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Feature

Tharp�s Thoughts

Market Update for December 2007

1-2-3 Model Is in Red Light Mode

by

Van K. Tharp

Look for these monthly updates in the first issue of each month. This allows us to get the closing month�s data.  In these updates, we�ll be covering each of the major models mentioned in the Safe Strategies book: 1) the 1-2-3 stock market model, 2) the five week status on each of the major stock U.S. stock market indices, 3) our four star inflation-deflation model, and we�ll be 4) tracking the dollar.  I�m also going to show you the five strongest and weakest areas of the overall market.

Part I:  Market Commentary

Overall, 2007 was an up year for the U.S. markets with the DOW 30 rising 6.4%, the S&P 500 rising 3.5%, and the NASDAQ 100 rising 18.5%.  However, that has to be tempered by looking at some relative statistics.  First, the dollar fell 8.9% on the year versus the world�s major currencies. So in relative terms you were only up if you held the NASDAQ 100.  In addition, according to John Williams� shadow statistics (i.e., tracking the CPI as it used to be calculated in 1990), inflation ran 11.7% in 2007.  Thus, no U.S. markets kept up with both inflation and the fall of the dollar, which, in combination, totaled a negative 20.6%.  Did you make over 20.6% in your investments (i.e., calculated in dollars) in 2007?  If not, then you didn�t really make money in 2007.  But this is what we have to put up with in a secular bear market.  You certainly didn�t want to be in cash where you would have lost 20.6%.  This secular bear market is clearly an INFLATIONARY BEAR market, but few people seem to be aware of it.

Let�s look at what you could have been in 2007 and see what would have happened.

First, inflationary periods are good for commodities.  The CRB went from 394.89 to 476.08, an increase of 20.56%.  This is what you lost being in the dollar and with real inflation.  However, the futures market is highly leveraged, so smart futures players did very well in 2007.

Next let�s look at the traditional store of wealth during such times: GOLD.  If you�d bought GOLD at the beginning of the year at $635.50 and sold it at the end of the year at $833.20, you be up 31.1%.  You�d have a positive gain in wealth of about 11%.

You also could have put your money in some of the emerging markets.  Let�s look at three of them � China (represented by PGJ), India (represented by IFN) and Brazil (represented by EWZ).  First, the India fund went from 46.01 to 62.26, which amounted to a gain of 35.32%.  Thus, investing in India would have been slightly better than gold.

PGJ went from 21.95 to 34.35 in 2007.  This represents a gain of 56.49%.  So investing in China would have given you a gain of two times over what you lost to inflation and the decay of the dollar.

And lastly, the Brazil ETF (EWZ) went from 47.5 to 80.70.  This amounted to a gain of 69.89%.  Brazil represents both a booming emerging market and a commodity based economy.  You could have made about a 50% gain in real wealth investing in Brazil in 2007.

By the way, I�m not an advocate of buy and hold as most of you know.  What I am advocating is an understanding of the big picture to shape your investments.  And, at least in hindsight, the big picture for 2007 was obvious.

So let�s look at what the market did in December.

The 1-2-3 Stock Market Model Is in RED LIGHT MODE and That�s Bad for Stocks

The 1-2-3 Model is in red light mode!  The Fed is not in the way and has actually started to lower interest rates.  That�s positive.  The market is not acting well, and that�s negative.  In addition, the PE ratio of the S&P 500 is above 17, which is not positive.  Thus, we are in red light mode. 

Let�s look at what the market has done over the last five weeks and compare that with where the averages were December 31^st last year.  These data are given in Table 1.

Notice that December was a fairly neutral month.

Part II: The Five Strongest and Weakest Areas

I�ve started a new feature here, listing the five strongest and the five weakest components in the market at the time of this update.  These can change daily, but the information will be accurate as of the publication of this update.

Here are the five strongest components, in order, with the relative strength of each component given in parenthesis:

1)      Indian Stock Market (94)

2)      Oil (61)

3)      Commodities (51)

4)      Brazilian Stock Market (50)

5)      Gold (50)

Even though this is just a snapshot and can change daily, doesn�t this look pretty much like the strength of the market in 2007?  It certainly does to me.

Five weakest components:

1)      Real estate (5)

2)      Japan (16)

3)      U.S. Small cap value (17)

4)      U.S. Small cap blend (18)

5)      Sweden (18)

Notice that the strong and weak components are still pretty similar to what they were last month. 

