The Van Tharp Institute

March 9, 2005 — Issue #210

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In this Issue:

Feature Article

The U.S. Dollar: A Potential Time Bomb, by Van K. Tharp Ph.D

Best Buy Dr. Tharp's Peak Performance Home Study Course.
Trading Tip

Interest Rates Mystify the Fed, by D.R. Barton Jr.

Recommended Reading

Trade Your Way to Financial Fre-edom

Listening In

Position Sizing for Max Yield Strategy Question

Coming Soon

Van's Core Workshops Peak Performance 101 and 202

Real Estate Article

Exploding Profit Potential In Out-Of-Town Preconstruction Deals, By Chris Anderson, PhD

View this newsletter on-line, or read back issues

 

 

Feature Article 

 The U.S. Dollar: A Potential Time Bomb

By

Van K. Tharp, Ph.D.

We are facing a potential time bomb and, to be frank, I’m not sure that we can do anything to keep it from exploding.  The only question is, WHEN?  The bomb will not go off immediately.  It may not go off for many years – thus, I’m not predicting a near term disaster.  However, I do want you to be aware of is the potential for disaster in your worse case contingency plans.  With that in mind, here we go.

That time bomb is the U.S. debt and its effect on the U.S. dollar.  The debt will be the fuse that will set off the problem when it gets hot enough.  And the explosion will come in the form of a tremendous fall in the dollar, the U.S. stock market, and a tremendous rise in interest rates. 

And what will the bomb look like when it goes off.  We had a glimpse of it on Tuesday Feb 22, when the Dow plunged 170 points just on rumors that the Korean central bank, with some $200 billion in U.S. reserves, was going to sell some of its dollars for Euros.

With a little pressure from Washington, the Bank of Korea’s position was “clarified” within a day and the markets returned to normal.  A spokesperson for the bank said that their position was NOT to sell its U.S. dollar reserves, but rather to diversify its foreign exchange holdings.  Of course, that almost means the same thing.  It means the Bank of Korea will slow its rate of buying U.S. debt and instead focus on the Euro.

Why did all of this happen?  The well being of the U.S. dollar is largely dependent on a few Asian central banks, which control about $2.5 trillion dollars in U.S reserves.  As readers of Safe Strategies for Financial Freedom and past Tharp’s Thoughts updates know, the U.S. dollar has been going down in value for about four years.  Your wealth, if it is all valued in U.S. dollars, has basically depreciated about 40% against the Euro and even more against major commodity based currencies such as the New Zealand dollar.

Now, imagine that you held a billion U.S. dollars as a reserve and the value of those dollars goes down 40%.  You probably don’t feel very good about the situation.  But what happens if you sell off some of those dollars to diversify your risk?  The bottom line is that the dollar would plummet and your remaining reserves would be worth even less.

Furthermore, you want to sell your products to the U.S. consumer, whose spending account for most of the economic growth of the entire world during the 1990’s.  If the dollar goes down in value too much, at least with respect to the value of your currency, then you are afraid that the U.S. consumer will stop buying your products.  Thus, you tend to buy U.S Treasury bonds and notes to support the dollar.  And as you do that, your reserves of U.S. dollars continues to skyrocket. 

It’s not a pretty picture to watch.  You must buy U.S debt so that your currency doesn’t appreciate too much against the dollar, which would cause U.S. consumers to stop buying your products.  However, your reserves of U.S. debt continue to grow and grow as you are doing this strategy.  And those reserves are in a depreciating currency.  And if you sell some of it off, you will stampede the downfall of the U.S. dollar, depreciating your reserves even more.

The only solution for these countries is to slowly diversify out of the dollar.  Stephen Englander of Barclays Captial Research estimates that Korea’s reserves have gone down from 80% U.S. dollar denominated to about 70% at the end of 2003.  Furthermore, he believes that it may be as low as 55% today.

Similarly, China, has placed about 50% of its reserves in the U.S. dollar.  In 2004, however, according to the Bank Credit Analyst, China’s reserves grew by $112 billion, but only about 25% of that was U.S. dollars.  And China has also signaled that it is moving more to the Euro as a reserve.

