Workshops

Blueprint for Trading Success Workshop Added to Schedule

December 3-5, 2008
Wednesday-Friday

Regular readers will recall that in the context of the article "The Fate of the Average Investor", Dr. Tharp suggested that the material in the Blueprint Workshop was so necessary to traders in these turbulent markets that he would add a workshop in December if there was enough interest. We've added one! December 3-5, 2008.

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Feature

Tharp's Thoughts 

Market Update for October

Market Condition: Volatile Bear

by
Van K. Tharp, Ph.D.

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 just point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, then you may not find them useful.  I find the market update information useful for my trading, so I do the work each month and I'm 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 condition (first mentioned in the April 30 edition of Tharp�s Thoughts), 2) the five week status on each of the major stock U.S. stock market indices, 3) our four star inflation-deflation model, 4) tracking the dollar, and 5) the five strongest and weakest areas of the overall market.

Part I:  Market Commentary

I don�t really see any major changes from last month.  We are in historical market conditions that could be worse than anything since the Great Depression.  The U.S., after the current bailouts (and, expect more to come) is way in the hole.  I heard one estimate that said if they taxed both personal and corporate taxes at 100%, we still couldn�t get out of the hole.  Over the last five weeks the Fed has increased its credit issuance by $867 billion�that�s an annualized rate of well over 100%.

U.S. Funds have bailed out Freddie Mac and Fannie Mae (and will continue to do so).  They�ve bailed out Bear Stearns (to the benefit of JP Morgan) and Washington Mutual (to the benefit of JP Morgan).  As of the end of the month, the total is over $5 trillion.  In addition, there has been a $500 billion support of the money market funds and another Congressional Stimulus package, called Mark II, estimated to reach $300 billion.  And, of course, all of this money is coming out of thin air.  The Federal Reserve is just printing the money.

We�ve already had the equivalent of a bank running out of money market funds to the tune of $500 billion. Most of this has gone into short term treasury bills.  I also know that Wachovia, when it was announced that it was failing had a one day bank run.  If you went there, your ATM card was eaten up by the machine and you couldn�t get any cash.  I actually went to the bank that day to discuss another matter and was greeted by two bank officers when I came in the door.  Little did I know why they were really there.  And in late September I had a major problem with an account that I held in Wells Fargo that I was quite upset about.  It�s now nice to know that Wells Fargo has taken over Wachovia (said ironically).  But such are the times we are in.

By the way, our banking system only has about 10% of the cash on hand that it has on deposit.  Thus, they cannot afford to have everyone suddenly come in and want cash because they don�t have it.  When you deposit $100, the bank is free to issue $900 worth of loans on that $100 and that $900 only exists on the books of the bank.  Thus, if 20% of a bank�s customers demanded cash, the bank would be in big trouble and they�d be doing what Wachovia did that day.  I wonder what excuse they would have given me if I�d walked into the bank asking for $100,000 of my money.

European central banks have pumped over 2 trillion USD into saving their systems for an equity stake.  Most European countries are now bank owners.  The Bank of Japan will offer its lenders as many U.S. dollars as they want.  We�ve currently had a major bull market move in the U.S. dollar, but that is because so many people are paying off loans that are denominated in U.S. dollars.  Thus, the U.S. dollar is very much in demand right now.  But how long will this last?

The U.S. GDP is about $14.3 trillion.  According to the Federal Reserve, the US. credit market is now about $51 trillion.  Thus, U.S. Debt as a percentage of the GDP is now 356%.  Back in the Great Depression it was only about 250%.  The excess debt can only be eliminated in two ways: we can default on it or we can print it out of existence.  Which one do you think will happen?  Perhaps the good news is that Bernanke is a student of the Great Depression.  It�s pretty obvious which course Bernanke wants, but can he stop the credit crash?

I just heard that tankers are arriving into the Port of Long Beach at 15% of the normal rate.  That means there is a big shortage of food supplies leaving the country for other countries and a big shortage of supplies coming into the country. 