Part III: Our Four Star Inflation-Deflation Model

As I�ve stated many times in these monthly updates and already in this one, we are in an inflationary bear market.  The bear market is not necessarily reflected in prices, but in PE ratios.  PE ratios will continue in a downtrend even though the Dow is making new highs.  And the inflation is obvious, but simply masked by government statistics.  Okay, so now let�s look at the results for the last six months.  And remember that the Fed has now chosen to produce inflation and a strong dollar devaluation over the pain of the subprime crisis.

We�ll now look at the two-month and six-month changes during the last six months to see what our readings have been.

The results of this model are much more sensitive (I believe) than the model I presented in Safe Strategies for Financial Freedom.  The model once again shows that inflation is winning slightly.  Click here for more information on the model.

Part IV: Tracking the Dollar

With the Federal Reserve lowering interest rates, I would now expect currency traders to start selling the dollar and moving to currencies that pay a better interest rate.  Look at the data in the chart because it really says it all.

I mentioned earlier that there was historic support at the 80 level and that a drop below the 80 level could signal a plunge.  We�ll that�s clearly happening.  This tells me that the dollar�s status as the world�s reserve currency will be very much in doubt in the near future.  And that�s one reason that oil is above $90 per barrel.

What Can We Expect From the Market in 2008?

First, 2008 is an election year.  The Republicans will do whatever they can to stimulate the economy this year in an attempt to win the election.  However, the question becomes how much can they do in the face of several issues:

�   a secular bear market,

�   huge debt,

�   huge deficit spending (with the debt and deficit spending both masked by fake statistics), and

�    an economy that is bankrupt, according to a study commissioned by the Federal Reserve. 

�    In addition, we are facing a subprime crisis which is much more significant than most people realize. 

Under these conditions, the government can do very little except to manipulate the statistics some more.  And I expect that will happen.  I seriously doubt that they�ll allow their statistics to show that we�re in a recession.

Incidentally, a recession is defined by a negative GDP for two consecutive quarters.  However, the government is manipulating the statistics.  According to John Williams (who keeps real statistics at www.shadowstats.com), the United States has been in a recession since the 2^nd quarter of 2004.  In fact, the first quarter of 2004 was the only positive GDP quarter (based upon real data) since the inflationary bear market started in 2000.

So what can you expect in the stock market in 2008.  It�ll probably be up because it is an election year.  The government wants to tell you that the market has gone up five straight years and that everything will be fine.  But will the market increase be enough to cover real losses to your wealth from a decline in the dollar and from inflation?  By the way, DR Barton was right about the dollar last month.  Short term it went up.  As a currency trader with leverage, you could have made money.  But I wouldn�t bet on it being up over the next 12 months.

I think Gold and Commodities will again be the place to be in 2008.  And Gold started the new year hitting a high of $861 (up 3.5% in one day). In addition, emerging markets will probably do well.  However, the question to ask yourself in 2008 is whether or not the subprime crisis has the potential to pull enough money out of the markets to impact the booming emerging markets in 2008.  Stay tuned for the answer.

I�ve been invited to speak before John Templeton�s group in Brazil at the end of this month.  I�m giving them a full one day workshop on position sizing and risk control.  And at the same time, I�m going to get a good flavor for what�s going on in Brazil, including catching part of the Carnivale in Salvador (that�s where the Brazilians go, not Rio).  Stay tuned for the next market update to hear about what�s going on in last year�s hottest country.

Until the January update, this is Van Tharp.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling book Trade Your Way to Financial Freedom 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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Trading Tip

The Ugliest Word in Trading and Investing, Part III

by D.R. Barton, Jr.

�Knowledge is an unending adventure at the edge of uncertainty.�  -- Jacob Bronowski

Uncertainty is a concept that really strikes at the heart of what trading is all about.  It really is at the core of the nature of markets and is therefore central to being able to invest and trade. 

I had a good time over the holidays talking to different people about uncertainty (since I�m writing this series, the subject has been in the front of my consciousness).  We talked about uncertainty in many areas of life from the deeply personal (life expectancy, chance of contracting diseases and illnesses, etc.) to the mundane (chance of being hit by lightening or stung by a bee) to the bizarre. When was the last time you discussed the Gaussian distribution for sugar cookie browning rates and the duration of first dates in the same conversation?