Unlike China and Korea, Japan, which has been in a decade long recession, is still increasing the size of its reserves.  And, in my opinion, this continues to be one of Japan’s major economic problems.  For example, in the 15 month period ending March 2004, the Bank of Japan acquired $320 billion worth of U.S. debt – a substantial portion of the entire U.S. deficit.  The Japanese stock market, however, has just hit an eight month high – indicating that investors think Japan can overcome this problem.  Actually, Japan is being forced to inflate its currency by buying dollars and that’s helping them fight deflation – even though it is unintentional.

Let’s look at some basic math.  Right now the U.S. has net foreign liabilities amounting to 90% of our Gross Domestic Product (GDP).  In fact, the interest payments to service that debt is now 1.5% of the GDP.  Our trade deficit picture is so bad that we must grow our exports 5% faster than our imports, just to stabilize the debt.  Correcting it would require even more drastic measures.  As a result, unless these remedies are taken, Asian central banks must double the size of their foreign reserves just to stabilize the dollar.  (See Stephen King, The Ticking Time Bomb, HSBC, January 2005). 

And what does this begin to mean to the U.S. stock market.  When the U.S. stock market crashed in 1929, U.S credit amounted to 176% of the GDP.  And this increased to 287% by 1933 as the U.S. economy imploded.  In other words, during deflationary period the value of debt becomes even worse.

Today, U.S debt amounts to a whopping 304% of the GDP, according to a study by fund manager Trey Reik.  In 2004, the U.S. government itself estimated that its debt, including future liabilities, was over $35 trillion dollars.  That figure amounts to $139,000 per person in the United States. 

Will the U.S. government trim the budget?  Not likely!  The U.S. reported a deficit of nearly a half trillion dollars last year.  Neither the Republicans nor the Democrats campaigned against the debt as a major issue.  Why?  People don’t seem to care and our elected officials are only concerned about short-term problems, not long-term solutions. 

The U.S. consumer is saving at a rate of just over 1% -- down from over 10.8% in 1984.  Instead, U.S. citizens are increasing their debt, paying over $65 billion in interest in 2003.  And if the U.S. consumer starts to save, then the U.S. economy will probably slow down dramatically.

Why do I bring this material to your attention?  Because you must develop investment strategies with the big picture in mind.  And that big picture says that the dollar has a long way to fall and that our economy is vulnerable.

Yes, the dollar might seem cheap now compared to the Euro.  But with global factors I’ve described, be very, very careful.

Actions to Take Now:

1)      Be sure you have prepared a worst-case contingency plan for each of your trading strategies.  If you don’t know how to do that, then listen to the Business Planning CD series.

2)      Be sure your strategy is at least somewhat compatible with the scenarios suggested by the size of our debt and the large proportion of it held by foreign governments.

a.      Make sure you can withstand a huge increase in interest rates should it suddenly happen.

b.      You might be long in the stock market, but make sure you can withstand a number of severe down days that might be caused by a sudden shift in policy or a slow down bear that might be caused by a gradual shift in policy.

c.      Do you have any adjustable interest rate loans?  If so, make sure that you have an exit point should your rates go beyond a certain point.

3)      Be sure that you continue to monitor the situation.  The attitude of “something as bad as you’re suggesting could never happen” won’t help you if something drastic does happen.

4)      Start to build up some very liquid reserves.  They don’t have to be in a money market fund or cash, but just make sure that you have enough liquidity to protect yourself.

5)      Lastly, make sure that you are not too heavily loaded in real estate.  Real estate seems to be the “hot” investment now.  But if everything suddenly implodes, will you be okay?

How do I protect myself?  First, I am currently 100% long in the stock market.  My personal account was up 24% in February.  The reason is because there are so many explosive stocks right now – in the energy, steel, and home building sectors.  However, I protect myself with a tight stop on my entire portfolio.  If my portfolio drops by 5%, I basically get out of everything that’s in the red.  I had to do that several times if February.  But if the market collapses, I’ll have my gains and I’ll have cash to go short as the market proves itself on the downside.

