Tharp's Thoughts Weekly Newsletter (View On-Line)
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Market Update for Period Ending May 1, 2013
Market Condition: Strong Bull Normal
I always say that people do not trade the markets; they trade their beliefs about the markets. Consequently, I'd like to point out that these updates reflect my beliefs. 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.
If, however, your beliefs are not similar to mine, then this information may not be useful to you. If you are inclined to perform 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. Know that I acknowledge that these are my beliefs and that your beliefs may be different.
These 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 and readable on our web site), 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, and 4) the movement of the dollar. I now report on the strongest and weakest areas of the overall market in a separate SQN® Report. I may come out with that report twice a month if there are significant market changes.—Van K. Tharp
Part I: Commentary—The Big Picture
Taxes are going up and the government is cutting expenses (well, a little), but the world has not ended. The U.S. National Debt clock (www.usdebtclock.org) reports real-time on a number of national fiscal figures. According to the debt clock, our national debt stands at $16.84 trillion — that’s up $180 billion in the last month. And that includes the 2013 tax increase that totals $73 billion thus far. The tax increase is 6.18% of the federal spending. That might sound OK, until you remember that the deficit is running at $1,050B ($1T) for the fiscal year.
The US population remains at 316 million with a workforce drop last month of 100,000 now totaling 143.4 million. In its earliest stages still, the Boomer retirement wave hasn’t yet swelled the ranks of retirees which now stands at 46.2 million. The number of disabled people collecting social security stands at 14.2 million, while food stamp recipients total 48 million. That means that 108.4 million people are currently supported by either the government or the 143.4 million workers. The debt clock no longer lists bankruptcies and foreclosures, but I didn’t trust that data anyway. I’ve replaced that section in our regular table with the workforce and the percentage of people supported by them.
Here’s a debt clock update for figures so you can monitor the changes over time. Some of the figures vary slightly from month-to-month and may not make complete sense. I have no idea why the trade deficit jumped by 50% over the last month or whether that’s completely accurate.
Part II: The Current Stock Market Type Is Strong Bull Normal
Each month, I look at the market SQN® score for the daily percent changes in the S&P 500 Index over 200, 100, 50 and 25 days. For our purposes, the S&P 500 Index defines the market. The market SQN score helps me understand the market’s trend.
This month, I want to talk about how different approaches get different market type results. When Ken Long taught his Day Trading workshop here last week, he told me his current market type was bull volatile. By historical statistics, though, the market is quite quiet. The ATR% since the 1950s (so over 60 years of data) has an average value of 1.34 with a standard deviation of 0.72. I remember in 2002 when I designed a bear market mutual fund system; I was basing it on the S&P 500 moving an average of 2.5% per week. In 2003, a bull market, we only had one or two weeks in the entire year when the S&P 500 moved that much. And when the market became a little more volatile (but still nowhere near 2.5% per week), CNBC called me up and actually wanted to know how traders were handling the increased volatility. Nobody called me in 2008, though, when that question would have been legitimate and timely. Well, right now the ATR% is almost a half standard deviation under the historical ATR% average for the last 60 years.
Nevertheless, Ken Long told me last week his market type was bull volatile. Additionally, in a seeking alpha article this week, one guru was talking about how to handle increased volatility. Well, Ken’s market type looks at volatility within the last 100 days— so it’s high within that framework, and therefore volatile. I understand volatility measured in terms of historical norms better and by those standards it is still quite low. I’m not that worried about a bear market coming from nowhere — even though I do have an occasional day when I get stopped out of all my long positions in this market.
The first chart shows volatility. You’ll notice how it has gone up since the first of the year, but how low it is compared with where it can be – up in the yellow and red zones. It is just above quiet now, very low in the normal range at 1.06 — which is well below the mean of the last 60 years.
(To see the following three charts stacked and aligned, click here.)
The next chart is a weekly bar chart of the S&P 500 with the last bar only being two days. Notice the beautiful uptrend. This is the time to be long the market or the strongest stocks. It’s very clear.
Finally, let’s look at the market SQN® score. While I look at the SQN score for 25, 50, 100, and 200 day periods, we primarily focus on the SQN 100 score to label the market type. The SQN for 200 and 100 days is strong bull. The SQN for 50 days is bull, and the SQN for 25 days in neutral. That’s the only weak sign I see at all, and that’s not very much.
(To see the three previous charts stacked and aligned, click here.)
Notice that the SQN 100 has been particularly strong for the last few months although it has retraced and is now in the strong bull zone. This is why the shorter SQN values are much weaker now.
