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Feature Article

February 2016 Market Update:
Bear Volatile Market Type

by Van K. Tharp, Ph.D.

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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, and 4) tracking the dollar. I will now report on the strongest and weakest areas of the overall market as a separate SQN™ Report. And that may come out twice a month if there are significant market charges.

Part I: The Big Picture

So what’s going on in the world? First, we have China experiencing massive economic problems. Second, we have Europe falling apart with people in many European nations thinking that the European Union will end. Third we have negative interest rates in Japan. Fourth, we are having a crash in oil and commodities. And even though the US has been in a recession that started in 2000 (based upon real numbers), we have the strongest economy around despite our massive debt.

So what are the markets telling us now? Over the last 100 days, the S&P 500 went down -2.76%. The Market SQN score for 100 day periods was bearish for 14 out of 20 trading days in the month of February. The remaining 6 days showed a sideways market. The S&P 500 remained in the volatile category throughout the entire month of February. Nevertheless, if the rally that started at the end of the February continues, that could easily push the market into sideways territory again soon.

Three out of our four Market SQN periods are bearish right now — 200 days, 100 days, and 50 days. The 25 day score is sideways. Thus, in my opinion, we are in a bear market. This is still, however, not an “official” bear market (down 20% or more) but that could easily change within a month.

Debt Clock

So in February, usdebtclock.org says our official debt went over the $19 trillion mark and stands now at $19.06 trillion. To put that number in a different form — your family’s share of the US debt went up about $3,300 last month. Subtract that from your taxes and what you earned last month and it really gives you a good estimate of how unprofessional our government is. And by the way, politics is a game where candidates argue over non-relative issues and stir up the public. Anyone who campaigns on real reform — such as starting a plan to eliminate deficit spending (much less the debt) is considered to be too far out there to be a legitimate candidate. That’s why I tend to consider politics as a joke. The voting choice for President of the United States this year might come down to Hillary Clinton and Donald Trump? Come on.

Incidentally, the website says there are 119.6 million taxpayers. It also says 161.2 million receive government support, however, I’m not sure how they determine that figure as some of the sections there are certainly duplicated. As a result, I add together US Retirees (49.5 million) food stamp recipients (45.2 million) and disabled people drawing social security (10.8 million). I don’t think there is any overlap here. Those groups total 105.6 million and that’s why I say that they constitute a group that’s 88.2% of the number of taxpayers. I could also include all government employees (23.8 million) as among those supported by taxpayers — but they do pay taxes. Remember about 10% of the taxpayers (12.0 million) pay most of the tax revenue.

Part II: The Current Stock Market Type Is Bear Volatile

My market type classification is not predictive but descriptive — rather than telling us what’s going to happen, it simply tells us what’s going on now. Using it is like looking at a trend. You can say, well, it’s going down right now, however, that doesn’t mean that in a few days that the trend might turn up.

The graphs below include a chart of weekly bars for the S&P 500 over the last year, the Market SQN^® score for 100 days, and the ATR percent volatility.

The chart below shows that during the four months the market has been in bear territory and that it spent most of 2015 in either neutral or bear territory. Most of last month was in bear territory but my expectation for a strong bear by the end of the month did not happen.

The third chart shows the volatility and while it was starting to look quite ominous at the beginning of February, it has been declining and moving toward the normal range which is a sign of perhaps a more sideways market condition.

Below is a chart of the recent weekly changes in the three major US Indices. After a very weak January, some new lows in February, the DOW is now down 4.0%, the S&P 500 is down 4.7%, and the NASDAQ 100 is down 7.8% from the start of the new year.

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 understanding inflation and deflation can help traders understand some important big-picture processes.

See the tracking table below.

Here are the model components and how the prices looked at the end of February compared with two months back and six months back.

So the first two months of 2016 have been completely neutral. The Federal Reserve started to raise interest rates but they are also very cautious. What they’ve done so far has had little impact on the economy.

Banks are still not lending money — which is a deflationary sign. This chart from the St. Louis Fed’s website shows the M-1 money multiplier is about 0.785 which means banks are lending about 78% of the money supplied by the Fed. The money multiplier figure used to be more than twice that amount in the years before the global financial crisis. It needs to be much higher than that to really stimulate the economy (and bring back inflation). Around 1987, just to put things in perspective, the money multiplier was over 3.

Part IV: Tracking the Dollar

The US Dollar Index was rising throughout most of February and is now close to 99. It’s still quite strong and I’d expect that to continue if the Fed continues to raise interest rates.

Conclusion

The market spent almost all of 2015 in a neutral to down mode. That is the market was sideways and relatively quiet. Those are about the hardest market climates in which to make money trading.

Now, the Chinese economy is not doing well, with their stock market hitting a 13 month low. The US dollar (because we’ve raised interest rates) is the strongest currency, despite our official debt now topping $19 trillion. And although our debt continues to grow at unsustainable rates, we have a deflationary to neutral climate in which the dollar seems to purchase more (meaning that the impact of the debt is growing). Europe is not in good shape. We have a major bear market in commodities. Energy is in a major decline.

While we use market type only to understand what’s happening now, many fundamental factors would suggest that we are due for a significant bear market in 2016. Watch volatility. If it climbs back up, we will finally have a much easier climate in which to make a lot of money in the market.

Harry Dent is predicting a major bear market. Nothing new. Elliot Wave International is predicting a major bear market. Nothing new. And I saw the following headline today.

“Historical Pattern Says the Risk of a 2016 Bear Market Is Zero”

The author’s premise is based on a few days in mid-February. On Feb. 12, 16 and 17, the S&P 500 gained more than 1.5% a day for three consecutive days. Since 1970, this has happened only eight other times. Every single time the S&P 500 gained more than 1.5% a day for three consecutive days, it traded higher a year later. In 1970, 1987 and 2011, the S&P 500 closed at a 52-week low just before soaring higher. In February, 2016, the S&P 500 closed at a 52-week low. So obviously, the conclusion is that the market is going higher.

My conclusion? The market type right now is Bear Volatile. Right now we have a short term rally. Who knows what it will be at the end of next month

Can you make money in this climate? If yes, then do what you do. If no, then your best bet is probably the US dollar — especially in a deflationary environment with a strengthening US dollar.

I will be in Australia at the end of March, so next month’s update will be written by RJ Hixson.

About the Author: Trading coach and author Van K. Tharp, Ph.D. is widely recognized for his best-selling books and 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.vantharp.com. His new book, Trading Beyond The Matrix, is available now at matrix.vantharp.com.