About Van Tharp: Helping others become the best trader or investor that they can be has been Tharp's mission since 1982. Dr. Tharp offers very unique learning strategies, and his techniques for producing great traders are some of the most effective in the field. In 1997 he began to model the process for building wealth, adding to his overall expertise in the area of investing. If you have not yet studied Dr. Tharp's work we suggest you begin with the book referenced in this Market Update, Safe Strategies for Financial Fre-edom

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.

 

Best Buy:

Peak Performance Course  

 

Dr. Van Tharp is a consistent, astute and systematic researcher of human behavior. The opportunity to learn from someone of his caliber does not come along every day. He has collected psychological profiles from over 5,000 investors and traders and has personally interviewed hundreds of top people in the field to determine what makes them excel and how they make immense profits. 

He then carefully crafted the information from his studies into a model that people like you can use to improve your skills and increase profits. Furthermore, Dr. Tharp only studied people whose professional and personal lives were balanced. As a result, when you apply his model, it typically helps you lead a much happier and more satisfying life in all respects—not only in your trading. Buy now before the price increase set for later this month.

"I discovered your course and enrolled... I began trading again and I could not believe the difference in how I felt when trading. The anxiety level was gone, sleepless nights disappeared." —Terrance R. Caffey

"I considered myself to be a top successful trader before taking this course and even more successful after completing "Peak Performance." I highly recommend it as a requirement in the basic training category to anyone interested in trading. That goes for beginners, average traders, as well as successful traders." —Larry Satell

 

Trading Tips

Trading Tip

by  D. R. Barton, Jr.

Interest Rates Mystify the Fed and a Giving Little Credit to Dr. Sjuggerud

Life would be very boring if everything happened just the way it was supposed to.  There are myriad jokes that follow this theme – what would life be like if every golf shot was a hole-in-one and every swing of the bat resulted in a home run?  Would this be heaven or Hades?

I think all observers of the U.S. interest rate landscape can attest to the fact that this area is anything except boring.  As reported in my series on the potential real estate bubble, the Fed has spent the better part of a year raising interest rates (the Fed Funds rate, to be exact).  During this same period, 30-year mor-tgage rates have dropped significantly.

To be blunt, that’s just not supposed to happen.

In fact, Fed Chairman Alan Greenspan recently called these diverging rates a conundrum.  Robert Samuelson, Newsweek Magazine’s economic columnist reported on this interest rate phenomenon in last week’s issue.  The short article is worth a read and can be found at http://msnbc.msn.com/id/7038215/site/newsweek/ .

While Mr. Samuelson joins Dr. Greenspan in trying to understand why interest rates aren’t doing what everyone expects, let’s work on what to do about it.

1.      Stay nimble and be prepared for a major shift.  When things are out of whack, they tend to get back in line sooner or later.  Nature abhors a vacuum, and that sort of thing.  In plain English, long-term rates can’t keep diverging from short-term rates forever.  The correction probably won’t be quick, but it could be dramatic.  What will this effect?  Long bond prices, mort-gage rates, and eventually housing prices.  Don’t bet on cheap and easy mort-gage credit lasting forever.

2.      Look for other egg baskets.  Warren Buffet made his well-publicized move out of the U.S. dollar for macro-economic reasons and for diversification.  But if U.S. long-term interest rates start to rise, the dollar will cease to be a whipping post, if only temporarily.

3.      Don’t get caught stuck in the herd.  Steve Sjuggerud (editor of the insanely popular True Wealth advisory service) made a bold call in November of last year to stray from the herd of Wall Street analysts and retail investors who were betting “en masse” that long-term bond prices would continue heading down.  The good Dr. Sjuggerud was spot on with his call to buy bonds and his readers benefited by going against the herd mentality.  Watch for the point at which every pundit is convinced that bonds can only down go up and you’ll have a good starting point for shorting bond prices and betting that long-term interest rates are finally headed up.  Full props to Steve Sjuggerud for his bold and timely call on bond prices.

