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March 2, 2005 � Issue #209 | |
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Feature Article Van Tharp's Market Update, Includes the 1-2-3 and Four Star Model
Best Buy Dr. Tharp's Peak Performance Home Study Course. Trading Tip What Can We Learn from China�s Automobile Market? by D.R. Barton Jr.
Recommended Reading Trade Your Way to Financial Fre-edom
Listening In Does Van's Method of Position Sizing Apply Directly to Funds as Well?
Coming Soon Van's Core Workshop Peak Performance 101
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Market Update for February 28, 2005 1-2-3 Model Still in Red Light Mode By Part I: Market Commentary. Last week was a very interesting market. On Tuesday, the Dow Jones Industrials was down 170 points � one of the worst days we�ve had in some time. The talking heads on CNBC were talking about a new bear. The market recovered all of that in the next two days. Furthermore, by Friday the Dow had recovered from its loss and the talking heads were talking about how the market was now up for the year. In the meantime, the market activity reminds me of early 2000. Some sectors of the market are on fire with their charts being almost parabolic. It�s not like the technology stocks in the first part of 2000 (where a stock could go up 50% in a month), but my personal portfolio had many stocks that were going up 2-3 points every single day. Wow�I love that, but at the same time this market is scary. Let�s look at what those stocks are. They are all stocks that you�d expect to rise in inflationary markets. The sectors on fire are homebuilders, energy, and basic commodities (especially steel stocks). Companies like TOL, MDC, JOE, VLO, XOM, NUE, X, CMC were all on fire. Will they keep going? Who knows, but it fits the inflationary bear scenario that we�ve been talking about for some time. Take a look at a chart of VLO and you can see what I mean. It was going up nicely for a while and then it started going up 2-3 points every day. But that�s the danger. Today, it hit a new high of 74.85 in the morning. However, suddenly it started dropping and it hit a low of 65.50 � that�s huge volatility, but that�s the kind of behavior you can expect in these stocks now. I�m writing this in the afternoon of February 28th before the market has closed for the end of this month, because I�m not available tomorrow. But as of this writing, all three indexes are up slightly on the year. However, this year, during the best time of the year, when pension funds tend to flow into the market, has been quite flat. What will happen in May, when the pension fund flow stops? Also most of the new money is flowing into foreign stock markets, not the US stock markets. Latin America is on fire. Brazil is on fire. And generally most of the emerging markets are the place to be. For example, take a look at the exchange traded funds representing those areas of the world, including EEM (an emerging markets ETF), ILF (a Latin America ETF), and EWZ (the Brazilian ETF), and you�ll see what I mean. So what do we have in this market. First, we have lots of big mergers going on. Second, we have commodity stocks on fire. Third, we have money flowing to foreign stocks markets (rather than the US stock market). And, lastly, we have a Federal Reserve that is raising interest rates again. Pretty soon, this will have a significant impact on the stock market. The 1-2-3 Stock Market Model IS IN RED LIGHT MODE. BE CAREFUL. But before you make specific decisions on where to put your money, let�s take a look at what the market is doing. Right now it is definitely going down. Currently, the S&P 500 and the Dow Jones Industrials are above their price five weeks ago. The NASDAQ 100, as of the current price right now at 2PM on Feb 28th, is below its price five weeks ago. A large drop in a single week, could easily change the whole picture. But so far, the 2005 market is down slightly on the year and it�s overall behavior is a lot like 2004 � flat with very few trends. The table below shows the five week status of each of the major markets.
Incidentally, this data is calculated by hand based upon last Friday�s close (i.e., Feb 25th). There is always a possibility of human error in our numbers. What�s a good strategy for the month? You might get in efficient stocks like the one�s mentioned, but you risk the potential for highly volatile down days such as today in VLO. You might get a portfolio of the most efficient ETF, like Ken Long recommends in our ETF workshop. Or for many of you, it might be best to stay on the sideline until this market tips its hand a little more. Part III: Our Four Star Inflation-Deflation Model. As mentioned in Safe Strategies for Financial Freedom, we are due (in terms of cycles) for a deflationary bear market. And, indeed, there are major deflationary forces at work in the world today. And these were listed in the book. I read today (Feb 28) in Richard Russell�s commentary, that U.S. companies plan to double the amount of outsourcing given to India this year. That�s certainly a deflationary factor. For example, did you know that over 100,000 U.S. federal and state tax returns are being prepared in India? However, the United States at this time is a huge debtor nation. Our government has the largest debt of any nation ever (probably over 35 trillion including future obligations). Our corporations have huge debt and individuals also have huge debt. As a result, the Federal Reserve has stated that it will do whatever it takes to make sure that we do not have deflation. This means turning up the printing presses. However, the printing presses are currently fighting the deflationary forces. And the net result, right now is that inflation seems to be slightly winning. Indeed, that was the Fed�s rationale for raising interest rates. And with last month�s announcement, we have the sixth interest rate increase since we turned to red light mode in July, 2004. Let�s take a look at what the model is showing us right now. Remember, the model says that the more stars, the more likely we are to have inflation. Let�s look at those four factors. Commodities Prices are definitely going up. Commodity prices, as measured by the CRB, have been going up slowly since June of last year. They went from 255.77 on the close in 2003 to 283.9 on the close in 2004. I don�t have today�s closing price, but yesterday�s close in the CRB was the first one above 300 in over 20 years. Commodities are on fire. And that�s certainly a sign of inflation. In addition, I�ve already talked about how �commodity type stocks� are also on fire. This is a huge first star for inflation. Consumer Price Index � Consumer prices, as measured by the government adjusted consumer price index are starting to