Feature

Tharp’s Thoughts

Market Update for the Week ending September 30, 2009

Market Condition: Normal Strong Bull

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 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 U.S. stock market indices, 3) our four star inflation-deflation model plus John Williams’ statistics, 4) tracking the dollar, and 5) the five strongest and weakest areas of the overall market.

Part I: Van’s Commentary—The Big Picture

Perhaps the most important aspect of the current big picture for US citizens is that the US dollar is the world's reserve currency. Other nations all over the world use the US dollar to back up their own currencies. Ask any country what’s behind their currency and chances are it’s a lot of US dollars (they print their own money, but keep the dollar as backing). So right now these countries are in a position in which they depend upon the dollar for the safety of their own reserves. If they were not in such a position, the dollar would have collapsed long ago. 

But what if the dollar were to collapse in value? What then are the currencies of all of these other countries worth? Nothing! So there is growing pressure on the US to get the dollar in better standing. They want to pressure the Federal Reserve to stop their out of control printing of money.

So now let’s explore how this looks from the Fed-US Government point of view. First, when about 40% of the world’s wealth collapsed in a few months in the last year, there was every possibility that the US was in for deflation. But the US has nearly $11.8 trillion in debt and about $107 trillion in unfunded future obligations. When the Federal Reserve Bank of St. Louis published an article in mid 2006 claiming that the US was bankrupt, the total debt at that point was only about $67 trillion. But since then, the total debt has gone up $40 trillion.

The US currently pays 3.36% interest on its national debt —but only on the $11.8 trillion amount and  not the full $118 trillion. It cannot pay interest on social security (which owns much of our debt as an asset) or Medicare.

What can the US/Federal Reserve do? One possible outcome is that the US will default on its contractual obligations, eliminating the unfunded future obligations and leaving lots of elderly voters screaming. It will never default on its debt, but it could simply inflate it way out of that debt. 

Remember this (the largest note ever printed)?

I currently have about a $15 quadrillion worth of these bills. Perhaps this is the way we will think about our debt one day. By the way, everyone attending Peak 101 and Blueprint next week will get one—a little $100 trillion personal gift from Van.

We’re still in a secular bear market and if the Fed stops channeling money directly into the market, we could see another severe down leg soon. But who knows for sure when/if that will happen.

Part II: The Current Stock Market Type Is Normal Strong Bull

The SQN^(TM) for 100 days is still in a strong bull market. And the ATR as a percentage of the close is only slightly above the mean at 1.5, so it’s normal. The 25 day SQN still turned to neutral with the large down day on October 1st. The100 day has been bullish since July 21st.

Let’s look at what’s happening in the three major US indices. The next table shows the Dow, the S&P 500, and the NASDAQ over the past five weeks.

All three indices are showing nice gains. It’s hard to believe that all three indices were down huge amounts just a few months ago. Remember that the DOW 30 is now an entirely new index after losing GM and Citibank. 

Part III: The Strongest and Weakest Market Components

I have a new model in which we track the relative strength of the various ETFs representing the economy of the entire world. I will be publishing this once a month. Ken Long, who developed the algorithm we use, publishes a similar report every weekend at www.TortoiseCapital.com. If you’d like more information, then I’d suggest you attend one of Ken’s workshops, which are held several times each year. The next one will be held in New Zealand in February (details about those workshops are available on our website). Ken explains how these numbers are derived in this workshop, and he covers numerous systems that have System Quality Numbers^(™) above 5.

The September 30th data are given below.

The areas in green are strongest (the total rating is at least one standard deviation above the mean); those in yellow are the next strongest (above the mean). Those below the mean are in brown, and those more than one standard deviation below the mean are in red. I’ve taken out all the double leveraged funds from my database so that they don't dominate all of the tops and bottoms for each category.

The strongest geographic areas are Thailand, Russia, Brazil, Latin America, Taiwan, Australia and Emerging Europe, and India. In terms of sectors, Oil and Gas Equipment, Broker Dealers, Media, and Pharmaceuticals are doing above average. 