But I did get to turn most of these discussions toward a conversation on market uncertainty.  And while I got many different takes on uncertainty, the most common response that I heard was that many folks deal with uncertain outcomes by ignoring the uncertainty in one way or another.

People ignore uncertainty in several ways.  And all of them have trading lessons:

Treating uncertainty as if it doesn�t exist.  Many people think that outcomes for a great many things are predetermined.  This usually comes from a belief that some large outside mechanism or institution is controlling things.  For example, many people believe that the stock market is �rigged� either by government intervention or by the action of large institutions like hedge funds, brokers, etc.  They then conclude that certain stocks can only go one way, or that individual investors don�t have a chance to succeed.  Believing that things are �rigged� allows one to ignore uncertainty and jump to conclusions.  In trading, it�s tempting to think that market activities are being controlled. And in some less liquid markets and time frames, I�m sure that big players can have an unusually large influence.  But some traders use that mindset to push them to the conclusion that they can never get an edge in the market because the �big players� control everything.  This can lead to not taking responsibility for ones own results and is not a useful belief for traders.

Treating uncertainty as if it can be eliminated.  I exchanged some interesting e-mail with folks in various professions (including engineers, accountants and programmers) who maintain that their job is to eliminate uncertainty.  I maintain that in most real-life situations, that uncertainty can only be understood and perhaps minimized, but not eliminated.  If we think that uncertainty is tamed, either by understanding it quantitatively or by seemingly eliminating it, we set ourselves up for really big problems when an unplanned event happens that is outside of our quantitative calculations or outside of our assumptions.  In trading, we must always be prepared for an event, streak or other unexpected occurrence that will throw our a proverbial monkey wrench into our plan. 

We will continue to delve into uncertainty and look at quantifying it, ignoring it, transferring it and living with it.  And I would love to hear your stories on dealing with uncertainty.  If you�ve had an experience dealing uncertainty that provided a great learning, a vexing question, or just a good belly laugh, please forward it to me:  �drbarton� at �iitm.com�.  Let me know i I can use the story (either anonymously or credited) in a future article.

Great Trading!

D. R.

About D.R. Barton:  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 where he is one of the most widely read and followed traders and analysts in the world.

He is a regularly featured guest analyst on both Report on Business TV,  and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio.  His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at [email protected].

 

Melita's Inspirational Corner

All About Me

by Melita Hunt

I�m sitting here uninspired, doing my best to write an �inspirational piece.� This is my fourth attempt of coming up with something and even with a string of ideas and a page of potential topics, the words just aren�t gelling on paper.

Thankfully, the stupidity of it all is putting a smile on my face rather than frustrating me. Sentences started and then discarded, and the simple reason is I�m not feeling particularly inspirational today. We all have our bad days. It is what it is.

After a particularly painful week, both physically and emotionally, I was still committed to write this column and probably the most inspirational thing that I can do is just write my truth.

Here�s the truth: I can�t think of anything profound to write about. I�m at a loss for words, and for anyone that knows me, that is quite a feat in itself. So instead of using my own words and thoughts, I am just going to share some thoughts from a simple little book called All About Me.

All About Me is filled with questions about your thoughts, beliefs and ideas. You can use it to learn more about yourself, or have fun learning about other people. It isn�t designed to be profound. It�s just simple, fun and light and sometimes that is what we need to break up our day. 

So please forgive my lack of brainpower and finesse this week, and I hope that you enjoy answering these questions (actually, the first answer that comes to mind is usually the best). Feel free to share your answers with me too, it might just be the inspiration that I need!

1. A smell that reminds you of childhood
2. A city you like to visit
3. A game you like to play
4. Your earliest happy memory
5. Your motto
6. Something you have hidden in the closet
7. Your most spiritual moment
8. Your prized possession
9. A character trait you inherited from your mother/your father
10. Best piece of advice given to you
11. Two traits that you admire in your best friend
12. A compliment that made you blush
13. The animal that best describes you
14. Three people you consider to be geniuses
15. A lesson you learned the hard way
16. The emotion you tend to hide the most
17. An existing book or movie that defines you
18. Your longest grudge
19. If you could visit any time period, which era would you choose 
20. Something you learned this week

Simple and fun (if you take a minute to do it).

Have a Great 2008 Everyone!

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita�s progress regarding her recently diagnosed lung cancer. Please feel free to read her blog at www.myleftlung.com.

You can contact Melita at [email protected]

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