Tharp's Thoughts Weekly Newsletter (View On-Line)

• Workshops Your Last Chance to Attend Ken Long's Workshops in 2010
• Article August Market Update: Volatile Strong Bear by Dr. Van K. Tharp, Ph.D.
• Trading Education Free Shipping...on Almost Everything!
• Trading Tip Revisiting the Analysis of Long-Term Treasuries by D.R. Barton, Jr.
• Mail Bag A Response to Ken Long's Zero State Article

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Feature Article

Market Update for the Period Ending August 31, 2010
Market Condition: Volatile Strong Bear

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 strongest and weakest areas of the overall market. Note, the methods I now use for the market update replace methods I used in the past such as the 1-2-3 model from my book Safe Strategies.

Part I: Van's Commentary—The Big Picture

I was traveling for most of the last month and had the misfortune of my car breaking down on the US-Canada border.  It was towed to a repair shop in Vermont where it took the local shops three weeks to get Jaguar test computers to determine and fix the problem.  I returned to Cary for a Peak Performance workshop in mid-August and flew back to Vermont at the very end of the month once the car was finally repaired. 

To make a long story short, I just returned from picking up my car, so I haven’t had the normal amount of time to read much during August.  However, I think the data for last month speaks for itself. For example, I get daily emails of various stock screens and one of those is for positive and negative efficiency stocks.  On Sept 1st, I had 10 positive efficiency stocks and 121 negative efficiency stocks—despite the fact that Sept 1st was a huge up day. After those three big up days at the end of last week, the efficiency screen yesterday showed 87 negative efficiency stocks and 0 positive efficiency stocks.

Part II: The Current Stock Market Type—from Volatile Strong Bear to Normal Bear

Each month I look at the SQN® of the daily percent changes in the S&P 500 over 200, 100, and 50 days.  On August 31st the 50- and 100-day market SQNs were strong bear or bear and the 200-day market SQN was neutral.  The 100-day period is the period we rely on most for market type classification.  The volatility measurement on August 31st was in the volatile range. 

On August 31st, the 100-day market type was volatile strong bear but then after the strong up day on Sept 1st, it switched to normal bear.  My market type is somewhat like a moving average crossover because when the measures are close to the line between types, the market type can cross back and forth quite often.  I believe it’s most important to know the trend for the 100-day market type, which you can see in the next figure.  

The charts below present the two components of the 100-day (our primary focus period) market type.  I believe this graphical presentation of the market type is much easier to interpret than the table format that I have used for the last year or so.  Each month I will show two one-year charts:

1. Market direction based on the market SQN.
2. Volatility level based on the market ATR%. 

You’ll notice that, except for a few detours into neutrality, the 100-day market SQN has been in bear territory since May, and it is now beginning to enter strong bear territory (based upon new criteria, see below). 

Excel draws this graph automatically, so it’s not as clear as I would like; however, the overall trend is very clear.  Whether it’s exactly bear or strong bear is unimportant.  Just focus on the trend to see what’s going on.   This is what I mean by trading in the now: let the market tell you what’s happening; don't let your internal chatter get in the way.

The next graph shows that the current market volatility is in the normal range, which makes the bearish movement seem a little less ominous.  Strong bear markets are usually associated with volatile and very volatile markets.

While I was traveling last month, my staff published the final version of the July update, which included a correction for the June update.  My staff didn’t realize that I had changed the criteria for what levels constitute the various market types.  Based on my new criteria, everything originally reported in the June newsletter is correct.  As a result, no correction was needed to June’s market type, which was Volatile Bear.  I will explain my criteria adjustments and the reasons for them in subsequent articles.

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 few years.  All three indices are down now over the first eight months of the year. 

For many years, the weekly change in the S&P 500 (and the other indices) was a little over 2%.  Then, we had several years in which we seldom had a week during the entire year in which the weekly change was over 2%.  In 2008 volatility returned with a vengeance only to die out with the bull market of 2009.  Notice that the weekly change was over 3% during two of the last three weeks.  But that was my old measure of volatility.  Now I use the 20-day ATR% rolling windows, which show the market in a normal volatility range right now.