What’s doing poorly? China, Japan, Mexico, Sweden, and South Africa all qualify as doing poorly. The British Pound and the Mexican Peso are the weakest currencies. And Biotech, Building Materials, Home Builders, Semiconductors, and Regional Banks are doing poorly. 

The next chart shows the futures, real estate, bonds, and the strongest and weakest ETFs.

Here commodities, natural gas, livestock, and global agri-business are not doing too well. The best areas are silver, long term bonds, and junk bonds. The strongest and weakest ETFs seem to be the ones we have already pointed out.

Part IV: Our Four Star Inflation-Deflation Model

Once again, we are in credit contraction mode, so this is not the inflationary bear market I once thought we were going to get six or seven years ago. But I suspect that we’ll be in one by the end of 2009. Gold is certainly suggesting that.

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 CRB is almost at it’s high set last May.

We appear to be moving toward deflation again based on the movement of our index. 

Part V: Tracking the Dollar

The dollar is heading down again with its weakest showing since August last year. 

General Comments

Crisis always implies opportunity. Those with good trading skills can make money in this market, but you need the training and self-work to do so. Right now we are in a manipulated bull market. Just to give you a perspective, I thought you might like to see a chart the DOW since 1982.

You could make the argument that the uptrend was broken in 2002 or you could redraw the line to include the 2003-7 uptrend. Whichever way you choose to look at it, there’s no question that the uptrend was broken in 2008.

Next week, Florian Grummes will update us on gold. The following week, I’ll continue with my update of other market types. We’ll be discussing the oil market at that time. 

Until the next update, this is Van Tharp.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books 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

Don’t Let Outside Influences Spoil Your Plan

 by 

D.R. Barton, Jr.

The popular press is an amazingly powerful communication media.  New “independent” sources of information such as blogs and Twitter are closing the gap between the reporting of pure facts as they happen and the highly editorialized information provided by print, TV and radio.  But such independent outlets can be too fast with their news sometimes—meaning facts aren’t checked and fabrications/distortions are mingled in with the reporting of validated information.

In general, I’d say that the popular media has a strong tendency to drive one point of view down readers’/listeners’ throats.  Since this occurrence is so prevalent in news about general topics, it’s no surprise that the same thing happens with the news about markets, especially at market highs and lows.

I got an interesting glimpse of this phenomenon after writing last week’s article describing my triumph with our household garbage disposal.

I was very surprised when some readers wrote me e-mails (very well written and even congenial, I would add) about my “admission” that I was sending solid food waste in the liquid water drainage system.

For years, environmental advocates have been arguing against using garbage disposals with warnings about the bad effects of putting solids in the waterways.  Without any study on the subject of wastewater treatment, this information would lead you to the conclusion that using a garbage disposal is environmentally irresponsible.  With a little research (as I did), however, you might arrive a very different conclusion.  Let me explain.

When you grind up an orange peel in the garbage disposal, the wonderful aroma makes the kitchen smell great.  Then, that ground up orange peel—and any ground food solid—goes into the drainage system but never gets anywhere near waterways.  Those solids get stopped at a wastewater treatment plant where live organisms digest them in a very environmentally friendly method, resulting in a bio-rich fertilizing sludge that is typically land applied, not land filled.

In short, if you live in an area with an efficient wastewater treatment processing system (as I do), using a garbage disposal to take care of food solids is just fine.  (For a concise explanation of this issue, please see the “P.S.” segment below contributed by a team of world-class environmental engineers.)

Decision Making and Outside Influences

Van did a masterful job when he outlined a useful decision making process in the Peak Performance Home Study Course:  See> Recognize >Feel Good > Act.  Most trader errors occur when they add extra steps or feedback loops to the process.

Problems can also crop up when we See> Recognize> Feel Good>Act based on information that hasn’t been validated. And that’s what often happens when we’re influenced by the media.  To gain more readers, viewers, or listeners, editors slant stories to appeal more broadly to the public so the public will want to “consume” them.  Also, editors tend to want to match their stories with other stories that are out there so they don’t stray too far from the norm.

