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Tharp�s Thoughts

Market Update for September 2007

1-2-3 Model in Yellow Light Mode

By

Van K. Tharp

Look for these monthly updates in the first issue of each month. This allows us to get the closing month's data.  In these updates, we�ll be covering each of the major models mentioned in the Safe Strategies book:  1) the 1-2-3 stock market model; 2) the five week status on each of the major stock U.S. stock market indices; 3) our new four star inflation-deflation model; and we�ll be 4) tracking the dollar.

Part I:  Market Commentary

The market correction seemed to bottom on my birthday (August 15).  The Federal Reserve finally lowered the discount rate and Wall Street breathed a sigh of relief.  And I found it interesting that right about the time I hedged my portfolio, the market started to rise.  However, to me, this is a very mixed market and the future is still quite unknown.

The subprime crisis is far from over.  And if the Federal Reserve keeps lowering interest rates, then what is going to happen to the dollar, which is already at the brink of a cliff (i.e., all-time lows), when people start going elsewhere for better interest rates?  It�s a very interesting situation.

So let�s look at what the market did in August.

Part II: The 1-2-3 Stock Market Model Is in YELLOW LIGHT MODE and That�s Good for Stocks

The 1-2-3 Model is borderline yellow light.  The Fed is not in the way and has actually started to lower interest rates.  That�s positive.  The market is not acting that well, but with a slight change it could be positive.  And, here�s the one I�m a little concerned about:  the PE ratio of the S&P 500 is at about 17.  According to the model Steve Sjuggerud developed (and we presented in Safe Strategies for Financial Freedom), if the S&P 500 drops below 17, the market is positive.  However, here�s my precaution about that one: we are in a secular bear market where PE ratios keep falling.  I expect them to keep falling until we get to single digits, which may take another 10 years or so.  As a result, I�d expect this variable to be positive for a long time now, even though the market may be negative.  Anyway, we�ve been in yellow light mode since December 29^th.  And the average yearly increase in the S&P 500 is about 10.9% during yellow light mode.

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.  These data are given in Table 1.

Notice that the market is still up for the year.  In addition, even though the media claims that the market is highly volatile, for the five year period from 1996 through 2001, the weekly change for the S&P 500 averaged about 2% and the weekly change for the NASDAQ 100 averaged about 4%.  Compare that with the so-called highly volatile data from the month of August shown in the table.

The market reached a low in mid-August and then recovered slightly.  I gave my comments on the sub-prime crisis recently and I don�t think we�re out of danger by any means, although the Federal Reserve is now injecting massive liquidity into the market. No predictions on where the market will go from here, but I believe we�re in a secular bear market and we haven�t had the second major leg down yet.  Is this the start of it or just a minor correction in the up phase?  We�ll have to see.

An interesting observation is that years ending in "7" have not been kind to the markets historically as compiled by financial astrologer David McMinn (his website is at www. davidmcminn.com).  Let�s look at what has happened over the last 120 years.  Is this just an interesting correlation or can we expect a 10-50% drop in the DOW over the next few years?

So will the pattern continue in 2007?

Part III: Our Four Star Inflation-Deflation Model

As I�ve stated many times in these monthly updates, we are in an inflationary bear market.  The bear market is not necessarily reflected in prices but in PE ratios.  PE ratios will continue in a downtrend even though the Dow is making new highs.  And the inflation is obvious, but simply masked by government statistics.  Okay, so now let�s look at the results for the last six months.

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

The results of this model are much more sensitive (I believe) than the model presented in Safe Strategies.... Click here to see the model explained.

The model once again shows that inflation is winning slightly.  

In the May report, I said the Federal Reserve stopped the M3 statistic, claiming that it wasn�t useful.  But it shows how much money the Federal Reserve is really printing.  And current estimates for that figure run at 13% annually.

That says there is a huge inflation underlying what is going on.  It hasn�t been reflected in the price of gold because the European banks have been selling gold to keep the price down and make the markets look more stable.  However, they announced on June 1^st that they would not sell any more until September.  And now gold  is moving higher.  In addition the total score is at 3.5, which is the highest we�ve seen since I�ve been tracking this model.

Part IV: Tracking the Dollar

The dollar hit a multiyear low against the pound when I was in London.  The dollar in my opinion looks really weak and could now fall substantially.  Look at the data in the chart because it really says it all.

