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Feature
Tharp�s
Thoughts
Market Update for January
2008
1-2-3 Model Is in Red Light Mode
by
Van K. Tharp Ph.D.
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,
and 5) the five strongest and weakest areas of the overall market.
Part I:
Market Commentary
The high in the market was on October 9,
2007, and at one point we had a 16% down movement, which is nearly a
bear market. And we�ve
had two events -- the subprime crisis and the largest loss ever by a
Rogue trader � which could have led to this decline.
Many banks have had to virtually write off all of their
assets involving subprime mortgages and for many banks that amounts
to losses that are several times their book value.
At the same time, we�ve had the Federal
Reserve lowering interested rates a full 125 basis points.
This is a huge stimulation for the market and it�s put a
temporary stop to the decline. But
is it enough or will the market resume its downtrend this month?
While I don�t know the answer, I�d like
to remind everyone that we are in a secular bear market in which PE
ratios go down and will continue to do so for some time.
If you haven�t read my article, Lies,
Damned Lies, and Government Statistics, then I suggest that you
do so. Basically, the
government has made major adjustments to the
CPI
. For example, based
upon how the
CPI
was calculated for many, many years, inflation last year was over
10%. Furthermore, since
the
GDP
has to grow more than the
CPI
, if you look at the real
CPI
figures, we�ve been in a recession since 2000 with the exception
of one quarter in 2003.
Last month, I showed that with real inflation
and the decrease in the value of the dollar, you needed to make 20%
on your investments just to break even.
Gold did this, and countries stock markets like
China
,
India
, and
Brazil
did much better. However,
even they are affected by the subprime crisis because when a lot of
assets are suddenly worthless, other assets need to be sold to
maintain some liquidity and, in my opinion, this is what the markets
are facing right now.
Part II: 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 a clear red light mode
and that�s not good for the stock market.
The Fed is not in the way and has actually started to lower
interest rates. That�s
positive. The market is
acting poorly and the PE ratio of the S&P 500 is above 17, both
of which are negative. 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 31st last year.
These data are given in the table below.
|
Weekly
Changes for the Three Major Stock Indices |
| |
Dow
30 |
S&P
500 |
NASDAQ
100 |
| Date |
Close |
% Change |
Close |
%Change |
Close |
% Change |
| Close 04 |
10,783.01 |
|
1,211.12 |
|
1,621.12 |
|
| Close 05 |
10,717.50 |
-0.61% |
1,248.29 |
3.07% |
1,645.20 |
1.49% |
| Close 06 |
12,463.15 |
16.29% |
1,418.30 |
13.62% |
1,759.37 |
6.94% |
| Close 07 |
13,264.82 |
6.43% |
1,468.36 |
3.53% |
2,084.93 |
18.50% |
| 4-Jan-08 |
12,800.18 |
|
1,411.63 |
|
1,963.52 |
|
| 11-Jan-08 |
12,606.30 |
-1.51% |
1,401.02 |
-0.75% |
1,912.81 |
-2.58% |
| 18-Jan-08 |
12,099.30 |
-4.02% |
1,325.19 |
-5.41% |
1,844.09 |
-3.59% |
| 25-Jan-08 |
12,207.17 |
0.89% |
1,330.61 |
0.41% |
1,789.17 |
-2.98% |
| 1-Feb-08 |
12,743.19 |
4.39% |
1,395.42 |
4.87% |
1,855.27 |
3.69% |
| Year
to Date |
12,743.19 |
-4.09% |
1,395.42 |
-5.23% |
1,855.27 |
-12.38% |
Notice that market has returned to more
normal volatility and that only the Fed intervention saved the last
week from a major downturn.
When we look at the strongest and weakest
areas of the markets, it seems to be mostly commodities, with even
the strongest country ETFs taking big hits.
As of January 30, the date of my last reliable internet
connection while traveling, these are the figures for the five
strongest and the five weakest components in the market. These can
change daily, but the information will be accurate as of the
publication of this update. The
relative strength of each component is given in parenthesis.
Five strongest components:
1)
Gold (97)
2)
Commodities (75)
3)
Oil (63)
4)
Corporate Bonds (61)
5)
Mexico
(60)
Five weakest components:
1)
China
(16) -- hopefully
you�ve sold your Chinese stocks.
2)
South Korea
(21)
3)
NASDAQ (29)
4)
India
(29)
5)
Singapore
(31)
Remember when the Chinese stock market led
the list a few months ago? Also
notice that while Gold is very strong, gold stocks are not.
But I think this is due to the liquidity problem produced by
the subprime crisis.