Part III: The Strongest and Weakest Market Components

As I’ve mentioned over the last few months, I decided to use SQN to measure the market performance of geographies, countries, currencies, and sectors in my world model.  I use the SQN 100, which calculates the SQN of the daily percent change of the various ETFs we follow over the last 100 days.  A score over +1.45 is very strongly bullish; a score below -0.7 is very weak.  I have kept the same color scheme:

• Green (strongest): Those that are more than one standard deviation above the mean (about 1/6 of the ETFs scanned).
• Yellow (the next strongest): Those above the mean up to one standard deviation (about 1/3 of the ETFs scanned).
• Brown (weak): Those below the mean and within one standard deviation (about 1/3 of ETFs scanned).
• Red (very weak): Those more than one standard deviation below the mean (about 1/6 of the ETFs scanned).

I removed all the leveraged funds from my database, which means that the top and bottom funds are devoted to the true strongest and weakest performers rather than to leveraged instruments.

View Larger Image of Graphic

Right now, the strongest country is Chile; Malaysia and Thailand are still among the strongest.  Wow, something continued for two months finally!  The Japanese yen is now the strongest currency (and the US dollar is barely positive).  Gold and agriculture are the only green sectors.  Oil, regional banks, health care, financial, semiconductors, and the Euro are all very weak.  Many countries are negative, but none fall into the super weak category for August.

The above table shows commodities, real estate, interest rate instruments, and the strongest and weakest areas of the overall market.  Commodities, except for gold, silver, and agri-business, are generally weak.  Financial areas, health care, and oil are the weakest business sectors.  Bonds are strong or super strong.  What does this tell you?  The bond trend has been persistent.  People are scared to death of the stock market and will accept any interest to be in a bond fund where they think they are safe.  Unfortunately, these funds pay ridiculously low interest and bond funds can take a huge hit if interest rates go up (with no hope of recovering anything by holding to maturity).  People seem to be doing exactly the wrong thing.  If you are in a bond fund, please get out before you become a major casualty.

This monthly market update continues to demonstrate what I’ve said many times: this is a market in which very little can be relied upon to hold its strength.  That means the markets can be traded, but long term investors will really suffer.

Part IV: Our Four Star Inflation-Deflation Model

We are starting to see weakness in our inflation measurements, which signals a movement toward deflation.  These are the same signs we saw in 2008.  Gold and commodities are higher although commodities have started to weaken.

We'll now look at the two-month and six-month changes during the last six months to see what our readings have been.  These are the strongest results I’ve seen since I’ve been doing this.  That’s good for a country with the debt we have.

Before we get too optimistic, let’s look at some other factors.  The Shadowstats web site shows that M3 (which they calculate because the government no longer releases the data) is at minus 6%.  That means that our total measure of money is shrinking at an annual rate of 6%.  In addition, the M-1 money multiplier is still below 1.0 meaning that banks are not lending out all the money that the Fed is printing.  The multiplier is often at 3.0, but over the last few months it’s had a meager increase from 0.838 to 0.856 (reported on the last available date of August 11th.)

The Shadowstats data also show that real unemployment is 22%, inflation is 8% based upon the original way the CPI was calculated, and the GDP (adjusted for real inflation) is still in a recession (which it has been most of the time since 2000) with a negative 1% annual growth.

Part V: Tracking the Dollar

The Fed numbers seem to be a little more stable lately, but they are a month behind.  I’m still going to show you what the futures contract in the dollar looks like.  As you can see in the chart, after bottoming out in early August, it bounced up by has stalled and is in danger of reversing.

General Comments

We’re in a secular bear market.  And we’re in a bear phase of that market.  We could easily have another down leg to the market that could take us way below the March 2009 lows.  A lot of people seem to believe this, which is why they are fleeing to bonds.  When interest rates start to go up, they’ll discover that bonds are not safe either because their price can go down.  The only safe thing right now is short-term trading, but only if you’ve had enough training to know what you are doing.  That doesn’t fit about 99% of the American population.