The dollar has fallen every month since the January close, although it didn�t go any lower last month with the subprime crisis.  During the year, the dollar has fallen 5.9%, so that is real money that you�ve lost on a worldwide basis.  Think the stock market is up on the year?  No, with respect to the fall in the dollar, you are not even covering inflation if you are matching what the overall market indices are doing.

Until  the October update, this is Van Tharp.

P.S. I'd like to thank you everyone for my birthday wishes and share more information about the new puppy. Click here for puppy update and photos...

About Van Tharp: Trading coach, and author Dr. Van K. Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com.

September Workshops

Trading Tip

Conduits and Big Banks: Making Things Purposefully Obtuse

by D.R. Barton, Jr.

My good friend and market guru extraordinaire, Christopher Castroviejo, suggested that I get up to speed on what�s happening in the intricately linked worlds of conduits and big banks.

If these terms are confusing for you, please read on, and I�ll try to put them into simple English�

When Christopher suggests something, I usually listen because he�s adept at identifying big issues.  And this issue of �off balance sheet� liabilities for banks has all the components of a pending implosion:

• It involves staggering amounts of money.

• It is an area of accounting alchemy that has little to no regulatory oversight.

• The liabilities are easily hidden from investors.

• The potential problems are big enough that they will require government bailouts if the situation in the credit markets worsen.

If those items got your attention, let�s look at a summary of the issue and then clarify what�s going on.

Banks have been providing �off-balance-sheet� guarantees to conduit companies.  They do this to generate revenues in the form of fees paid to the bank by the conduit company. But the off-balance-sheet guarantees mean that the potential liabilities do not show up (at least directly) in any of the bank�s financial statements.

This practice is actually legal from an accounting standpoint, but the lack of transparency causes lots of issues.  Usually, these conduit companies traffic in extremely safe assets. They buy assets (like account receivables and securities) from companies and then sell short-term debt instruments (called commercial paper) that are backed by the assets.  For years, this has been a relatively safe, cash generating monster for the banks.

But more recently, several things have happened to make the �safe assets� much less safe:

• Conduit companies have moved from debts backed by a single asset to ones backed by multiple assets and even multiple asset classes, reducing transparency.

• The sheer magnitude of the assets being collateralized (over $3 trillion).

• The rise of sub-prime mortgage assets that has infiltrated many conduit companies.

In short, banks are on the hook to guarantee massive amounts of short-term debt that was once thought extremely safe, but is looking more tenuous by the day.  And the dollar figures are mind-boggling.

In this day and age, we throw terms like billions and trillions around pretty casually.  But $3 trillion is a massive number.  It�s so big that only two countries on the planet have an annual Gross Domestic Product (GDP) that exceeds that amount: the U.S. and Japan.

Next week we�ll look at how the pieces fit together and try to simplify how all of this works.  We�ll then look at the potential for this turning into a real problem and why traders and investors should care (and we should!).

Until next week�

Great Trading!

D. R.

About D. R. Barton: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena where he is one of the most widely read and followed traders and analysts in the world.

He is a regularly featured guest analyst on both Report on Business TV,  and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio.  His articles have appeared on SmartMoney.com and Financial Advisor magazine.

Melita's Inspirational Corner

Fluff Words

by Melita Hunt

We are told that the intelligent way to make decisions is to keep your feelings out of it. And it is practically an unwritten law for traders not to feel their feelings. Yet it is very practical and useful for traders to be willing to feel their feelings. ~ Van K Tharp

Feelings� Nothing more than�.Feelings� Ugh.

I am sure that even the thought of the word can cause many �thinking� types to go into an absolute spin!

�I control my emotions; I don�t do that mushy stuff� can be heard ringing through the brains of sensible professionals everywhere, and even better: �feelings are for women!� Now isn�t that a doozy of a belief! (Did that push any buttons ladies?)

I believe that there is a distinct misunderstanding about what feelings really are and some people are actually fearful of their own feelings. This is especially evident among the male population. (Did that push any buttons guys?) What if feeling your feelings led to a complete emotional breakdown? That could be a very scary thought for people who have spent their lives being in control.

It doesn�t have to be so drastic.

