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Feature

Market Update for the Period ending January 31st, 2010
Market Condition: Long Term Bull Normal, 
Short Term Bear Normal, Caution!

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, you may not find them useful. I find the market update information useful for my trading, so I do the work each month and am 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 US 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:  Van’s Commentary—The Big Picture

A friend recently asked me what I thought was going on in the market. I believe there are many people out there wondering the same thing.

To help me understand what the market is doing, I write this update once each month, and I believe that is usually enough for me.  Remember that you can only trade your beliefs about the market.  I say this over and over again.  Your beliefs might be different from mine so my thoughts could also be completely irrelevant to you.  Do you understand your beliefs about the market enough to know what is significant for you? 

Does what I believe about the market seem significant to you?  If so, ask yourself, “Why is Van’s opinion that significant for me?” 

It’s not that significant to me because typically I ask the following questions for my market update process:

• What’s the market doing now?

• Has anything changed?

• Does this require me to change anything about what I’m doing because it’s no longer in the flow of the market?

And this could change from week to week.

Here are my beliefs about the big picture right now.  They haven’t changed in some time, and I think the market has been verifying what I’ve been saying.

1. We are in a secular bear market in which PE ratios will go down.  This probably won’t end until 2015 to 2020, and it usually ends when PE ratios are in the single digit range.  The PE of the S&P 500 was recently above 100 because earnings shrunk dramatically.  I’m not sure that it is a contradiction to the long term cycle, since they rose as a result of the earnings shrinking dramatically.

2. We’re probably due for a major downturn in the market soon.  But let the market tell you when that’s happening.  Right now the market type is normal volatility—recently having moved up from quiet.  The 100 days SQN (market direction) is bullish, the 50 day's SQN has been neutral since Jan 22^nd and the 25 day's SQN has also been neutral since Jan 21^st.  Neutral is a sign that something may be changing.

3. Currently, the market is being propelled by government bailout money finding its way into the stock market instead of flowing to you.  In my opinion, that’s all that’s holding up the market.

4. I thought our debt was out of control when it reached a trillion dollars… It’s now officially at $13 trillion and unofficially, including unfunded future obligations, over $100 trillion.  That means, to me, that the dollar will one day be defunct.  When that will happen I have no idea, but it is something to be cautious about.

5. The government manipulates statistics as it is one of the few ways they have left to manipulate people’s thoughts about the market.  Based on the old statistics, we have been in a recession since 2000 with only one quarter (late 2003) of positive GDP growth.  In addition, real unemployment is currently at 22%.  These data are from shadowstats.com.

6. You cannot make money buying and holding mutual funds or stocks in this market… that’s a very dangerous strategy now.  But you can make money—good money—in these markets as a trader.  From March 10^th, 2009 to the end of the year, the S&P500 was up 69% (one of the strongest rallies in the history of the stock market).  However, it was not a normal rally as it was done on very low volume and no base was formed prior to its beginning.  (See point #3 above.)

I recently saw a copy of the Elliot Wave Theorist.  Basically, they are saying that the market high in 2007 was the end of a 200 year cycle, and we are now in real trouble.  They also say we’re due for DEFLATION, which with our current debt means big, big problems.  In comparison to that, my beliefs about the market are quite optimistic.

Part II: The Current Stock Market Type Is Now Bull Normal to Bear Normal

The SQN^TM for 100 days has moved back from a strong bull market to now just bull normal.  The 50 days has moved from strong bull to neutral to bear normal all within two week’s time—clearly a dramatic change.  Last month the ATR as a percentage of close was quiet, but now it has moved to the normal volatility range.  I’d be very, very careful under these conditions.

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

You’ll notice that the Dow is up 18.82% after being down 33% in 2008.  The S&P500 is up 23.45% after being down 38.49% in 2008.  And the NASDAQ is up 53.54% after being down 41.89% in 2008.  And this is after huge declines in early 2009. Bear market rallies can be substantial and from March onward, 2009 was very generous to the bulls.  Watch our market type closely because I doubt if much of 2010 will be bullish and the last four weeks may be just a harbinger.  January was a down month for all three major indices: -3.46% for the Dow, -3.70% for the S&P 500, and -6.41% for the NASDAQ.

Part III:  The Strongest and Weakest Market Components

By this time most of you understand how we track the relative strength of the various ETFs representing the economy of the entire world.  I publish this model 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, then I’d suggest you attend one of Ken’s workshops which are held several times each year. The next one will be held in New Zealand this month (details about those workshops are available on our website).  Ken explains how these numbers are derived in this workshop, and how to use them with his numerous trading systems—many of which have System Quality Numbers™ above 5.  And by the way, the Australia and New Zealand dollars are still both strong against the U.S. dollar, so now is probably the time to get the best deal on those workshops if you plan to attend.  But the U.S. dollar recently started rising (see the world market below).

