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Tharp�s Thoughts

Market Update for Period Ending August 2005

1-2-3 Model Still in Red Light Mode

By
Van K. Tharp

Look for these monthly updates on the first issue of each month. This allows us to get the closing month data.  In these updates, we�ll be covering each of the major models mentioned in the Safe Strategies book.

Part I:  Market Commentary

The market seems to be continuing its trend of  doing nothing by going sideways. 

However, when inflation is strong enough to produce a boom in housing and oil prices hitting $70/barrel, the stock market that does nothing is clearly in a bear cycle as we�ve been saying for some time.  Hurricane Katrina should have a major impact on the US economy and we should see the impact.  Can you remember when you paid $0.99 for a gallon of gasoline?  Like, wasn�t that a few years ago?  And did you pay over $3.00 per gallon this weekend?  This market is looking more and more like the sideways inflationary market that we had from 1966 through 1982 with the Dow 30 bouncing between 500 and 1000.  Perhaps in this climate it will bounce between 7000 and 11000 over the next 15 years. 

The 1-2-3 Stock Market Model IS IN RED LIGHT MODE.  BE CAREFUL!

What the market is doing.  Currently, two of the major averages are still 1) down for the year, and 2) and all of them are down over the last five weeks.  

However, the size of the changes is miniscule.  It�s just being a very subtle bear, making it hard for anyone to take much money out of the market.  It�s probably nibbling most of you to financial ruin�but just a few percent each month.

So let�s look at what the market has done over the last five weeks and compare that with where the averages were December 31^st last year.  This is given in the next table. 

Incidentally, this data is calculated by hand based upon last Friday�s close (September 3, 2005), so there is always a possibility of human error in our numbers.

I was totally amazed at the news headlines last week as America suffered its worst devastation in my 59-year lifetime with Hurricane Katrina.  On August  29, after Katrina�s immediate impact the market was actually up!  The media proclaimed, �Katrina was downgraded and diverted from a direct hit on New Orleans, so traders celebrated.�  So a category four storm devastates a city and it�s good news?  And now after a long weekend to digest everything, the market was still up, again, like it's all good news. This market will never cease to amaze me.

What�s a good strategy for the month?  I�m again doing my efficiency scans on the market.  See Safe Strategies for Fina-ncial Fre-edom for a discussion of efficient stocks and how to trade them.  As of September 2nd, there were 63 stocks with an efficiency rating above  plus 10 and there were 11 stocks with an efficiency rating below minus 10.  Thus, smart traders can still make money in this market on the long side.

The top three efficient stocks, in my opinion, are ASF, HNT, and a trio of energy stocks (pick one from SUN, FTO, and VLO).  VLO has been one of my favorites all year, and even with a 20 point runup after Katrina, it still has a PE of only 13.  

If you like short candidates,  three favorite negative efficiency stocks are FDO, PRX, and FNM.

I will be presenting on how to trade efficient stocks at the AIQ meeting in Lake Tahoe on October 19th.  Anyone interested in attending can call AIQ at 1-800-332-2999.  I think the hotel is already sold out, but there is probably still space in the room.  And I�m the keynote speaker at the conference.  I made a portfolio of my 10 best stocks in terms of efficiency and well see how they do over the next six weeks.

The end of the summer is typically not a strong time of the market.  The market likes to go down big time in September and October, so be careful.  And now we have the impact of Katrina � and if the Federal Reserve continues to raise interest rates after Katrina �  watch out. 

Part II: Our Four Star Inflation-Deflation Model

So what�s our new indicator telling us about inflation?

1)      The CRB index

2)      The price of Gold

3)      The CPI and

4)      The trend in interest rates.

Since the description of the model we�re now using is not in any of my books, I�ll continue to give it here. 

1)  The CRB Index.  I believe that the CRB index is the one we have currently that is the least manipulated by the government.  But what�s the best way to measure it?  For consistency, I plan to give two measurements. 