Interest rate trends are not acting logically right now.  And history has shown us that market confusion is often a great place to search for profitable ideas.  So keep an open mind and a watchful eye for the time when long-term rates begin their move up in earnest.

D. R. Barton, Jr. is a lead instructor for Van Tharp Institute courses. He is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching and teaching in the markets since 1986.  D. R. has created extensive and innovative new training products and taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-doom and co-creator and contributing author on Fin-ancial Fre-doom Through  Electronic Day Trading. He also writes a stock screening newsletter called Ten Minute Trader, has feature articles in Market Mastery, writes for Traders-U and is a regular contributor to Tharp's Thoughts.

 

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

Order Book

 

Listening in....

 

Excerpts from Dr. Tharp's MasterMind Trading Discussion Forum

Max Yield 

Author: Craig

Date:   03-02-05 15:30

In Safe Strategies a recommendation of investing up to 20% of your assets in the Max Yield strategy is made. The money I need to redistribute into Max Yield is within an IRA. 

That means that I must invest in favorable mutual funds meeting these guidelines.

The question I have is, does the same position size rules that apply to stocks and funds apply to funds purchased to implement the Max Yield Strategy? 

If that is the case does it make more sense to go to cash (where needed) because of an oversized position and wait to the correct entry point for Bear Market Mutual funds strategy?

Anybody have any ideas how to best handle this situation where you do not have hard cash to buy CDs?

Thanks

 

 Re: Max Yield 

Author: Ken Long 

Date:   03-03-05

My own personal application of this is to look for a no-load, country-specific fund or ETF that tracks the country favored by the max yield strategy.

Recently New Zealand was in favor, and so I bought some CNZLX (a no-load, no transfer fee fund available at Scottrade and other deep discount brokers) which focuses on NZ and Australian equities. I compared that chart against the Aussie ETF EWA over multiple time periods, and both of them against SPY as the US proxy, and the results were compelling

http://stockcharts.com/webcgi/perf.html?CNZLX,ewa,spy

Its not a pure application of the Max Yield strategy but the logic heads in the same direction.

The funds and ETFs, while not CDs, do allow for stop losses and no penalty for early withdrawal etc.

Cheers,

Ken


Read the full, unedited thread on the forum,   link here. (Hint for finding it, look at the heading and the date) Van K. Tharp and traders, investors and wealth builders around the world connect on this site, share ideas and learn from each other. Search specific topics 

 

Coming Soon:

Peak Performance 101

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. Enroll Now

Advanced Peak Performance 202 

Re-invent yourself as a trader or investor. We identified a minimum of eleven levels at which the trading game is played.  Each level has its own set of rules and tends to superimpose those rules (at least for those who are unaware) on the levels below it.  Most people reading this are probably playing at one of the bottom three levels.  As a result, there are many rules superimposed upon you that you unconsciously obey.  But you don’t have to do that – especially once you are aware of the game and how it is played. Enroll Now

 "My personal performance improved in every area of my life [following the Peak Performance 101 course]. My relationships improved, my organizational skills, my rock climbing improved (dramatically), my golf game... Well...actually my golf game didn't improve but I noticed I am having a lot more fun playing golf than I ever have experienced before. My self-confidence is soaring off the meter! My trading performance has improved. There is a sense of serenity that I learned to create (as a mental state) around my self whether I'm winning or losing. I'm much more calm watching the markets whipsaw. This mental state control has in turn improved my overall technical edge. I can focus better on the programming tasks."— B.C., Salt Lake City, UT, Past Peak Performance 101 Attendee

 

Real Estate:

Exploding Profit Potential In Out-Of-Town Preconstruction Deals

By Chris Anderson, PhD

Historically, real estate investing has been thought of as a local’s activity.  That is, you live in a community, you learn the real estate market, then you invest in the community.  For some real estate investments, that may make perfect sense but yet for others, it may be the worse thing you can do.