The Jan 29th data are given below.

The areas in green are strongest (those areas are more than one standard deviation above the mean); those in yellow are the next strongest (above the mean up to 1 standard deviation).  Those below the mean are in brown, and those more than one standard deviation below the mean are in red.  I’ve taken out all the double leveraged funds from my database, which means that the top and bottom funds are not devoted entirely to those groups.

The overall market components are not nearly as strong (relatively speaking) as they were last month at this time.  The strongest countries are Chile (65) and Russia (65).  No other countries are green, confirming a general downward trend.  Other strong areas include biotech (64), the U.S. dollar (63), pharmaceuticals (63), biotech and genome (62), the Japanese yen (60) and the Indian Rupee (60).  The Japanese yen has really flip-flopped: it was at the top in November, then at the bottom in December, and now is at the top again.  In strong bull markets, areas of strength stay strong for months, not weeks.

Particularly weak areas include Spain (23), Brazil (26), international building materials (27), , China (29), Germany (29), and Australia which doesn’t look that strong. (If you are interested in trading bear market strategies, we are presenting our new Bear Market workshop in New Zealand this month, in the US in May, and then in Germany this summer.)  

The next chart shows the futures, real estate, bonds, and the strongest and weakest ETFs.

Here business Internet (79) remains on top, regional banking is now strong (77), emerging market (76), biotech (72), and being short the NASDAQ 100 (71).  Many short ETFs are now at the top of the list.  Interest rate products are all strong.  Again, the month to month changes are what stand out, although B2B Internet has remained on top for two months after being the weakest area previously.

Now, the weakest areas include broadband (7), gold mining stocks (12), clean energy (17), natural gas (18), metals and mining (19), and international real estate.

  Part IV: Our Four Star Inflation-Deflation Model

The US economy and much of the world economy is in a credit contraction mode.  While the quantity of money in the economic system may be higher, its movement around the economy—the velocity of money— has slowed significantly in the last year.  The personal savings rate is way up, people and companies are trying to pay down debt, and overall bank lending is in decline.  Six or seven years back, I thought we were in for an inflationary bear market but that is not the case for now. 

As you can see from the long term numbers below, gold is way up from a few years back but there’s no strong multi-year trend visible in the CRB or the materials ETF (XLB).  Conversely, financials (XLF) are, in fact, half of what they were just three years back.  On a long term basis, these indicate we do not have inflation. Yet.

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 at its highest level on the table and so is gold.

The Elliot Wave Theorist predicted a huge deflationary wave ahead of us, and a one month move from +2.5 down to +1 certainly suggests a movement in that direction. 

Part V: Tracking the Dollar

The dollar has been going up for the last two months partly because of the seasonal weakness in the Euro.  As I mentioned last month, the Euro typically starts going down in December and that can last into the spring.  And Europe has been hit by much worse economic conditions than the United States.  

General Comments

Glen Greenwald wrote an article in Reuter’s recently showing how taxpayers’ money was allocated in 2009.  He noted the following expenses:

• 44.4% military spending for current and past wars

• 10.0% interest on non-military debt  (with much of that debt arising from former military spending).

Right now, I think the market is at the edge of a cliff, barely hanging on.  I put both the long and short term market conditions in the title this month because by early March, everything could be bearish.  If you moved into long term positions with the idea of holding while the market stayed bullish, it’s probably time to consider an exit.  Bear market rallies are typically strong but short-lived.

In these monthly articles, I try to give you a general update about market conditions and when they might be changing.  (Incidentally, that seems to be happening now.)  If, however, you rely on these updates to guide your trading, as my friend seems to be doing, that’s a big, big mistake.  You need a system of your own that signals good exit points.  Furthermore, you should never open a position in the first place without knowing when to get out.  That’s a fundamental axiom for trading and investing.

Additionally, you should know how your system will perform under various market conditions.  If you haven’t heard this before or the other ideas mentioned above, read my new book Super Trader, which covers all of this to help you make money in any kind of market.  

Until the February update, this is Van Tharp.

Crisis always implies opportunity.  Those with good trading skills can make money in this market—a lot of money.  There were lots of good opportunities in 2009.  Did you make money?  If not, then do you understand why not?  The refinement of good trading skills doesn’t just happen by opening an account and adding money.  You probably spent years learning how to perform your current job at a high skill level. Do you expect to perform at the same high level in your trading without similar preparation?  Financial market trading is an arena filled with world class competition.  Additionally and most importantly, trading requires massive self-work to produce consistent, large profits under multiple market conditions. Prepare yourself to succeed with a deep desire, strong commitment, and the right training. 

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. 