�        Is the CRB index higher than it was six months ago?  If it is, we are on track for inflation.

�        Is the CRB index higher than it was two months ago?

Now there are several ways to monitor these two indices.

�        If both differences are higher, we�ll count one star for inflation. 

�        If the six-month change is higher, but the two-month change is not, then we will only count � star for inflation. 

�        And if both the two and six month changes are lower, then we�ll be minus one for inflation.

 �        However, if the six-month change is lower, while the two-month change is higher, then we�ll be minus � star for inflation.  Obviously, the two minus scores will point to deflation.

2) The Basic Materials Sector ETF (XLB).  In an inflationary environment, basic materials will definitely go up and this sector, to the best of my knowledge, is not manipulated by the government.  Thus, we will use this sector to monitor inflation and we�ll use the same measurements used for the CRB.  (1) Is the XLB higher than it was six months ago; and (2) Is the XLB higher than it was two months ago.  These two measurements give us four possible results.

�        If both differences are higher, we�ll count one star for inflation. 

�        If the six-month change is higher, but the two-month change is not, then we will only count � star for inflation. 

�        And if both the two and six month changes are lower, then we�ll be minus one for inflation.

�        However, if the six-month change is lower, while the two-month change is higher, then we�ll be minus � star for inflation. Obviously, the two minus scores will point to deflation.

3) The London PM Gold price at the end of each month.  Although the government can manipulate Gold, I still like to look at monthly gold prices.  However, to be consistent, we�ll use the same two measurements that we�ve used for the other indices that we are monitoring.  1) Is the price higher than it was six months ago? and 2) is the price higher than it was two months ago?  Again, these two measurements give us four possible results.

�        If both differences are higher, we�ll count one star for inflation. 

�        If the six-month change is higher, but the two-month change is not, then we will only count � star for inflation. 

�       And if both the two and six-month changes are lower, then we�ll be minus one for inflation.

�       However, if the six-month change is lower, while the two-month change is higher, then we�ll be minus � star for inflation.  Obviously, the two minus scores will point to deflation.

4) The Fourth Measurement we�ll use is related to the Financial Sector of the S&P 500.

The financial sector (XLF) tends to do well when we have deflation and poorly when we have inflation.  Martin Pring, in fact, has used an index in which he divides the XLB by the XLF.  Since we already use the XLB, we�ll use the XLF by itself as well.  Again, we�ll use the change over six months and over two months.  However, the four possible outcomes will give us a different interpretation.

�         If both differences are higher, we�ll count one star for deflation. 

�        If the six-month change is higher, but the two-month change is not, then we will only count � star for deflation. 

�        And if both the two and six month changes are lower, then we�ll be plus one for inflation.

�        However, if the six-month change is lower, while the two-month change is higher, then we�ll be plus � star for inflation.  Obviously, the two minus scores will point to strong inflation.

Okay, so now let�s look at the results for the year.  

We�ll now look at the two-month and six-month changes during 2005, to see what our readings have been.

The results of this model are much more sensitive (I believe) than the model I presented in Safe Strategies.  The model seems to be signaling a struggle between inflation and deflation with inflation winning slightly.

Part III: Tracking the Dollar

The next table shows the dollar index over the last five months and compares it with its price at the close of the last three years. 

I�ve found a table of government figures that is easier for me to track.  The values are slightly different from what I�ve been using, but the trends are still easy to see.  The fact that the numbers are different just shows that the government can simply change the way they calculate their statistics whenever they wish.

The dollar is now much higher than it was at the start of the year and its gone up every month of the year except March and August.  However, as I said last month, it�s probably bottomed out against the Euro as shown by last month�s drop.  And the index is highly weighted toward the Euro.  However, my guess is that it will continue to be weak compared with commodity currencies such as the Canadian Dollar, the New Zealand dollar, or the Australian dollar.  Fundamentals (with the main factor being the US debt) suggest that the dollar has a long ways to go on the downside.  However, we could have made that argument for much of the last ten years. 

