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

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• Article November Market Update: Bull Normal by Van K. Tharp, Ph.D.
• Workshops New Workshops Dates Added June-April 2011
• Trading Tip Practical Implications for Year End "Window Dressing" by D.R. Barton, Jr.
• Mailbag Volatility

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Feature Article

Market Update for the Period Ending November 30, 2010
Market Condition: Bull Normal

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.

Part I: Van's Commentary—The Big Picture

The Federal Reserve is pouring lots and lots of money into the system by buying debt.  However, the banks are not lending.  The St. Louis Federal Reserve money multiplier is currently at 0.927.  That’s up slightly from several months ago when it was 0.83, but it’s way down from before the crash when it was 1.7 and its peak in the late 1980s of 3.2.  When the money multiplier is less than 1.0, it means that banks are lending less money than they are getting.  So the Fed is unable to jumpstart the economy like it wishes.  The effect of the Fed’s policies won’t be inflationary, but that money is finding its way into the stock market.  Also the little guy is still looking for yield and buying blue chip stocks, such as McDonald’s, that are yielding more than treasuries are paying.  The little guy is also buying bonds like crazy.  And, of course, in the long run that will prove very dangerous… the next bubble to pop.

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

Each month I look at the SQN® of the daily percent changes over 200, 100, 50 and 25 days.  On November 30, the market volatility was neutral, which suggests no immediate bearish action.  Furthermore the volatility had declined significantly and the market type graph showed a trend moving toward bullishness.  On November 30th the SQN 200 was neutral; the SQN 100 (our primary indicator) was bullish, the SQN 50 was bullish, and the SQN 25 was neutral.  So based upon our 100 day data, the market is bull normal.  If you are 100% invested, there is no strong reason yet, not to remain so.

Fundamentals are still very weak.  We’re in a secular bear market, but the market looks good, especially non-US aspects of the market as we’ll see when we look at the world model. 

The overall trend of the model is quite clear: it’s up, and it’s been going up since early September.

You can see what’s going on just based on the recent trend.  We actually moved up to strong bull and are now in a downtrend. 

The next graph shows market volatility. 

You can see that the trend since May has been towards lower and lower volatility but that can change quickly (e.g., April/May 2010). Volatility has started to pick up slightly in the last few weeks; however, it still suggests nothing ominous approaching. 

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 up nicely for the year now with the NASDAQ 100 actually up 14%. 

Weekly Changes for the Three Major Stock Indices
	Dow 30		S&P 500		NASDAQ 100
Date	Close	% Change	Close	%Change	Close	% Change
Close 04	10,783.01		1,211.12		1,621.12
Close 05	10,717.50	-0.60%	1,248.29	3.07%	1,645.20	1.50%
Close 06	12,463.15	16.29%	1,418.30	13.62%	1,756.90	6.79%
Close 07	13,264.82	6.43%	1,468.36	3.53%	2,084.93	18.67%
Close 08	8,776.39	-33.84%	903.25	-38.49%	1,211.65	-41.89%
Close 09	10,428.05	18.82%	1,115.1	23.45%	1,860.31	53.54%
28-Oct-10	11,113.95	6.58%	1,183.78	2.79%	2,129.73	14.48%
04-Nov-10	11,434.84	2.89%	1,221.06	1.65%	2,187.80	2.73%
11-Nov-10	11,283.10	-1.33%	1,213.54	0.95%	2,173.11	-0.67%
18-Nov-10	11,181.23	-0.90%	1,196.69	0.59%	2,134.77	-1.76%
26-Nov-10	11,092.00	-0.80%	1,189.40	0.02%	2,153.91	0.90%
Year to Date	11,092.00	6.37%	1,189.40	6.11%	2,153.91	15.78%

Over the last three weeks all three indices have shown slight down movements.  The recent weekly changes, however, have not been very big.

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 over 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.

We still have a lot of green in the market.  Once again, a number of countries have 100-day SQNs above 2.0 including Hong Kong, Chile, and Thailand.  Malaysia, and India were in that category last month but are now much lower. 

Other strong sectors include Biotech, Food and Beverage, Gaming, Oil and Gas Equipment, Retail, Telecom, and Software. 