The next table shows the activity of the three major U.S. indices at the closing Friday of each week:
All three indices show solid gains for the year. The S&P 500 is hitting new highs and both the DOW and the S&P 500 are showing double-digit gains over just a three-month period. The NASDAQ 100 includes AAPL or it would be doing the same.
Part III: Our Four Star Inflation-Deflation Model
In the simplest terms, inflation means that stuff gets more expensive, and deflation means that stuff gets cheaper. There’s a correlation between the inflation rate and market levels, so the inflation rate can help traders understand big-picture processes. Here is my four-star inflation-deflation model for the last few years:
Looking back over the most recent two-month and six-month periods provides the current month’s score, given in the table below.
The model suggests that we are neutral with respect to inflation in the last month. Commodities, however, have been going down dramatically - usually a sign of deflation. As a result, I decided once again to check the real inflation at shadowstat.com. They show real inflation at about 5%, compared with government figures at about 2%.
Part IV: Tracking the Dollar
The dollar looked fairly strong in March but it retraced a lot of its gains in the last 30 days, as show by the chart below. You might even argue that it’s forming a double top with a huge down move ahead of us. However, with historically low interest rates, a fiat currency, and a huge debt there is nothing really supporting the dollar.
I sometimes look at Richard Russell’s daily remarks. Richard has been writing a commentary on the market and Dow Theory since the 1950s and he’s seen a lot. Here is a recent quote about the current environment and the US dollar.
"Today's investors are in a most unusual position. I say that because I believe we are close to witnessing and living through some of the greatest and momentous changes in world economic history. It will be, historically, tantamount to those of us who fought and lived through World War II.
It is my opinion that within the next year or possibly two years, the dollar will lose its reserve currency status, and the US bond market will crash, taking the stock market with it. …. We hear about nations agreeing to trade with each other in their own currencies (in order to avoid trading in dollars). We hear about nations moving dollars out of their reserves. I'm predicting that these bearish (for the US) trends will accelerate. These trends are forecasting the end of the US dollar as a wanted store of value." (Russell’s Remarks, April 22nd)
Before the market moves down much, we will likely see a continuing increase in volatility—bear markets don’t tend to start out in quiet volatility conditions. If volatility declines from here, we may see the market drift sideways or continue upward from here. Yes, volatility has gone up, but so far, the move has been only from quiet to the very low side of normal. I’m not concerned yet and I plan to stay fully invested.
For the foreseeable future, the Fed will keep interest at an effective rate of zero and continue its efforts to drive money into the economy — which has shown up in equities. In search of yield, capital has little elsewhere to go for now.
While I think Russell is right, I also think that it will be obvious when to get out of the market (or go short) well before anything serious happens. Our model signaled the start of the bear market in late 2007, well before the Nov 07 through March 09 crash.
Until next month, this is Van Tharp.
These monthly market updates are not intended for predictive purposes; rather, they’re intended to help traders decide which of their trading systems should work best in the current market conditions. In bear markets—which are almost always volatile by nature—shorter-term strategies, and those that allow going short, tend to work better than long-only or intermediate/longer-term systems.
Which of your trading systems fit this current market type? Of course, this question implies that you have multiple trading systems and that you know how they perform under various market conditions. If you haven't heard of this concept or the other concepts mentioned above, read my book, Super Trader, which covers these areas and more, so that you can make money in any kind of market condition.
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 2012, and many more to come in 2013. 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.
Why Don't You Trade Forex?
- "I’m too small to trade against the mega banks & hedge funds"
- "It’s a 24 hour market - I have to work and sleep some time!"
- "I can’t keep up with all the macro economic trends for the economies of the world."
- "I don’t even know half the currencies out there, how could I trade them?"
Here Are the Realities:
- The currencies market is the most liquid market in the world.
- It’s easily accessible and tradable by individuals today.
- Forex does not require huge amounts of capital to trade.
- The technical aspects of trading Forex are much more similar to trading equities or futures than they are different.
Don’t believe that last point? Take this test and see for yourself.
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April 2013 SQN® Report
There are numerous ETFs that now track everything from countries, commodities, currencies and stock market indices to individual market sectors. ETFs provide a wonderfully easy way to discover what’s happening in the world markets. Consequently, I now use the System Quality Number® (SQN®) score for 100 days to measure the relative performance of numerous markets in a world model.
