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Feature

Tharp’s Thoughts

Market Update for the Week ending July 31, 2009

Market Condition: Normal Strong Bull

by

Van K. Tharp, Ph.D.

I always say that people do not trade the markets; they trade their beliefs about the markets. In that same way I'd like to point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, then you may not find them useful. I find the market update information useful for my trading, so I do the work each month and I'm happy to share that information with my readers.

However, if your beliefs are not similar to mine, then this information may not be useful to you. Thus, if you are inclined to do some sort of intellectual exercise to prove one of my beliefs wrong, simply remember that everyone can usually find lots of evidence to support their beliefs and refute others. Just simply know that I admit that these are my beliefs and that your beliefs might be different.

These monthly updates are in the first issue of Tharp’s Thoughts each month. This allows us to get the closing month’s data. These updates cover 1) the market type (first mentioned in the April 30, 2008 edition of Tharp’s Thoughts), 2) the five week status on each of the major U.S. stock market indices, 3) our four star inflation-deflation model plus John Williams’ statistics, 4) tracking the dollar, and 5) the five strongest and weakest areas of the overall market.

Part I:  Market Commentary

The market volatility has returned to normal and under those conditions, bullish conditions are much more likely.  And the 25 day SQN™ is now bull and the 100 day SQN™ is now listed as strong bull.  However, in my opinion this rally has a lot to do with market manipulation by the government and is not based on sound fundamentals.

For example, Richard Russell, who just turned 85 and has been writing a newsletter since 1954, says that when corporations raise their dividends or start paying them, that's a sign they are doing better. Is that what's going on now? No. Actually, it’s just the opposite. In the second quarter 2009, there was an all-time low of 233 corporations that increased or resumed their dividends. Furthermore, 250 corporations cut their dividends or completely eliminated them which makes 2Q 2009 the worst quarter for that category in more than 50 years.

So why is the market going up?  What’s actually happened is that many, many companies (i.e., over 70%) are beating their estimates in terms of earnings.  Though earnings are weak, the market seems to be interpreting beating the estimates as good news.  Earnings that beat dismal estimates is not good news in my book.  In fact, U.S. corporate profits were actually down 35% in the second quarter, but on that news the market is now in strong bull territory.

Let’s see, the U.S. government plans to spend $3.45 trillion in 2009, with an expected deficit of $1.84 trillion.  Most of that will have to be financed by other countries buying our debt, but they are supposed to do that for very low interest rates even while they bear the risk that the Federal Reserve might print so many dollars that the dollar becomes worthless.  We endure the risk that at any time the other countries might not buy into this plan which means the dollar is basically no longer the world’s reserve currency.  

Let’s put that risk into perspective. China now has reserves of $2.13 trillion with most of that in dollars.  But the U.S. government is looking at a deficit that’s almost equal to China’s reserves.  Do you think China will be willing to finance enough to effectively double its reserves?  It’s doubtful.  And if foreign countries stop buying our debt, it means the Fed will have to just print money which will end the U.S. dollar’s reserve status.

Meanwhile, unemployment is above10% officially, and unofficially it's over 20%, according to John Williams at www.shadowstats.com.  Also, freight is one of the best measures of economic activity and it is way down. The Baltic dry index (a measure of ocean freight) was down 18% in June.  Here's another statistic, manufacturing in the US has shrunk now to about 14% of its economic base - second only to France among industrial countries.

That is the economic big picture.  So when my market update says the market is normal strong bull right now, you can understand why I also add the caveat—beware and stay very alert.

Part II: The Current Stock Market Type Is Normal Strong Bull

The SQN for 100 days is now about 1.5 which makes it a strong bull market.  And the ATR as a percentage of the close has gone into normal territory which hasn’t happened for some time.  Both are bullish signs, and both the 25 day and the 100 day have been bullish since July 21^st.

Let's look at what’s happening in the three major U.S. indices.  The next table shows the Dow, the S&P 500, and the NASDAQ over the past five weeks.

All three indices are up for the year, but remember that the DOW has lost Citi and GM. Like a reshuffled mutual fund, the DOW is now a whole new index.  GM no longer represents America…. or does it?  GE, the oldest member of the DOW, is still a very poor performing member of the index.

Part III:  The Strongest and Weakest Market Components

In a new model we track the relative strength of the various ETFs representing the economy of the entire world.  I will be publishing this once a month.  Ken Long, who developed the algorithm we use, publishes a similar report every weekend at www.TortoiseCapital.com. If you’d like more information on how to use this model for trading, then I’d suggest you attend our ETF workshop, which is held several times each year. The next one will be held for the first time ever outside of the US in Berlin, Germany.  Ken explains how these numbers are derived in this workshop.  You can sign up for it here.  Ken teaches numerous trading systems with excellent System Quality Numbers™ (See Q&A below for more detailed information).

The July data for the world model are given below.

View Larger Chart

The areas in green are strongest (the total rating is at least one standard deviation above the mean); those in yellow are the next strongest (above the mean).  Those below the mean are in brown; and those more than one standard deviation below the mean are in red.  I have taken out all the double leveraged funds from my database so the top and bottom funds are not devoted entirely to those groups.