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"You don't trade the markets.  You trade your beliefs about the markets." —Dr. Van Tharp  

What does that mean?  How do you even find out what your beliefs are?  With this course, learn how to identify your beliefs and find out which ones are useful and which ones cost you money in the markets. Learn to trade more profitably and consistently.

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Trading Tip

The Late January Swoon: A Bump in the Road or Something More?

by
D.R. Barton, Jr.

The broader U.S. market indexes all made new 52 week highs in mid-January. Then, in the last two weeks, they have given back all of the ground they gained in the previous 10 weeks—since the first of November.

The markets were certainly due for a pullback from overbought conditions. The pressing question for traders, however, is, "Was this rapid drop just a temporary rebalancing or the first leg of deeper drop?" Let’s take a look at some key technicals to gain some perspective.

Bump or Dip?

First of all, look at the magnitude of the late January drop in the chart below. It cuts through two key support structures: a 10 month trend line and the 50 day moving average.

Now it’s trying to approach the 50 day simple moving average (SMA) from below. The next few days will give us some key input as to whether the 50 will act as resistance. This same technical condition exists for the Dow, Russell 2000 (small caps) and the Mid Cap index. However, the QQQQ (NASDAQ Index) is still far from retracing to its 50 (actually, it’s still more than 2 percent below its 50 day SMA).

This gives us an interesting disconnect: tech is not rebounding as enthusiastically as the broader market.

Foreign Market Performance

What about other markets? Let’s compare the major U.S. indexes along with a few representative international indexes to see if their relative performances give us any clues.

This is a “performance chart” from Stockcharts.com. This type of chart shows how several indexes or stocks are performing in relation to each other.  For our purposes, I wanted to see the relative performance of the selected domestic and foreign indexes since January 14.

As I mentioned earlier, the S&P 500, Dow, Midcap and Russell 2000 have all had similar performance. You can see that they are the top four lines in the chart above and those four indexes all have had the best relative performance during the market pullback and subsequent two day recovery early this week.

Globally, the worst performers have been Latin America, Emerging Markets, Europe, China and, as previously mentioned, the NASDAQ. These are not encouraging signs for the bulls, and the recent tech sector and foreign market relative weakness is significant for me. 

Summary

Sustained S&P 500 price action above its 50 day SMA (especially if the QQQQ can climb up there) will provide a case for the intermediate term upside scenario. Based on the technicals and weak geographic participation in our little two day rally, however, that upside scenario is looking like a lower probability outcome right now. 

If the S&P 500 cannot sustain this rally with a strong up week including a couple of closes above its 50 day SMA, we’ll most likely look back at this current rebound as a temporary pause in a bigger down move. 

Great Trading,
D. R.

About D.R. Barton, Jr.:  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.  He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  “drbarton” at “iitm.com”.  

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Mailbag

What Are the Proper Specs for a Successful Trading System?

Q: I always enjoy your newsletter. THANK YOU! 

All the talk about systems, developing your mindset, and having a proper evaluation period for a system, is good stuff, but can you discuss  the proper specs for a “successful” system might be. For instance, if I am trading the S&P index futures “E-Mini,” what are the “numbers” that I should be looking for that will actually cover slippage, $5 round turns commission and offer enough of a dollar cushion to actually make some money? How many trades over what time period should be “tested” real time before going live? What numbers should I see for a successful system using these performance measurements?

• Average $ per trade

• % successful

• Appropriate drawdown

• Profit factor

• Return retracement #’s

• RINA

• Sharpe Ratio

• K-Ratio

If possible, can you explain what these numbers are and why/how they should be considered?

A:  I probably cannot answer your questions to your immediate satisfaction. I could give you numbers and define the terms you mention but those will not truly help you in the end. 

Traders come to us daily looking for one or more systems or for how to build a great system. You can only do that effectively, however, after you have a deep understanding of your beliefs. Beliefs about yourself, about the markets and about your objectives. 

System performance is entirely subjective because it truly depends on you. Dr. Tharp continually points out that you are the single biggest factor in your trading success. How well do you understand you? If that sounds strange, might I suggest that read Dr. Tharp’s latest book as an introduction – Super Trader. There’s also a plethora of free content in back issues of newsletters on vanktharp.com to get you started. We strongly encourage people to work on the Peak Performance Home Study Course or attend the Peak 101 workshop before getting into systems development. Clients who work on systems before working on themselves find that the same patterns that have shown up their whole life continue to show up in their trading. At the right point, I’d be happy to talk to you about the Systems Home Study Course or the Systems workshop. 

Take care and good luck to you.

Sincerely,

RJ Hixson

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Quote:
"When written in Chinese the word 'crisis' is composed of two characters: one represents danger and the other represents opportunity." 
~John F. Kennedy

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