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Market Update for the Period ending February 26, 2010
Market Condition: Long Term Bull Normal, Short Term Neutral Normal—Caution!

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 US 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

I'm writing this update from New Zealand where we just finished three workshops for our Asia clients. Several days ago in the local newspaper, I found an interesting headline in the business section: World Trade Had the Biggest Drop since the End of World War II. When I'm traveling, I notice I find such articles but I don't see this kind of news in the U.S. newspapers. And when it does show up, it is certainly not in the headlines. Would you agree? Also, this story is also interesting to me because bear markets don't end on this kind of news.

Part II: The Current Stock Market Type Is Now Normal Volatile Bull to Neutral Trend

Again, we're right on the fence between market types, but the market didn't get any worse during the month of February. Over the last two months the SQN^TM for 100 days has moved back from strong bull to normal and now back to bull. The 50 day SQN has moved from strong bull to bear and back to neutral. Last month, the ATR as a percentage of close was quiet, but now it has moved to the normal volatility range. I'd be very, very careful under these conditions.

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 and over the last few years.

You'll notice that the Dow is down 1% after an 18% climb in 2009. The S&P 500 is down 1% after being up 23.45% in 2009. And the NASDAQ is down almost 20% after being up 43.89% in 2008. However, the second half gains in 2009 were huge after big losses in the first quarter. Watch our market type closely because I doubt if much of 2010 will be bullish.

Notice that the overall market as measured by the S&P 500 and the DOW is lower than it was at the close of 2004. And the NASDAQ is only slightly higher than it was at the close of 2004.

Part III: The Strongest and Weakest Market Components

By this time, most of you understand how we track the relative strength of the various ETFs representing the economy of the entire world. I publish this model once a month. Ken Long, who developed the algorithm we use, publishes a similar report every weekend at www.TortoiseCapital.com. Ken uses his data as a framework for trading a number of his systems.

The February 26th data are given below.

The areas in green are strongest (those areas are more than one standard deviation above the mean); those in yellow are the next strongest (above the mean up to 1 standard deviation). 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, which means that the top and bottom funds are not devoted entirely to those groups.

The overall market is relatively weaker than it was at the end of January. China is the only country that is green, though it is still weak. China's slight uptrend in the last month helped its score because the most recent month's performance is heavily weighted in this algorithm. No other country is green, confirming a general downward trend.

Particularly weak countries include Spain (28), Austria (34), Germany (39), Taiwan (39), and Emerging Europe (39). Weak currencies include the British Pound (33), the Euro (39), and the Swiss Franc (41).

From a sector standpoint, utilities (42) are on the weak side. Relatively strong areas include consumer discretionary, metals and mining, retail, REIT, semiconductors, media, and the DOW transports. I wouldn't consider any of those as investment worthy; they are just the best sectors of a generally weak bunch at the moment.

The next chart shows performance for commodities, real estate, bonds, and the strongest and weakest of all non-leveraged ETFs.

There's an interesting mix on this table with nickel and biotech on top with oil, coal, steel, and real estate also being areas of relative strength. The weakest areas are natural gas, broadband, global energy, Spain and Italy. Interest rate products moved from relative strength last month to relative weakness this month after the Fed's announcement about increasing the discount rate.

What currently stands out to me is the absence of any month to month trends. We used to see strong areas stay strong for many months. Now the strongest areas are that way for a single month and right now nothing is very strong.

Part IV: Our Four Star Inflation-Deflation Model

The US economy (and much of the world economy) is in a credit contraction mode. While the quantity of money in the economic system may be higher as a result of massive government infusions, its movement around the economy—the velocity of money—has slowed significantly in the last year. What's causing this? The personal savings rate is way up, people and companies are trying to pay down debt, and overall bank lending is in steep decline. Six or seven years back I thought we were in for an inflationary bear market, but the slowing velocity of money makes that scenario less likely for now.

As you can see from the long term numbers below, gold is way up from a few years back, but there's no strong multi-year trend visible in the CRB or the materials ETF (XLB). Conversely, financials (XLF) are half of what they were just three years back. On a long term basis, these indicate we do not have inflation….yet.

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

Again, the model shows us moving towards deflation. For some time, The Elliot Wave Theorist newsletter has been predicting a huge deflationary wave ahead of us. A two month move from +2.5 down to +1 certainly suggests we are moving in that direction.

Part V: Tracking the Dollar

The dollar has been going up for the last four months partly because of the seasonal weakness in the Euro. As I mentioned last month, the Euro typically starts going down in December and that can last into the spring. And Europe has been hit by much worse economic conditions than the United States. The PIIGS debt situation has also been weighing heavily on the Euro with Greece getting much of the current attention.

General Comments

I'd like to point out here that while I've said that we've been in a secular bear market since 2000, Dow Theory basically says that the real bear market started in 2007. In 2007 the DOW passed 14,000 to hit a low of only 6747.05 last year. There is a lot more of the bear market to come.

In these monthly articles, I try to give you a general update about market conditions and when they might be changing. That being said, please don't rely on these updates to guide your trading. This article is no substitute for you having a system of your own that signals good exit points. Furthermore, you should never open a position in the first place without knowing when to get out. That's a fundamental axiom for trading and investing. You could consider this update as a way to help you decide when to change what systems you trade based on the market type changes.