Since most areas are generally weak right now and our relative strength is influenced most by recent activity, I’d suggest that you not rely only on this information to determine what sectors of the world to invest in. This information could support your ideas, but it should not be the only basis. The strongest areas here are Singapore , Korea , Asia (less Japan ), Sweden , and Hong Kong . Notice how much change we’ve had since last month, when Chile and China were really strong. You cannot count on trends to last very long in this market. 

The weakest areas are currencies and interest rates – almost across the board – but the dollar is among the weakest.  Natural Gas is still very weak as well. The next chart shows the commodities, real estate, bonds and the strongest and weakest sectors for July 31^st.

The strongest areas include biotech and  U.S. home construction and coal.  But again, in this market you cannot expect trends to last long.  These market conditions are great for short-term trading, but terrible for long term investors.

Part IV: Our Four Star Inflation-Deflation Model

Once again, we are in credit contraction mode which means we are not experiencing an inflationary bear market. Six or seven years ago I believed this would be the case but now I suspect we may see one by the end of 2009. Gold is certainly suggesting that.

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 CRB is finally bottoming.

We appear to be moving toward deflation again based upon the movement of our index.  We were at 3.5 the last two months.  

Part V: Tracking the Dollar

The dollar is heading down again with its weakest level since September 08.  It wouldn’t surprise me to see it at last July’s level when I arrive in Germany. If it does go back to 71, then Tharp’s law will be in effect again: Van travels and the dollar goes down.

General Comments

Right now we seem to be in a manipulated bull market, but the crisis it creates implies opportunity. Those with good trading skills can make money in this market, you just need the training and self-work to do so.

Next week, Florian Grummes will update us on Gold, and the following week I’ll continue with my update of other market types.  We’ll be discussing the London market at that time.  

 Until the next update, this is Van Tharp.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books 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. 

Trading Tip

The Best Trading Book Ever

by
Ken Long

A friend of mine who is seeking to develop his skills as an equity trader asked what book on trading he should read if there were only one.

I started to think about the different masterpieces I have read and have applied in my own trading. There are masterpieces of fundamental analysis, of technical analysis, of trading technique, and investing strategy out there. It was a daunting task to settle on just one.

When it finally hit me, though, everything fell into place. There is one book that is so powerful that it stands out head and shoulders above all others to such an extent that it is not even a close contest.

It’s a book that has a direct effect on the trader no matter what style, time frame or technique is being applied. It works for men and women, for any kind of trader in any kind of market.

It's a book that bears reading and re-reading and will always allow for new insights and nuances.

It’s a book that adapts to you and your emerging style.

It gets better the more you use it.

It’s not cheap but it IS free.

It will reward you based on the amount of time you put into it. It will perfectly mirror your needs of the moment and help you find your strengths and weaknesses.

You can buy it in any store that sells office supplies, and while there is only one edition, it can fill many volumes.

It tells many stories, and the plot will often change before your eyes. It will take you to places you never imagined, although there is a thread of familiarity that ties everything together.

In short, it contains everything you will need to be successful as a trader if you put the time and effort into it.

Naturally, I am speaking of your trading journal, an intensely personal unique approach to how to trade the markets.

I’d suggest that the time and effort you put into refining the craft of journaling and reflection will be directly proportional to your continued success as a trader.

So, if there’s only one book for you to read and study as a trader, that’s the one.

About the Author: Ken Long, a retired Lieutenant Colonel in the U.S. Army with a Master's Degree in System Development.  Ken is founder and Chief of Research of Tortoise Capital Management, www.tortoisecapital.com.  He is a proud husband, dad, and ju jitsu practitioner. Read more of Ken's essays at http://kansasreflections.wordpress.com.  

Q&A

What Are The SQNs for Ken Long's Trading Systems?

Q: I’m living in Holland and am seriously considering going to Ken's ETF workshop in Germany. Your letter explained that he teaches six trading strategies. Can you say anything about the SQN's for those systems? With kind regards, Chris 

A: Dear Chris,

The SQNs generally vary by market conditions but I have recorded these results:

* The 2x mechanical systems (swing trade, simple rules, end of day data) have averaged between 2.5 and 3 in all market conditions.

* The ETF2 weekly asset allocation strategy SQN has been about 3.3 in Bull market types and ranged between 2.6 - 3 in Sideways and Bear market types.

* The Triple Screen system SQN has come in around 3.5 in Bull market types. I only trade Triple Screen in Bull Markets because that is the only time it works. 

* The Washout and 5DD pattern systems’ SQN have ranged between 4 in Bear markets and 5 in Bull Markets. 

I will also describe discretionary rules that can improve the SQNs of these mechanical systems. When a trader uses discretionary rules rather than the mechanical system rules, the systems’ SQNs then become a function of the trader. If an experienced or talented trader applies these discretionary rules consistently well, then he/she can achieve higher SQNs than the mechanical systems. Cheers, Ken Long

Editors Note: Past systems performance may not be indicative of future results.

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