There are only three negative ETFs on the entire chart: the US dollar bullish, regional banks (both just like last month), but Spain has gone negative while Homebuilders is no longer negative.  US micro and small caps have improved significantly. 

The next table shows commodities, real estate, interest rate instruments, and the strongest and weakest areas of the overall market.  This month we’re not seeing the extreme numbers of last month.  The Financial preferred, Chile, Hong Kong, Internet, and Silver are the strongest performers.
The five weakest ETFs are all short major US indices.

Among the commodities, coal, silver, and global agribusiness are still strong.  Long term bonds, however, don’t look good at all, which is part of the reason that investors are looking for dividend paying blue chip stocks.

Part IV: Our Four Star Inflation-Deflation Model

Inflation looks a little stronger this month. 

Date	CRB/CCI	XLB	Gold	XLF
Dec 05	347.89	30.28	513.00	31.67
Dec 06	394.89	34.84	635.50	36.74
Dec 07	476.08	41.70	833.30	28.90
Dec 08	352.06	22.74	865.00	12.52
Dec 09	484.42	32.99	1,104.00	14.10
Jan 10	465.29	30.14	1,078.50	14.18
Feb 10	478.32	31.50	1,118.30	14.68
Mar 10	467.25	34.51	1,115.50	16.08
Apr 10	481.11	33.98	1,179.25	16.16
May 10	458.70	30.75	1,207.50	14.68
Jun 10	471.37	28.37	1,244.00	13.81
July 10	499.05	32.01	1,169.00	14.71
Aug 10	496.73	31.04	1,246.73	13.55
Sep 10	536.12	32.78	1,307.00	14.35
Oct 10	566.28	34.80	1,346.75	14.56
Nov 10	565.96	35.19	1,383.50	14.46

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.

Date	CRB2	CRB6	XLB2	XLB6	Gold2	Gold6	XLF2	XLF6	Total Score
	Higher	Higher	Higher	Higher	Higher	Higher	Higher	Lower
Nov		+1		+1		+1		+1/2	+3.5

We are in an inflationary environment unless we have another massive derivatives collapse.  However, little inflation will be seen until the banks start lending and then it could become interesting.

Part V: Tracking the Dollar

Month	Dollar Index
Dec 00	104.65
Dec 01	109.51
Dec 02	101.48
Dec 03	86.21
Dec 04	80.10
Dec 05	85.65
Dec 06	80.89
Dec 07	73.69
Dec 08	80.69
Dec 09	73.82
Jan 10	72.81
Feb 10	75.49
Mar 10	75.18
Apr 10	75.35
May 10	78.44
June 10	79.00
Jul 10	76.74
Aug 10	75.93
Sep 10	74.00
Oct 10	No info given
Nov 10	No info given

I couldn’t find the government database for the dollar that I’ve been tracking.  I hope that something was wrong with their servers and that I’ll find it next month.  In the meantime, I’ll show you a chart of the U.S. Dollar futures index. 

As you can see, the dollar has moved up nicely for the last month or so.  By the way, if you plan to attend our Australia workshops, we’d recommend registering quickly.  The dollar is still at a pretty good price versus the Aussie dollar, but if the uptrend continues, the longer you wait the more expensive the workshops will get.

General Comments

We’re in a secular bear market.  And a long term trend will mean dramatic reductions in valuations, taking the S&P 500 PE ratios into the single digits.  Fundamentally, things certainly support that trend even though in some secular bear markets the economy can actually be doing quite well.  And as I said last month, the next down phase looks like is has been put off;  bear markets don’t generally spring out of normal market volatility.  However, these are trading markets (and that goes for every country in the world right now).  It’s not a buy and hold market.

Most people spend years learning how to do their professional work.  Doesn’t it make sense to put the same kind of effort into learning to trade rather than just buying and holding and watching your nest egg deteriorate?