My understanding is that there was an Asia Europe Summit on October 24th and 25th in Beijing with 43 nations attending. The U.S. was NOT there. This is all in preparation for a meeting in Washington D.C. �on November 15th on the economic future of the world. My guess is the U.S. dollar as a world reserve currency was a major topic in Beijing and will be a major topic in Washington, D.C. More results next month. What can we expect? All 20 nations that will be in Washington use the U.S. Dollar as their foreign reserve. I wonder if our new president will be in attendance at the November 15th meeting?

Here are some possible ideas of discussion:

�     A return to Bretton Woods 1944.

�     The U.S. abolishment of its 750 military bases worldwide that it can no longer afford.

�     The abolishment of NATO, which the U.S. can no longer afford.

None of these will be very favorable for the U.S. but perhaps they�ll be a parting gift from one of our most unpopular presidents ever.

Part II: The Current Stock Market Type Is Volatile Bear

I have now substituted my new market type for the 1-2-3 model (which is still red light).  The reason I�ve done that is that the 1-2-3 model has now gone below a certain PE ratio (which has turned Steve Sjuggerud quite bullish) that automatically turns on one of the three signals to go.  However, I expect us to be in a secular bear market until the PE ratios of the S&P 500 reach single digits.  Thus, the 1-2-3 doesn�t really fit my current beliefs.

By the way, what is the average person hearing in the face of all of this?  �If you are a long term investor, the wise thing is to keep your money in the market.  These things always pass and the market always goes up long term.�  That comes from Suzie Orman, Jim Cramer, Warren Buffett, Dick Grasson, (the former chairman of the U.S. Stock Exchange), Charles Schwab, etc.  Just watch CNBC and you�ll hear that advice over and over again.  

My advice is that secular bear markets usually end when the PE ratios of the S&P 500 hit around 6-8 (e.g., 1932, 1942, and 1982).  Some people, like Robert Schiller, argue that one should use a regression slope to determine the average, which puts it at 15.7.  But remember we�re in the worst crisis since the Great Depression and perhaps in one that is worse.  Are you willing to risk the PE ratio of the S&P 500 dropping to single digits?  My advice, get in the market when prices are above the 200 day moving average and get out when they are below (or at least stay out until our market type turns to bullish for at least two weeks).  That would have kept you out of this market all year.

Last week I heard a market commentator start a sentence, �If I were a fool and believed in market timing�.�  We published Chuck Lebeau�s article for just that reason.  Fools are often wiser than others think�especially as defined by the standards of the norm.

I looked up the current PE ratio on the Internet and found the following chart from www.BullandBearWise.com.  When you think that secular bear markets go to the single digits, this chart is scary.  Most people act like the historic norm of 15 is significant.  No it isn�t.  Prices can go significantly below the mean‼ 

I�ve now changed how we measure volatility.  Using the ATR, as I had planned, did not work because the ATR gets bigger as the price of the S&P 500 goes up.  Thus, the market, based upon historical ATRs has been nearly 100% volatile since 1996.  As a result, we now look at the ATR as a percentage of the close and that does the trick on an historical basis.  In the table below, the left hand column shows the new classification.  The right hand table shows the old classification.  Notice that every week in 2008 is volatile on an historical basis.  The quiet markets do not start until August 2007.  The yellow weeks on the right are the market types that changed with the new system.

The historical ATR as a percentage of the close has been 3.1%.  The last two weeks have been over 10%.  Last week ATR for the S&P 500 was 103.5 with the 30 year average being about 20.81.  The standard deviation is about 18.3, so we are looking at 5 standard deviation markets. On a daily basis, they reached as high as 12 standard deviations from the norm. That's how extreme these markets are.  

Notice that even a 10% gain last week didn�t get us out of �volatile bear� territory.  We�re still down 25% over the last 13 weeks, while the historical average for 13 weeks is under 5%.  We need to form a base for quite a while before we can shift to sideways.

)     Notice that throughout the year, we�ve only had two weeks that we labeled bullish and they, in my opinion, were abnormalities.  So now let�s look at what the market has done during the month of October. 

