is ahead by 5%. Given the recent weak market conditions, these are all respectable returns and many investors would put money in these funds based on their one-month gains. The chart below illustrates their performances since mid-January.

The red line is BHH. Notice that the bulk of its gain came in a three day period in January. Since then it has actually given back some returns. The other funds on the chart are TTH (green line), IYT (yellow line) and EWZ (purple line). Below are the same funds on a one-year chart. Obviously the longer perspective changes the picture. Now the top fund is EWZ, which has gained more than 70% over this period. But the gains were not always steady. There were sharp, short advances as well as some periods of correction. Now we can see that the past month has actually been a weak period for this fund and that it is still in a sustained advance. This would make it a good candidate for purchase.

Compare that to BHH, which is up 23% over the past year. While that seems like a good return, a glance at the red line shows that in addition to the three-day rally in January, the rest of its gains came during a sharp one-week rise in October 2005. The fund exhibits no sustained trend. Purchasing it at this point would appear to be nothing more than a gamble. There other two funds are a little more difficult to judge. Notice that the green line, TTH, has made a nice gain since mid-October.

A few days ago I ran into a former neighbor that I hadn’t seen for a year or so. At that time he had been owner of a small business struggling to survive. I asked him if things had improved. He said he sold the business a few months ago and took a position with an investment firm. I was a little surprised, because I didn’t realize he had any experience with the financial markets. It turns out that he hasn’t had any investment experience and he holds no securities licenses. The firm he works for is also unlicensed and unregistered. He explained that the licensing is not needed because the firm does not provide specific investment recommendations. Instead, they tell investors about five or six investment options and then have the investors choose from among them.

Although I like this person, I am worried about his potential clients. There are literally hundreds of thousands of available investment options. I doubt this man knows the difference between a commodity future and a variable annuity. So when he consults with people about their investments, how will he know what is appropriate for them and what is not? Even if he is not actually managing their assets, how will he be able to filter through thousands of possibilities to present the best choices?

Unfortunately, this situation is not uncommon. There are plenty of ignorant people willing to advise other people about how to invest their money. So how does an investor separate the wheat from the chaff?

First, let’s consider the issue of licensing and registration. There are plenty of licensed and registered advisors who are unethical and untrustworthy. There are also people who know a lot about investing and the financial markets without being licensed. Licenses and registration do not provide any guarantees about an advisor’s knowledge or record of success. But the licensing and registration process offers a measure of protection for investors if the advisor does something illegal or unethical.

If a licensed advisor absconds with a client’s money, or invests the money in something inappropriate, or does something else that is misleading or wrong, the client can make an official complaint. Whether the governing body is the Securities Exchange Commission, the National Association of Securities Dealers, or a state insurance board, the consumer has recourse and protection. If the advisor or firm is unlicensed, the situation is much murkier and a wronged investor is left to pursue the matter through police and the courts.

In addition to dealing with licensed advisors and firms, here are some other items investors should consider when choosing a professional investment manager:

How long have you managed actual money with your current firm/system?

Managers change firms and systems for many reasons, but most of those are bad for clients. You want someone who has been with his current firm at least three years. Five years is better. Ten is better still.

How much of your money is invested in the portfolio you recommend for me?

If a manager is unwilling to put his own money into his own investment system, do you really want him to manage your finances? Be specific. Ask if he has the same type of account you will have and what percentage of his assets are committed.

What do you need to know about my financial situation?

A responsible investment manager is going to ask some specific questions about your investment experience, your investment history, your employment, your annual income, your income needs, etc. He needs this information to make certain his recommendations are in line with your needs and your risk tolerance. Federal regulations require him to ask for such information. If he doesn’t want to know your specific needs and expectations, it is unlikely he will be able to satisfy you. When it comes to investing, one size does not fit all.

Can I get referrals from people who have been clients for three or more years?

Privacy regulations prevent money managers from releasing information about a client without his consent. But any reputable money manager should have many clients willing to give permission for a potential client to call and ask about their experiences.

Where is your office? Can I come for a visit?

Successful investment managers usually do well financially. A small, run down office is a bad sign. Conversely, a big, fancy office is certainly no guarantee that the manager can do what he promises. If a money manager works out of his house, that could raise a lot of red flags.

What happens if you are wrong?

All investment advisors have losing trades. How they handles the losers is generally more important to the bottom line than how many winners they choose. A good manager should be able to provide specific details of how he handles trades that go against him. Listen to the explanation, then check the actual account statements to see if he does what he says.

Tell me about your performance.

This is the thing every investor asks about first. Unfortunately, it is also the most misleading. Numbers can be hyped and twisted in unlimited ways to give distorted views of performance. Years ago I was working for a U.S. company in Russia shortly after the collapse of Communism. I asked for an accounting report of our in-country operations. The accountant, who had spent the previous 20 years working for Communist bureaucrats, asked me what I wanted the report to show. “What do you mean?” I asked. He explained that he could create a report that showed either a profit or loss, and even a level of profit or loss, depending on what I needed. I was a little stunned at the time. Now I am convinced he went to the same school as many of the people who calculate investment performance for unscrupulous advisors.

How are you compensated?

It might seem like a brazen question, but you have a right to know. Will you pay a management fee, commissions, or both? Is he investing in mutual funds that charge front or back-end loads? No one manage investments for free. If an advisor says you won’t have to pay a management fee, then he is likely being paid by the companies he is recommending, creating a potential conflict of interest.

Who has control of my money and who will be the custodian?

In most legitimate situations, investment advisors are not the custodians of your money. Usually an account is set up at a third-party institution like a fund company, brokerage or bank. The advisor has discretionary authority to tell the custodian how your money is to be invested, but has no access to withdraw money from the account (except for management fees). This lessens the possibility that an advisor who is also a crook can clean out your account and flee to Central America. If an advisor ever tells you that you can just put that million-dollar check in his name or the name of his investment firm, all kinds of alarms should start flashing in your head.

I hope I haven’t given you the impression that most investment advisors are scumbags and scoundrels. But I am always surprised that some of the same people who double-check every grocery receipt seem to have no qualms about giving control of a half-million dollar investment account to someone they know little about.

I’m not including any market commentary this week because the situation has changed little since last week. Major averages seem content to remain in a trading range.

Have a great weekend.