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 December 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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Workshop

New Workshops Added to January-February, April

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March 15-17	$3,995 $3,295	Peak Performance 203 aka The Happiness Workshop	Sydney, Australia
Just Added April 2-3	$195	Oneness Awakening	Cary, NC
Just Added April 5-8	$3,995 $3,295	Peak Performance 202	Cary, NC
Just Added April 10-12	$3,995 $3,295	Peak Performance 203 aka The Happiness Workshop	Cary, NC
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Click here to Learn More about Our Workshops and check out our combo price offers To register for any of these workshops, please contact us at (919)-466-0043.

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Trading Tip

Practical Implications for Year End "Window Dressing"

by D.R. Barton, Jr.

Most mutual fund managers and many money managers only have to report their holdings on a quarterly basis.  This practice has led to a fund management phenomenon known as a “window dressing.”

In basic terms, managers want to make their portfolios look as desirable as possible in these reports.  “Desirable” holdings in the portfolio keep current investors interested and help attract new investors.  To accomplish this, managers sell off under performing stocks before the reporting date and replace them with the hottest, most desirable names.  Then when the portfolio contents are reported, the fund looks like it’s doing a bang-up job.

Since many investors make investment decisions for the coming year based on what they see from the previous year end, some traders try to take advantage of the quarterly and year-end window dressing process.

This practice of selling the lower performing stocks should have the effect of driving the prices of these under performers even lower, at least for a short time.  Well,  there is research that supports that series of events.

A Unique Way to Profit from Window Dressing

Jeffery and Yale Hirsh at Stock Trader’s Almanac have studied this window dressing occurrence and have come up with an interesting way to play the year-end version.

Looking back to 1974, they have calculated the returns that would have accrued if one bought all of the stocks trading at their 52-week lows on the 15th of December and sold them on the 15th of February.

The numbers are eye-opening.  In the 35 years of the study (the last 11 of which are from actual newsletter picks), there have only been 7 down years.  That’s an 80% win rate to start with. 

Beyond that high winning percentage, only one of those losses was a double-digit loss in percentage terms.  In contrast, out of the 28 winning years, an amazing 17 years produced double-digit gains. 

As a control or baseline to measure overall performance, buying the NYSE composite index on the same day in December and selling it in February resulted in a net gain of 113% over the 35 years for an average gain of 3.2%.  (Keep in mind that this is a seasonally strong time in the markets.)

Buying only the bargain stocks during the same time frame resulted in an impressive 453% total gain or an average of 12.9% for the three months of investing.

The Caveats and an Idea

The portfolio of stocks hitting new lows in mid-December can be too large for the average retail investor.  The most stocks ever required for the “bargain stock” portfolio was 112 and the average number of stocks bought and sold per year was 28.

Regardless, the concept is simple, interesting and—based on the Hirschs’ data—quite robust.  One thought seems ripe for further research:  we could narrow the portfolio to a limit of 10 per year and then test performance.  For example, which would prove the better filter: picking the 10 under performers with the worst 52-week performance or the ones with the strongest (worst of the worst vs. best of the worst)?  Or picking the 10 most volatile based on a long term average true range?

A Parting Note

One of the implications of this data is that portfolio managers who practice “window dressing” at the end of the year are most likely hurting their fund’s performance.   Perhaps that’s a little payback for a shady practice?

I’d love to hear your thoughts and feedback on this article or about trading and investing in general at drbarton “at” iitm.com.  Until next week…

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 »

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Mailbag

Q: I would like to ask a question regarding position sizing. I read your book, Super Trader. I found it very valuable and useful. Since I use volatility as a way to size my positions, sometimes when the volatility is low or my stop placement is tight, the amount of shares I can purchase is very large. One position could take up to 50% or more of my capital. Although the dollar amount at risk remains within my 1% guideline, I was wondering if using 50% of my capital on one position is such a wise thing to do. Am I taking excessive risk by doing that? Should I place some kind of limit on the amount of capital I allocate per position? If so, what would be a good guideline?

A: Volatility is not risk until you are also using a volatility stop. So I'd make sure your percent risk isn't too high as well. Other than that, to answer your questions I'd need lots of detail about your objectives, R-multiple distribution, etc. I'd suggest you read the Definitive Guide to Position Sizing which is my book on position sizing(TM).

Hope that helps,

Van

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