All three indices are down of the month of October� all at losses of greater than 40% for the year.  By the way, can you remember when defined benefit pension plans assumed that their retirement plans would go up at least 10% per year.  How has your pension plan done since 2000?  

Notice that the market is down more than 40% despite gains of 10-11% last week.  Are you ready to invest in these market conditions?

Even trading is difficult.  Here is an example.  During our Blueprint workshop, I found a perfect stock for shorting.  It was down and highly efficient both on a daily basis and an hourly basis.  I shorted it with a stop of 10%.  It went down the day I shorted it, but then in after hours trading went above my stop.  And it opened above my stop.  I assumed it would fill the gap, so I elected not to exit.  It started to move down, so I just watched it (but remember I was teaching a workshop).  During the last two hours of the workshop I was preoccupied, only to find out the DOW had moved up another 400 points for the largest daily point gain ever.  The next day the market in the stock I was trading gapped up another 12%.  That was it, I again felt the gap would be closed, but I didn�t want to compound my mistake.  I just entered a market order to get out at the open at about a 3R loss.  It took me 25 minutes to get my fill back and I was trading with a firm that guarantees a 2 second fill or it is commission free.  By the time I got my fill back, the stock was already down on the day.  I was filled at close to the high of the day at about $112.  Three days later the stock closed at $66.  Bottom line, even short term trading in this market is terrible.  Most of my 3R loss occurred outside of regular trading hours.

Part III:  The Strongest and Weakest Market Components

None of these are really worth investing in right now.  Let me repeat that - none of the strongest components are worth investing in right now.  You should probably be in cash. 

The strongest components: 

1) Corporate Bonds

2) Long Term Treasuries

3) The Dow Jones Industrials

4) The S&P500

5) Switzerland

Do you really want to be in any of those markets under these conditions?

Five weakest components:

1.      Austria (13)

2.      Oil (20)

3.      Belgium (21) 

4.      Singapore (25)

5.      Sweden (34)

These markets are also very dangerous to short right now.  As I said before, you should probably be in cash right now.

Part IV: Our Four Star Inflation-Deflation Model

Once again, we are in a credit contraction mode, so it is not the inflationary bear market I once thought we were going to get six or seven years ago.  The entire world is experiencing a credit contraction.  Real estate is crashing worldwide, although I don�t know the total amount.  And the commodity markets are crashing.

Yes, the Federal Reserve and other central banks are printing money like crazy, but they cannot print it as fast as money is disappearing in the credit crunch.  What happens in a credit crunch is that cash is king.  Once again, cash is king, but it must be safe.  When all of the bankruptcies play out, then money will be printed like crazy to stimulate what�s left of the economy.  And at that point, gold is the king.  This is my personal opinion.

By the way, I talked to John Williams, the economist who publishes the shadow statistics data.  His definition of deflation is a negative value on the CPI and we certainly have not seen that, so he�s predicting massive inflation and a dollar crash.

So with that in mind, let�s now look at our measure of inflation/deflation.

Notice the huge drops in all four categories.  We�ll now look at the two-month and six-month changes during the last six months to see what our readings have been.

Our model is clearly showing the credit crunch that is going on and the potential for deflation.  The magnitude of the drops are amazing.

Part V: Tracking the Dollar

Okay the Tharp effect on the dollar showed its first contrary indicator that I can remember.  The dollar went up almost the entire time I was in Europe and that began a bull run.  A lot more was going on than I thought.

We�ve seen a huge and sudden rise in the dollar and an acceleration into November.  I gave you the reason earlier.  People all over the world are paying off debt and that debt is denominated in U.S. dollars, so they need to acquire the dollar to pay the debt.  Once the debt is paid off, don�t expect this phenomenon to continue.  One of the few good trades around may be the collapse of the dollar when this debt paying process is over.  However, a lot of that depends upon the results of the meeting in Washington on November 15^th.

Incidentally, I heard one report that when you factor out the effect of the rise in the dollar, then gold is at or close to all time highs.  That might have been true in September.

What you should do?