When Van teaches the psychological exercises in our advanced Peak Performance workshops, one of the primary objectives is to push people�s buttons and stretch them outside of their comfort zones. When this happens, we notice people�s reactions fairly quickly. The thoughts that are racing around in their heads become much more noticeable in the body language and behaviors that start to show up in the room. Basically, people react to things that make them uncomfortable and this reaction is written all over them. Have you heard of the 7-38-55 rule?  That only 7% of communication comes from our actual words, 38% from the tone we use and 55% is communicated through our body language. From what I have seen in the workshops, I would definitely have to agree.

So there must be some type of feeling going on inside of those bodies�

But getting people to recognize their feelings, behaviors and reactions is a completely different story. Many of us have become so attuned to what we call �feeling� certain ways that we are completely shut down to what the real �feeling� is and have trouble explaining what is actually occurring in our bodies.

This week, let�s look for the actual physical sensations rather than just using the fluff words to explain what is going on. We can easily say I�m feeling Stressed, Exhausted, Frustrated, Angry, Moody, Excited, Nervous, Hurt, but how do we change them?  

Maybe noticing what they actually FEEL like physically is the first step.

Let�s look at the fluff word of feeling �stressed.� Here�s an example of mine: When I am feeling �stressed,� I feel tenseness and tightening in my shoulders and in my neck muscles. I can feel myself clenching my teeth and feel the tightening go up through my whole skull, making my eyebrows furrow and eyes ache. I feel myself leaning forward, hunching my shoulders, causing my stomach to crunch up, which in turn makes my breathing shallow. I feel myself swallow more frequently and feel my fingers hitting the keyboard much harder. When I focus on this �stressful� thought, I purse my lips, my temples start to pound, and I feel a deep ache in my stomach in one specific spot.

So what�s the point?

Ever had any of these feelings when trading? Do you think that I can change a lot of these things just because I am noticing them? You bet I can.

The more in tune we are with our bodies and the more we notice the actual physical sensations that we are experiencing, then the more aware we can be of shifting ourselves out of the ones that aren�t useful. Especially when trading.

In the instance above, I was able to put myself into this feeling state very easily and I decided to experience it while writing this article. But I can just as easily shift out of these emotions and feelings because 1) I am consciously aware of them  2) I�ve practiced a lot, and 3) I �believe� that I can shift out of negative feeling states.

So right now I�m actually feeling quite happy (another fluff word by the way�).

Some feelings can easily be shifted just by moving our bodies, changing posture, exercising, thinking about something else, etc�and of course there are a lot of deeper, emotional wounds and feelings that require more intense work (but that is way too much to cover here).

So let�s just stick to the basics for now and look at how many �fluff� words we use about the way we are actually �feeling.� If we choose to just say �I�m stressed� then we can keep ourselves stuck there unnecessarily, rather than dealing with it.

How many times do we ignore what is going on and just make ourselves feel better by ranting and raving, beating ourselves up or covering up these feelings with bad habits? You know what I�m talking about!

This week, my challenge for you is to recognize three fluff words that you use regularly � especially those relating to your trading, and really notice what is physically going on in your body. See if you can �feel� a tingle, an ache, a tightening, a pounding, a blush, grinding, burning sensation, dry mouth, etc�so that you can relate it back to the beliefs or thoughts that may be causing it.

Can you recognize when your buttons are being pushed? How does that �feel?�

Here�s a hint�observe yourself behind the wheel of a car when other drivers aren�t behaving the way you want them to. What are your reactions and what physical sensations occur in your body?

And guess what: these �feelings� are showing up in other areas of your life too.

Additional Resources recommended by Melita:

Van has written a brilliant article titled Feeling Your Feelings in which he goes into the subject of feelings in depth including COEXs, alexithymia (a condition of not feeling your feelings), and some of the models for change. This article is used in our Peak 101 class and is available as a 9-page special report for $39.95. However, I am offering it to our readers for $9.95 so that you can continue your studies about this subject if it really interests you. Click here to purchase a pdf download.

About Melita Hunt: Melita is CEO of the Van Tharp Institute. She has had a diverse career working in the fields of telecommunications, accounting, marketing and sales, real estate investing, and ultimately speaking, coaching and writing; which are her passions. Her energy and enthusiasm is the cornerstone of her writing and speaking success and she has a special interest in inspiring people to be the best they can be. She has an innate ability to simplify complex subjects and enjoys traveling the world and sharing her experiences. She has worked throughout Australia, in London and is currently working in the USA. You can contact Melita at mel@iitm.com.

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