heat up � much faster than most analysts have expected. The governments figure for January was again up � giving up another star for inflation. Gold Prices � Gold went up in February, but it is down on the year. Furthermore, this price of gold seems to be tied to the movement of the dollar right now. Thus, as I did last month, I�d call this one neutral. Interest Rates � Short-term interest rates are definitely going up, and long-term rates are starting to inch up. However, a thirty year fixed mortgage is still cheaper than it was six months ago. This is the Federal Reserves reaction to inflation to inflation. Thus, we have another star here. Incidentally, be careful here. Over half of the U.S. long term debt is now owned by foreigners. One day they�ll get tired of it, especially with a weak dollar. And if they either stop buying or start selling, watch out for a huge spike in interest rates. What�s the net result? We have 3 stars pointing toward inflation. Most of the inflationary figures are manipulated by the government, so the best we can do is estimate the underlying trend. However, I�ve recently come across some figures that are not manipulated by the government. As a result, I plan to revise the inflation-deflation model. Look for a special update on that when I do. Part IV: Tracking the Dollar. The dollar is neutral over the last few months, although it was up during February. It�s probably bottomed out against the Euro. However, my guess is that it will continue to be weak compared with commodity currencies such as the Canadian Dollar, the New Zealand dollar, or the Australian dollar. I�d still recommend putting some funds in the Max Yield Strategy for 2005 if you didn�t do so last month. Be careful here. Follow the guidelines we set for you in Safe Strategies for Financial Freedom. Fundamentals (i.e., with the main factor being the US debt) suggest that the dollar has a long ways to go on the downside. However, we could have made that argument for much of the last ten years. The dollar is once again looking very shaky and putting 20% of your portfolio in the max yield strategy makes good sense right now. What this all means. Our big picture continues to suggest that the stock market is a very weak place to be. Be very careful. We still expect a long term, inflationary BEAR market. However, we might not see big declines until May. Commodity stocks and very efficient ETFs are probably the place to be if you want a position in the market. Right now a flat market looks fairly likely and an inflationary bear market looks like it is ahead of us. We might not see a major decline until seasonal factors kick in at the end of the tax season.
Editors Note: Throughout the issues you will see certain words with odd spellings, such as Fre-deom and mort-gage. This is because spam filters are likely to block message that contain certain words and this is one solution.
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Best
Buy:
Peak Performance Home Study
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Trading Tip by D. R. Barton, Jr. What Can We Learn from China�s Automobile Market?
We just finished a long series evaluating both sides of the potential housing bubble here in Tharp�s Thoughts. While automobile and other so-called �durable goods� are different from real estate in many ways, they do share one key characteristic: most people by them on credit. My good friend TP from north of the border sent me an article that brings some interesting insight into the dynamics of a market that is driven by credit and lending practices. You can read the entire article at by clicking: http://www.thestandard.com.hk/stdn/std/Focus/GB28Dh02.html The desire of the Chinese government to slow overheated economic growth in that country has been well documented. But this article on the automotive market shows what happens when credit is significantly tightened in the short term. Fewer consumers can qualify for credit or for credit at reasonable rates, so fewer of them buy cars. Demand weakens and a market that was booming just one year ago has basically crashed. One salesperson profiled in the article has had her income cut 50 percent in just the last nine months. In China, car sales incentives aren�t working as consumers postpone this major purchase decision, waiting for a better climate, especially in the credit market. Contrast this to the U.S., where low or no interest incentives have almost become a given. Consumers have been spoiled as low cost financing continues to be practically thrown at them by all the major car manufacturers since the 9/11 tragedy necessitated such incentives in the eyes of the sellers. What lessons do we take from here? The U.S. economy is not overheated and certainly not to the extent seen in China. But with interest rates continuing to heat up and the dollar in a long-term downtrend (more dollars buying fewer foreign goods), we have some key ingredients in place for a credit crunch. I don�t see this as imminent, but the cost and availability of credit will continue to be a required component for almost all major purchases in the U.S. A chink in the seemingly impregnable �easy credit� armor could have effects that ripple through the automotive and housing sectors. Don�t jump into the land of paranoia, but some added caution may be prudent in making big ticket spending decisions.
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Recommended
Reading:
Trade Your Way To Financial Fre-edom by Van K. Tharp Learn what the best traders in the world do to produce top notch systems. The Holy Grail for you is in knowing yourself and your biases and how to overcome them. In this book, you'll learn specific techniques for overcoming your biases, entry techniques used by the masters, how to develop a high expectancy system through understanding exits, and how to achieve your objectives through proper position sizing. There are many critical topics that most books ignore such as expectancy, R-multiples, position sizing, the importance of objectives, and many more. 344 pages. $29.95
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Excerpts from Dr. Tharp's MasterMind Trading Discussion Forum
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Peak
Performance 101 Workshop Learn 15 ways to develop rock-solid discipline in your trading. Discipline really means controlling your mental state. Unfortunately, most people allow their mental state to control them. In contrast, real winners maintain discipline that allows them to charge ahead of others in the field. If you play in a zero-sum trading game, like futures, you need to know every trick. These are the real secrets that separate successful traders and investors from the average person.
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