�     FDIC insurance is being raised considerably.  Just make sure you don�t have money in banks beyond that amount.

�     Money market funds, although not insured, are generally safe.  There are a few instances where because of runs, they could only pay depositors 97 cents on the dollar.  But that�s not a huge loss.  And the Fed has now guaranteed them.

�     Watch the stock price of your bank.  Wachovia�s price looked awful and so did WaMu's.  How does your bank's look?

�     If you are a value player, be very careful.  You can get returns above 20% now.  You can get stocks selling for 50% of book value.  You can get stocks that are great buys based upon Graham�s number (see Safe Strategies for Financial Freedom).  But you need a game plan and a worst-case contingency plan to help you get through this safely as we teach in our Blueprint workshop.  

�     As I�ve been saying since I wrote Safe Strategies for Financial Freedom, we�re in a secular bear market.  Phase II is now waking up from hibernation.  This one could last a while.  There will be many opportunities for those who survive it, but the word now is survival.  And expect the entire bear to last at least another 10 years.  Remember that we still haven�t yet seen the effect of the baby boomers getting well into retirement and needing to withdraw their retirement money from the stock market. 

�     Long term I would expect the government to default on many of its future contractual obligations.  How can it honor over $100 trillion in unfunded future obligations?  This is just my opinion, but do you really trust the government?   It promised that social security was only a temporary cure of unemployment during the Great Depression and then it became a national retirement plan� supported only by taxes, not common sense. It confiscated all of the gold coins in circulation at one point.  It is capable of anything.  And your best interest is not really what it has in mind.  The government can change the rules anytime it wants.

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. 

Trading Education

Location, Location Location

In addition to the new December workshop, we're also hosting workshops on the West Coast (USA) and in Sydney, Australia. 

Trading Tip

So Simple That It Shouldn�t Work � But it Does!

by
D. R. Barton, Jr. 

We had such a great group of folks at our Day Trading and Swing Trading Workshops this past weekend.  Thanks to all of you who were there!  It was a pleasure spending time together.

In those workshops, we discussed a bunch of strategies and systems.  Some were simple and some were a bit more complex.  But effective strategies come in all sizes and shapes!

Today, I wanted to share with you a beguilingly simple indicator that many of you may have heard of, but have brushed aside as too rudimentary to matter. It is a stock index seasonality play that goes by many names, including the �Halloween Indicator� and the �Best Six Months� indicator.

Half of the strategy can be summed up by the catchy saying, �Sell in May and go away�.  The other half is easily seen by the �Halloween� moniker � that�s the time to buy.

In short, if you stay out of the stock market from May through October each year and stay invested November through April, you capture almost all of the positive movement in the markets.  Here�s a graph from the Chart of the Day website that is actually quite dramatic.

As this chart shows, the lion�s share of returns are made in the six months starting at the beginning of November (as indicated by the dark blue line above).

Making this simplistic timing indicator even more impressive is the fact that it has worked for so long and over so many markets.  Not only has this worked for the U.S. markets, but it was also proven effective in 97% of global markets in one university study.

Perhaps not surprisingly, no one has come up with a definitive reason for why the effect occurs.

And with the monstrous sell off that we�ve had in the fall of this year, it looks like the long term numbers will just get more confirming data points.  November 1, 2007 through the end of April 2008 was an atypical negative run for the �Best Six Month� period, with an S&P drop of 5.5%.  But the May 2008 through October 2008 collapse dwarfed those numbers, with the S&P down 30.8%.

Clearly this was another year to sell in May and go far, far away�

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�. 

D.R. is presenting the upcoming How to Develop a Winning Trading System That Fits You Workshop, January 09

Update

Melita is doing OK. She is currently busy planning her next trip back home, to Sydney, Australia, where she will get to spend lots of time with her niece, nephews and lots of other family. It's summer Down Under now and she feels much better in warm climates. She'll have more for her inspirational corner once she gets back and gets settled in. 

Melita Hunt is the CEO of the Van Tharp Institute and a regular contributor to the weekly newsletter. If you would like to keep up with Melita�s progress regarding her 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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