One place where this can be a terrible mistake is in preconstruction investing.  I am contacted on almost a daily basis from people who tell me that “in their area,” it is incredibly risky to buy preconstruction projects.  They give examples of a 2 bedroom condo going for over $0.5 Million while only being able to draw $1,500 in rent.  They tell me that if they buy this property and the price drops, they may be looking at either a large loss or a negative cashflow of -$1,500 or more. 

Others tell me that in their area, no investors can buy preconstruction projects since they are only sold to future owners that want to occupy the residence.  They want to know if there are special ways to get around these kind of restrictions.  While there are potentially ways to skin this cat, you have to start asking the question why would an investor want to do that?

What I have consistently found is that investors only consider these options because they don’t want to pass up what might be a “great” opportunity.  In many communities, preconstruction deals only come along once every couple of months and they will be gone if you don’t act.  Because of this, investors feel pressured to take the deal, with all of its warts, instead of really deciding if this opportunity fits their risk-to-reward profile.

Suppose we changed the picture a little bit….. Suppose that an investor had access to 20 potential deals per month, but they were in a variety of geographic areas.  Given that most investors can only do 1-4 of these per year without running out of capital and/or credit, then they could be VERY selective and take only those deals that made sense.  Of course, the first argument would be that this deal is over xxxxx miles away from where I live so how could I possibly do that.

So let’s look at this scenario, especially for preconstruction investing.  This is one type of investing where almost all the homework and the actual investing activity can easily be done long distance with a telephone and an internet connection.  Once made aware of a potential deal, then the investor simply must decide 1) if the risk profile matches what they are looking for, 2) if the potential return is suitable, and 3), what their escape path will be if things don’t work out well.  With a little training and getting used to it, this is something that one can easily accomplish in an afternoon from afar.

Once the investment decision is made, then contracts are signed and dollars are escrowed.  At this point, the only necessary step to take is to wait for the project to near completion, at which time the investor may considering flipping the property or preparing to close on it.  Sometimes, this may take up to 2 years to complete with absolutely no additional activity required!  Even if you were thousands of miles away, nothing else is needed from you.

For people that flip the property, especially if they are long distance, they enlist the aide of an agent that handles marketing and all the other details.  Again, this does not require a local presence.  About the only time when you may need actually be in the same locale as your property is if/when you close on the property and you have decided to rent it out.  In this case, you will probably need to line up a property manager and that is typically best done with a face-to-face meeting so that their other properties can be checked. 

Once you realize that you are not bound by geography, then this potentially solves two major problems:  1) my limit of deals to consider is only set by the practicality of getting deals presented to me and 2) if I don’t like the characteristic of the deals in one area, who cares since there are many, many other areas to consider. 

For savvy investors, this can also help drastically cut the risk of the perceived real estate bubble that has formed in some areas.  As an example, there are preconstruction deals out there where only $1,000 is required to be put at risk on a property that can easily support itself with rents.  Some of these properties have great appreciation potential with next to zero risk. 

So, the next time you are looking at real estate in your area and it just does make sense to make an investment, maybe you want to consider branching out and investing in other areas.

Dr. Chis Anderson is the on-line education coordinator at the Van Tharp Institute. In addition, he is a real estate investor and entrepreneur. He operates a web site of a community of investors at www.GetPreconstructionProfit.com.

 

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Quote of the Week:

"You cannot step twice into the same river; for other waters are continually flowing in."
--Heraclitus


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Feedback Corner: 


Just a quick thanks to Van for recommending "Marriage of the Spirit" a couple of weeks back. I purchased [the book] "Nothing "  in 1996 and put in a close spot on my desk so I would soon read it. Well it sat there for years, 8 to be exact, I mean its about nothing so what's the rush. Well I've reread it 3 times since and it has become the most important book I have ever read. I have the same feelings about "Marriage of the Spirit", thankfully I didn't wait so long to read it. All things happen at the right time. So I recommend both of these terrific books that help the "you" part of trading as opposed to the "markets" part of trading. Good Luck to all.
--Randy

 

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Dr. Van Tharp's Trading Discussion Forum
  www.mastermindforum.com

Ask questions, share ideas, information and feedback with Dr. Tharp and other like-minded traders and investors.