What This all Means

Our big picture still suggests a long-term BEAR market.  And it looks like a flat, inflationary type market for equities.  For example, all three major averages are down slightly for the year, while the CRB suggests that prices have gone up 4.5% during the same period.  This is not good for the economic well being of most Americans.  However, let�s continue to watch the market for more signs.  

Until the end of September update on the market�..this is Van Tharp. 

Van Tharp's Workshops are Known for High Quality and Value Received 

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Trading Tip: 

Trading Tip

Finding Free Market Data

by  D. R. Barton, Jr.

I am frequently asked where folks can find good free data on the internet.  I subscribe to two different high-end, real-time data services.   But despite that, I often take a quick look at these sources for practical reasons (I�m away from my computers, I need data from an exchange I don�t subscribe to, etc.)

So here are two great places to find free market data:

�        www.futuresource.com This website has a dizzying array of data with futures contracts and a variety of equity indexes from all over the globe.  Exchanges from the U.S., Europe, and Asia are represented.  Indeed, their symbol list contains 54 global exchanges!  Delayed data is free.  You can set up a quote page with multiple symbols that auto-refresher even get data on charts that are quite functional (they also have auto-refresh if you use the custom charting option).  It�s tough to find good end-of-day or intraday futures data.  Some other sites I looked at have incessant nag screens or intrusive watermarks, etc.  Futuresource has advertising, to be sure, but it is off to the side and doesn�t have any nag screens or expirations.  It�s a real find for those who don�t need real-time intraday data.

�        An Oldie But Goodie.  I know everyone with indoor plumbing has heard of Yahoo!, the venerable web portal.  But their finance site, finance.yahoo.com , is a treasure trove of free tools.  They have the best news aggregation interface for individual stocks that I�ve found.  But since we�re talking data, they have some of the best and easiest to use historical data around.  If you need 30 year old data on GM, they have it.  50 year old data on the Dow?  Yep.  This site is worth an hour of your time just to browse around and find all of the neat stuff it houses.

Sometimes free stuff isn�t worth the time or effort.  But these two sites are the rare exception.

D. R. Barton, Jr. will be teaching the September 2005 How To Develop A Winning Trading System That Fits You Workshop and is a featured speaker in the Van Tharp Institute Home Study Course, Make Money Work for You. 

He is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching, and teaching in the markets since 1986.  D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through  Electronic Day Trading.

Special Report

Self  Sabotage - Two Reports of Self Sabotage

Click here to read page one of each report, or to order. 

Listening In... 

Investment Manager/Trader Wanted 
Author: Peg

I have utilized investment managers, but I have never seen any that work with Tharp�s concepts for position sizing, exit strategy and simply growing the value of the portfolio. Most managers I know of focus on beating an index, S&P 500, MSCI World Index, etc. As I am just learning these concepts I am not ready to manage my entire investment myself.

Does anyone know of an investment management firm that uses Tharp�s concepts and consistently produces results that exceed the major indices?


Re: Investment Manager/Trader Wanted 
Author: Van Tharp 

No matter what you do, if you come across a manager that you want to put money with, please due your own due diligence. 

Tom Basso has some great criteria that everyone should use in selecting a money manager in his book Panic Proof Investing. If you are looking to find a manager, I strongly recommend that you buy Tom's book and read it first BEFORE you select a manager. (link to Amazon: Panic-Proof-Investing-Basso

Van

Reply To This Message 


Re: Investment Manager/Trader Wanted 
Author: David Stein

In addition to Tom Basso's book, you might also want to check out the following two titles: 

Managed Trading: Myths and Truths by Jack Schwager  Managed-Trading-Schwager
Searching for Alpha by Ben Warwick

Schwager's book contains information which might help you in evaluating a manager's performance. Warwick's book may provide some insight into money managers and their industry.


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