The SQN 100 score uses the daily percent change for a 100-day period. Typically, an SQN score over 1.45 is strongly bullish and a score below -0.7 is very weak. We use the following color codes to help communicate the strengths and weaknesses of the ETFs:
- Green: ETFs with very strong SQN scores (0.75 to 1.5).
- Yellow: ETFs with slightly positive SQN scores (0 to 0.75).
- Brown: ETFs with slightly negative SQN scores (0 to -0.7).
- Red: Very weak ETFs that earn negative SQN scores (< -0.7).
The world market model spreadsheet report below contains most currently available ETFs; including inverse funds, but excluding leveraged funds. In short, it covers the geographic world, the major asset classes, the equity market segments, the industrial sectors and the major currencies.
World Market Summary
Currently, the US equities markets are dark green in all major categories aside from large cap growth— which is probably because of AAPL (see top middle box of the next chart). Most sectors of the US stock market are also dark green or green except for metals and mining and oil exploration. This is starting to look similar to that of the 1990s - but the fundamentals are probably a lot more dangerous.
The rest of the world isn’t nearly as strong, showing only some green. The dark green countries include Australia, Japan, Thailand, and Switzerland. In addition, China, Hong Kong, Malaysia, Singapore, Brazil, Belgium, Sweden, and the UK are all light green. Only Russia and S. Korea are brown.
Currencies are all particularly weak with only the Brazilian Real, the Indian Rupee, and the Chinese Yuan being green. The dollar, which was the only strong currency last month, is now yellow.
(To see a larger version of this chart, click here.)
The next chart shows real estate, debt instruments, commodities and the top and bottom ETFs for the past 100 days.
First, commodities suggest deflation with many being red or brown. The red areas include blended commodities, gold, silver, base metals, agriculture, and livestock. The brown areas include coal and steel. So what does this say about the economy? Perhaps it shows how terrible the economy is really doing? Contrarily, the stock market is doing well despite the terrible economy because the Federal Reserve pumping new money into the financial system.
Oil is yellow. Natural gas, timber, and agribusiness on a global scale are light green. Only global water is dark green. Isn’t it interesting how water is now the best commodity?
Bonds all look weak except for the high-yield junk bonds. And generally, the longer the term of the bond, the weaker the group tends to be. Remember that not long ago, the stock market was weak and people were fleeing to bonds despite their tenuous position. As we discussed in this month’s report, bonds are a very dangerous place to be.
Real estate as a category is dark green (except for China).
Of the strongest ETFs in the database, the top 15 all have SQN scores over 2.5 and the top one (utilities) is over 3.0 which is very high. That might be a good short for this month. By the way, that’s not a recommendation - just an observation. Utilities and REITs dominate the top 15 with the top three strongest ETFs being utility issues.
Most of the weakest ETFs are short funds, the weakest being the short Dow 30. However, two that stand out on the weak side are gold stocks and the Japanese Yen. They might be good long candidates -- again, that’s not a recommendation.
What's Going On?
Overall, if you are fully invested in US equities markets, you should have done very well in the first four months of the year. US stocks have been the place to be and it doesn’t hurt that the dollar has recently been the strongest currency (even though it is now weakening).
Gold has taken a real hit dropping about $300 in a few days, however, the charts make it clear that this was a massive attempt to manipulate the gold market. The two day drop actually set up a really nice trade to the long side as shown in the chart below of GLD. When you think reward to risk, you start taking trades like this. Was the trade the bottom of the bear market in gold? Who knows? Does it matter if you can take 3R out of the market in about a week?
Generally, the market says you should be fully invested. We are in a strong bull market and almost everything in the US equity market is dark green. What more do I need to say? But then again, everything could change in a month or so.
Until next month’s SQN report, this is Van Tharp.
The markets always offer opportunities, but to capture those opportunities, you MUST know what you are doing. If you want to trade these markets, you need to approach them as a trader, not a long-term investor. We’d like to help you learn how to trade professionally; trying to navigate these markets without an education is hazardous to your wealth.
All the beliefs given in this update are my own. Though I find them useful, you may not. You can only trade your beliefs about the markets.
In this 17 minute video, Ken explains how one of his swing systems alerted him to a great intraday trading opportunity on April 25. He then went on to make a risk-free swing trade after he “paid for it” with his intraday trades. He uses the RLCO lens applied to 3 minute bars, hourly bars, daily bars and weekly bars to understand the potential for exceptional moves.
In this case and others, his swing trading systems helped him identify excellent intraday trading candidates which provided multiple “turbo” trades as well as a core swing position.
Click Here to Watch the Video
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