Incidentally, the Wall Street Journal
reported that Standard and Poors has downgraded (or threatened to
downgrade) more than 8,000 mortgage investments.
As a result, they are projecting mortgage securities losses
totaling more than $265 billion. The
market has been shell shocked by $100 billion in losses as big
financial firms go through mortgage downgrades.
So imagine the impact of another $100 billion.
In my opinion, make sure you have some short positions.
Part III: Our Four Star
Inflation-Deflation Model
As I�ve stated many times in these monthly
updates, 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 when the Dow makes 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.
|
Date
|
CRB
|
XLB
|
Gold
|
XLF
|
|
Dec-05
|
347.89
|
30.28
|
513
|
31.67
|
|
Dec-06
|
394.89
|
34.84
|
635.5
|
36.7
|
|
Jul-07
|
424.52
|
39.42
|
665.5
|
32.9
|
|
Aug-07
|
413.49
|
39.15
|
672
|
33.75
|
|
Sep-07
|
447.57
|
42.11
|
743
|
34.32
|
|
Oct-07
|
453.26
|
43.86
|
789.5
|
33.73
|
|
Nov-07
|
451.26
|
41.65
|
783.5
|
31
|
|
Dec-07
|
476.08
|
41.7
|
833.3
|
28.93
|
|
Jan-08
|
503.27
|
39.62 |
923.2
|
29.14
|
We�ll
now look at the two-month and six-month changes during the last six
months to see what our readings have been.
|
|
CRB2
|
CRB6
|
XLB2
|
XLB6
|
Gold2
|
Gold6
|
XLF2
|
XLF6
|
Total
Score
|
|
|
Higher
|
Higher
|
Lower
|
Higher
|
Higher
|
Higher
|
Lower
|
Lower
|
|
|
|
|
+1
|
|
+1/2
|
|
+1
|
|
+1
|
+3.5
|
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.
As
of this writing, Gold is well over $900 per ounce and has hit all
time highs. However,
these are not inflation adjusted all time highs.
The Gold market has a long way to go to reach that number,
especially if you look at real inflation and not the fake government
CPI statistics. By the real
inflation numbers, Gold would have to climb above $6250 per ounce to
reach a new high.
Similarly,
the CRB has really shot up. As
a result, this is a time to be in commodities, and real assets such
as precious metals, and top quality collectables such as rare
stamps, which we�ve talked about previously in this newsletter.
There are also starting to be real estate bargains out there
if you know where to look.
Part IV: Tracking the Dollar
With the Federal Reserve lowering interest
rates, I expect the dollar to really be weak now.
Who wants to buy treasury bills as the interest rate gets
lower and lower? So
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.
|
Month
|
Dollar
Index
|
|
Jan
05
|
81.06
|
|
Jan
06
|
84.29
|
|
Jan
07
|
82.37
|
|
Feb
07
|
82.07
|
|
Mar
07
|
81.23
|
|
Apr
07
|
79.87
|
|
May
07
|
79.20
|
|
Jun
07
|
78.93
|
|
July
07
|
77.51
|
|
Aug
07
|
77.51
|
|
Sep
07
|
75.91
|
|
Oct
07
|
73.93
|
|
Nov
07
|
72.94
|
|
Dec
07
|
73.69
|
|
Jan
08
|
73.06
|
My current trip in Brazil gives me a good
example of how weak the dollar is.
The dollar is now worth about 1.75 Brazilian Real.
It used to be way over 3 Real to the dollar.
Until next month�s 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
Uncertainty
- The Ugliest Word in Trading and Investing � Part VI
by D.R. Barton, Jr.
�So
what do we do? Anything. Something. So
long as we just don't sit there. If we screw it up,
start over. Try something else. If we wait until we've
satisfied all the uncertainties, it may be too
late.��Lee Iacocca
The
phone company came to run the fiber optic cable to my
house so that we could enjoy the wonders of light
transmitted communication (yes, Seinfeld re-runs do look more life-like
with fiber optics�).
Of course, they ran into the same problems that
confront every crew doing field work � there is never a
straight shot from the junction box to the house with no
obstacles.
In
our case, we have a willow tree at the corner of the
house. And so,
when confronted with a big root sprawling out from the
tree and blocking their path, the installation crew had to
decide how to get from one side of the root to the other.
They could have brought out the equipment that uses
compressed air to �blow� the cable under things like
sidewalks and driveways.
Or, they could just take the easy path and cut
through the root without a second thought as to how it
would affect the tree's health.
Guess
which option they chose�
In
the first article in this series on uncertainty, I talked
about how every profession has to deal with uncertainty.