Speaking of Americans, 87% of the attendees in the August Blueprint workshop were from outside of the United States.  In the Peak 101 workshop, our international attendees made up about 61% of the group.  What does that say about the psychology of Americans?  I’m not completely sure, but it certainly isn’t healthy.

By the way, I think my workshop attendance is a great indicator of what’s happening on a large-scale psychological basis.  In March of 2000, for example, we had the largest attendance I’ve ever had a workshop (it was a stock market workshop).

Once again, it’s my opinion that you should use the information in these monthly updates to discern when to switch trading systems and not to forecast the market.  This is why it’s imperative that you 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 book Super Trader, which covers these areas and more so you can make money in any kind of market.

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.

Until the September update, this is Van Tharp.

About the Author: 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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Trading Tip

by D.R. Barton, Jr.

Two weeks ago we looked at some interesting graphics about the intermediate-term prospects on debt for companies, countries, states and municipalities.  Then we contrasted that outlook with the strongly overbought condition of longer term US treasuries.

Today I’d like to revisit the chart from two weeks ago and give some perspective on where we might go from here.

First I must re-iterate the potential problem with doing any kind of debt analysis in this environment. Government interventions are an overwhelming and highly unpredictable external variable in this market.  The most insightful research can be rendered void simply with one wag of a policy maker’s tongue.

So . . . with that one minute caveat in place, let’s dive right in.

The View In Late August

The chart below showed treasuries in an ever-accelerating state of upward price movement and oversold by two momentum indicators about two weeks back.

In my previous article, I said, “Like all parabolic move, this one is not sustainable.  The last time I drew a chart with progressively accelerating price moves like this was in the summer of 2008 and we were talking about the unsustainable move up in crude oil prices.”

What Happened Next

Within eight trading days of that article, we saw a 6.1% price pullback.  That’s more than a three times Average True Range move in TLT—the ETF for long-term US Treasury instruments.  This is no small feat for the previously sedate market for long-term treasuries.  In addition, we see in the chart below that three of the price acceleration lines have been penetrated.

Where Do Treasuries Go Now? 

As always, there are three ways this volatile market can go: up, down and sideways.  I still believe that strongly up is the least likely scenario.  Sideways is a better possibility because—from a technical perspective—markets tend to make rounded tops (rather than very sharp inverted “V” tops).

I still have the conviction, however, that the most likely scenario is a more significant pullback.  There are lots of folks that bought treasuries all the way up.  LOTS of folks.  Average volume in TLT now is three times as high as it was in the first quarter of this year.

Look for continued volatility and the possibility (probability?) of a further pullback.  Then be on the lookout for statements and/or actions from a governmental or quasi-governmental agency (the Fed or other) that could throw a monkey wrench into the works!

Great Trading,
D. R.

About the Author: 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".

Disclaimer »

Mailbag

Ken Long's Zero State

A letter in response to last week's article by Ken Long.

Great article, Ken!  I am now 68.  In my 20s I was a top squash player.  You may know that squash is sometimes referred to as the world's second fastest game, behind jai alai.  I had reached a state in squash that is very difficult to describe, perhaps similar to your zero-state in some respects. 

Everything on the court ceased to exist except my mental presence and the ball, which would travel in "slow motion" (in my perception).   My racquet, my body, my opponent, and the court were reduced to elements of pure, unified awareness.  

It was my "mental presence" making the shots, not my body or my racquet.  There was no conscious effort of trying to strategize.  My mind just "placed" the ball with extreme accuracy where an opponent could not get to it.  In those days, it was not a matter of winning, but rather seeing if I could hold opponents to a maximum of 1 or 2 points per game.

Would that I could achieve that state in my trading. 

Your article sure gave me something to think about.  Thanks for your fine contribution. 

Sincerely, 

Bill Graves 

Everything that we do here at the Van Tharp Institute is focused around helping you improve as a trader and investor. Therefore, we love to get your feedback, both positive and negative!

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