This is why contrarian sentiment analysis can work so well for traders.  The magazine cover indicator—fading (going the opposite direction) stories on major financial magazines—has been shown to be a statistically significant and useful indicator.

So how can we use this knowledge about the mass media's habits today?  Fading magazine covers and talking heads on TV certainly takes some savoir faire over more mechanical trading strategies.  Regardless of the trading strategy you are using, however, it's important to not let stories and comments from the media (or other minimal depth research) throw you off your game plan.  This last point is especially critical to remember at market extremes, which can be periods of the greatest hype about market direction.  Media stories seem most plausible after long bull or bear runs because recent history is so strongly in their favor. 

The ages old adage to “Plan your trade and trade your plan” includes the concept of not being influenced by whatever conventional wisdom that the press is touting at the time. 

Great Trading!

D. R. 

P.S.  Here’s an excellent summary on the issue of garbage disposal use for getting rid of food solids:

1.  This is not a new issue by any means.  Environmental advocates have been arguing against garbage disposers since they arrived on the commercial scene.

2. If we were putting chemical or hazardous waste into the garbage disposal, then they would have a point.  But the "solid waste" we send through garbage disposals is 100% biodegradable and the local municipal Waste Water Treatment Plant (WWTP) efficiently processes that organic material. Underwater, this biodegradation takes far less time in a process similar to composting.   

3. Composting has its own set of questions about groundwater protection and runoff management to local streams.

4. In the US, the WWTPs operating permits prevent the discharge of high organic loads to surface water. The significant majority of bio-solids from municipal WWTPs are land applied, not land-filled. Some US facilities go so far as to capture the methane produced in the biodegradation process and use it as an energy source.

The bottom line is that garbage disposal units are one responsible way to deal with food waste in areas with municipal WWTPs.  On a related note, I learned that probably the biggest concern in waterway pollution today is nonpoint source pollution, especially storm water runoff in urban and agricultural areas.  That stuff is full of hydrocarbons, metals and pesticides that are causing eutrophication and toxicity issues for waterways. 

Thank you to all the folks who wrote and prompted my research.

About D.R. Barton, Jr.:  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".

Disclaimer 

Mail Bag

Should You Bet More During a Winning Streak?

Q: In re-reading Trade Your Way To Financial Freedom (First Edition) for the workshop next week I’ve come across something I don’t understand and would like some clarity for my trading.  I’m re-reading the bias section several times so I can understand them better to try and eliminate as many as possible when I get into my system design!

It seems that randomness is used to argue against investing more during a losing streak but in the second paragraph on page 38 you state, “When you understand what’s involved in winning, as do professional gamblers, you’ll tend to bet more during a winning streak and less during a losing streak. ”This seems to be saying that you should bet more during a winning streak. But I thought the whole point is randomness, which again is used against betting more while losing. If that is the case you can’t have it both ways. So if everything is not predictable and understandable and if these are just unjustifiable casual relationships where no patterns exist, then why would we change our investment/wager amounts during any streak, up or down?

Is it advisable to increase wagers/investments after winning and decrease after losing if in fact most moves are random moves over the short term?

Thanks. Best regards, Joe

A: I tend to distinguish price randomness as noise from any underlying price trend. You need to figure out for yourself how much randomness exists in prices and how you deal with that. Regardless, using the percentage risk method of position sizing, you risk a percentage of your equity— say 1%. During a winning streak your equity goes up and during a losing streak your equity goes down. In either case, however, you still risk 1% of your equity. When your equity is higher, the dollar amount of that 1% will be higher and when your equity is lower, your dollar amount risked will also be lower. Good position sizing helps you earn more with winning trades/streaks and lose less with losing trades/streaks. There are many more sophisticated position sizing methods that can accelerate your equity gains as well as put a brake on equity losses covered in The Definitive Guide to Position Sizing. Starting out though, percent equity position sizing can work quite well. — Van

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