Additionally, you should know how your system will perform under various market conditions. If you haven't heard this before or the other ideas mentioned above, read my new book Super Trader, which covers all of this, so you can make money in any kind of market.

Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. There were lots of good opportunities in 2009. Did you make money? If not, then do you understand why not? The refinement of good trading skills doesn't just happen by opening an account and adding money. You probably spent years learning how to perform your current job at a high skill level. Do you expect to perform at the same high level in your trading without similar preparation? Financial market trading is an arena filled with world class competition. Additionally and most importantly, trading requires massive self-work to produce consistent, large profits under multiple market conditions. Prepare yourself to succeed with a deep desire, strong commitment, and the right training.

Until the March 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

The Banking Sector:

Still at the Top of the Perception Ladder

by
D.R. Barton, Jr.

Last week I wrote about the historically high pace at which US banks have been decreasing their loan volume recently. 

I didn’t expect the depth and breadth of comments that I received about the banking industry in general and about the article in particular.

The public outrage at banks currently “just below the surface” promises to grow into a much bigger phenomenon. 

Why the Fervor? 

Actually, I think it’s a fairly simple explanation. Banks got into such big trouble by taking huge risks (e.g., relaxing mortgage requirements and making speculative investments outside of “traditional” banking areas). The whole current financial infrastructure almost ground to a halt thanks to their epic collapse.

Taxpayer dollars and massively favorable regulatory changes then bailed them out. This led to the environment in the last 12 months where the game is so one-sided that Rocky, our family’s Havanese dog, could have turned a profit if he ran a bank by borrowing money from the Fed at 0% interest and buying Treasury notes returning 2+% interest. And, oh yeah, no need to write down any of those bad mortgages; we’ll change the accounting rules so your balance sheets still look peachy.

So the big banks’ journey started “24 hours from extinction” and arrived at its familiar destination of huge bonus payouts in less than 18 months.

The problem is that the banks took that journey on the backs of taxpayers. 

Taxpayers’ Reward? 

So how have the banks rewarded the heavily leaned-on taxpayers for their rescue? With better rates? With reduced fees? With bridge loans to allow small businesses to make payroll in tough times? 

How about the opposite?

Banks have dropped savings account rates to basically zero interest. Bank fees have escalated, as have interest rates on credit cards. And what about a loan for anyone with a balance weaker than Cisco? Forget about it.

Politicians posturing for fall re-election will find a convenient “fall guy” in the banking sector. A public that is mad as heck will be more than happy to stand back and cheer.

Beyond the Outrage: Banks’ Other Challenges

Moody’s estimates that about one third of ALL mortgages in the country are under water (the property is worth less than the loan). And the Obama administration is looking at banning foreclosures until each individual case is reviewed by the government assistance agency (Home Affordable Modification Program—that’s a mouthful) to make sure the foreclosure candidate is not eligible for assistance. Talk about the foreclosure process grinding to a halt!! And if this little ditty is enacted, it won’t be long until the worst cases find folks paying no mortgage or rent while they wait months—or dare I say years—for their case to be reviewed. And the banks will be left holding the bag.

On top of that, my friend Jim W. wrote some interesting thoughts in a recent e-mail to me. Jim was a commercial lender for years but now consults with banks, so he speaks as a banking insider. Banks are seeing the structural appetite for loans changing radically—consumer appetite for debt is declining. This is a dramatic shift from the half century plus culture of debt-based consumerism. Combine this new trend with the likelihood of moderated real estate prices, and we could see an underperformance of the banking sector for years or possibly even for decades.

Conclusion

While my analysis last week was for a banking “catch-up pop” in the intermediate term (less than a year time frame), I think it will be a volatile catch-up and then drop cycle. I know many folks who have been playing banks, even day trading them over the last 18 months. It’s a bit alarming to me that banks are so volatile now that traders can treat them like tech stocks.

As traders, we can look for the volatility in bank stocks to continue and provide some nice catch up moves. Watch out for violent drops though when the government announces unfriendly legislative moves for the banking sector (and announce they will). 

As investors, keep in mind the longer term prognosis for banks is not so good. 

Buyer beware (or at least be nimble!).

Great Trading,
D. R.

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”.  

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Mailbag

Should I Change My Figures for My Specific Market?

Q: I'm from India and have your Peak Performance Course for trading. I also read your books Trade Your Way..., and Super Trader.

While I was reading Super Trader, I had one query concerning Indian Market conditions. You use a 13-week rolling change to decide whether the market is bullish, bearish or sideways. The average for your markets as discussed in your book is 5.53%. This same average for Indian market (NSE NIFTY) is coming out to be 11.85%. So my question is should we change this value to suit Indian markets for the purpose of arriving at market type, if we are just trading the Indian markets?

Secondly for 13-week ATR, the average for your markets as per your book is 2.87%, whereas for Indian markets (NSE NIFTY), it is coming out to be 5.24%. Should we use the 5.24% figure (for Indian market) to decide whether this is a volatile or quiet market?

A: Use the measurements taken from the market you wish to trade. It’s interesting to compare figures from different markets but the most relevant figures for you are from the market you trade. That you have already done this for your market provides you an edge. Gather and use as many edges as you can to help your trading. 

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