This is clearly true for problem solvers like
engineers, doctors and lawyers who have to survey the
environment and react to what they find there.
The same is true for construction contractors and
anyone who does field work.
Nothing is ever built according to plan!
And
when uncertainty rears its ugly head (or some
manifestation of uncertainty), we have to make decisions
on how to react. Sometimes
we can find an elegant solution, and sometimes roots get
cut.
As
traders and investors, when we deal with uncertainty, we
do it on two broad fronts:
uncertainty that is built into price movement (a
close cousin to volatility and variability) and
uncertainty that comes from the outside environment (news
and other events that move prices).
And
we need different tools and mindsets to deal with the
different types of uncertainty.
The
volatility / variability type of uncertainty requires us
to deal with day-to-day, even minute-to-minute
machinations in price.
These can be repeatable and predictable, right up
until the point where they act completely different than
they have in the past.
The
good news is that our tools for dealing with this
�structural� uncertainty are pretty good and provide a
useful roadmap for navigating within the world of
volatility and variability.
On
the flip side of the coin, we have uncertainties that show
up out of thin air: hurricanes
devastate distilling plants and distribution stations,
causing price shocks in crude oil and associated
commodities. Wars
and other conflicts break out.
Finance ministers make bone-headed pronouncements
at bone-headed times. Seemingly sound companies divulge
accounting irregularities � or worse.
These
types of unexpected events that cause huge price shocks
are much more difficult for investors or traders to handle
because they have some characteristics that are
psychologically and statistically counter-intuitive.
For one, they happen much more often than we think
they should.
Last
week we talked about dealing with the impact of price
shock news that we know is coming (things like Fed Funds
announcements, earnings reports, etc.).
In the coming weeks we�ll delve into useful ways
for traders and investors to deal with both structural
uncertainty and unexpected price shocks.
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 with 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 if 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.
He is a regularly featured guest
on both Report on Business TV,
and WTOP News Radio in Washington, D.C., and has been a guest
on
Bloomberg Radio.
His articles have appeared on SmartMoney.com and Financial Advisor magazine.
You may contact D.R. at
�drbarton� at �iitm.com�.
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 Melita's Inspirational Corner
The Frog Genie
by Melita Hunt
Last week I ended my article with a request that people write down ten things that you find great about yourself. How many of you took the time to do that? And how many of you actually did it every day for a week like I had suggested? I hazard to guess that most of you didn�t for one reason or another.
How do I know that? Because I did exactly the same thing. I forgot to continue to write down ten great things each day literally the day after I wrote it because I got so caught up in everything that I had to do this week. Sound familiar? And it is only in hindsight that I can see what a benefit it would have been to have done it and given myself a pat on the back a few times during this very busy week. Something so
simple is so easy to forget. Therefore this week, I am going to put a reminder in my calendar to make sure I do it and I�ve also decided to do it at
night because sleeping on nice thoughts will probably be an added bonus. I encourage you to do the same. When is the last time that you could honestly say that you gave yourself 70 compliments in a week?
So other than that idea, there isn�t a whole lot of inspirational �pow wow� oozing out of me this week. I am currently hooked up to
IVs while undergoing treatment in Mexico and being true to my convictions (i.e., kind to myself) I have decided to keep things simple. I had planned ahead and decided that if I wasn�t up to writing I would just share a joke or something else that I had on hand instead.
So here is my joke of the week. Don�t cringe, just lighten up and have a laugh!
The Frog Genie:
A woman was golfing one day when she hit her ball into the woods. She went into the woods to look for it and found a frog in a trap.
The frog said to her �If you release me from this trap, I will grant you three wishes.�
The woman freed the frog and the frog said �Thank you, but I failed to mention that there was a condition to your wishes. That whatever you wish for, your husband will get ten 10 times more or better!�
The woman said �That�s okay.� and she wished to be the most beautiful woman in the world. The frog warned her, �You do realize that this wish will also make your husband the most handsome man in the world, an Adonis that women will flock
to.�
The woman replied, �That�s okay; I will be the most beautiful woman, so he will only have eyes for me.�
KAZAM � and for her second wish she chose to be the richest woman in the world.
The frog said, �That will make your husband the richest man in the world and he will be ten times richer than you.�
The woman said, �That is okay; what is mine is his and what is his is mine.�
So, KAZAM, she�s the richest woman in the world!
The frog then inquired about her third wish and she answered:
�I�d like a really mild heart attack.�
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 (she is a never-smoker). Please feel free to read her blog
at www.myleftlung.com.
You can contact Melita at [email protected]
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