Tharp's Thoughts Weekly Newsletter (View On-Line)

• Special Offer Early Enrollment Discounts for Ken Long's Workshops Expire TODAY
• Article January Market Update: Quiet Strong Bull by Van K. Tharp, Ph.D.
• Workshops New, Special Evening Presentation in Sydney, Australia
• Trading Tip Interesting Markets: Short Term vs. Intermediate Term by D.R. Barton, Jr.
• SQN™ Report SQN Report for January 2011 by Van K. Tharp, Ph.D.

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Feature Article

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, and 4) tracking the dollar.  Beginning this month, I will now report on the strongest and weakest areas of the overall market as a separate SQN Report.  And that may come out twice a month if there are significant market charges.

Part I: Van's Commentary—The Big Picture

We are in an interesting situation right now.  A number of US states and local municipalities are in terrible financial condition.  Congress is preparing legislation to allow states to go bankrupt.  That means they will be able to default on their debt, which in turn means they can dramatically reduce the pension payments that they cannot afford and do pretty much whatever they need to unravel many years of fiscal irresponsibility.  The US government itself is in much worse fiscal shape than any of the states.  The federal government, however, has one distinct advantage over any of the states: the Federal Reserve can print money, which it is doing with QE2.  Meanwhile, the dollar is still the world’s reserve currency.  In fact, I’ve recently read that some believe the US dollar will be able to maintain that status at least through this decade.

QE2 effects are already showing up.  When you look at the SQN Report that follows, you can see a massive flow of cash out of the bond market.  And since most funds have to be fully invested, that cash is now flowing into the stock market.  All aspects of the US stock market—growth, value, and blend-in large, medium, small and micro caps—have SQN calculations above 2.0.  I haven’t seen anything like this in some time.

The energy sector seems to be a main sector for the money coming into the stock market.  Meanwhile, gold is heading down and the US dollar remains very weak.  I just returned from a conference in Toronto, and the exchange rate at the airport was about $90Canadian for $100US.  It’s not that bad, but that’s what you get for your hundred dollars at the airport.

The stock market is not a good place right now for long term investors.  For day and swing traders, however, it’s a great place.  I’ll be really surprised next month if the US stock market still has an SQN calculation of 2.0 and will be doubly surprised if the energy stocks are as strong next month, as well.

Part II: The Current Stock Market Type Is Now Strong Bull Quiet

Each month I look at the SQN calculation of the daily percent changes over 200, 100, 50 and 25 days.  On January 31st, the market volatility was quiet, which suggests no immediate bearish action.  Furthermore, volatility had declined significantly and the market type graph showed a trend moving toward bullishness.  On February 1st, the SQN 200 was in the neutral range, but the 100, 50, and 25 day SQN calculations were in strong bull, quiet. 

The next graph shows market volatility.  You can see that the trend has been towards lower and lower volatility since late May.  The market is still quiet but volatility seems to be picking up a little and is very close to “normal” territory.

The only negative data I can find on the stock market comes from Jason Goepfert’s SentimenTrader newsletter.  Dumb money is 67% confident in a rally, whereas smart money is 38% confident in a rally.  That’s not as negative as it was a month ago.

Here are the performance figures for the three major indices over the last month.  All of them are up nicely and the DOW actually closed over 12,000 on Feb 1st.

Part III: Our Four Star Inflation-Deflation Model

Inflation looks a little stronger this month. 

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

At this point gold is having a seasonal correction; this could call for another 10% drop and last through March.  However, the long term trend will continue much higher, in my opinion.

We are in an inflationary environment unless we have another massive derivatives collapse.  Inflation could remain subdued, however, until the banks start lending again and then it could become interesting. 

Shadowstats.com estimates the M3 growth is about -3%.  And the St. Louis Federal Reserve is still showing that printed money is not being multiplied by the banks with the current money multiplier at less than 0.9.  Usually the money multiplier is in the 2.0-3.0 range, so the banks are not lending money.  It’s just going into the stock market. 

Part IV: Tracking the Dollar

The government again changed many of their dollar numbers for the last few months from prior figures.  My guess is that they really don’t want you to know what is happening to the dollar—it’s not pretty.  Again, here is a chart of the U.S. Dollar futures index.  Note this is a futures index, whereas the government numbers represents the cash price.

As you can see, the dollar is down, although not yet to its November lows.  As I mentioned previously, on a recent trip to Toronto, I got $90 Canadian money for my $100 US.  I doubt that the experience will be any different for me when I visit Australia next month.  I can remember when the Euro was worth 85 cents, the Canadian dollar was $1.30 and the Aussie dollar was even better.

General Comments

We’re in a secular bear market. That long term trend will mean dramatic reductions in valuations, taking the S&P 500 PE ratios into the single digits.  Fundamentally, things certainly support this trend even though in some secular bear markets the economy can actually be doing quite well.  And as I have said recently, the next down phase looks like it has been put off; bear markets don’t generally spring out of quiet volatility conditions.  Still, this is not a buy and hold market.  These market conditions, however, are great for trading and that goes for every country in the world right now. 

Once again, it’s my opinion that you should use the information in these monthly updates to discern when to switch trading systems and not to forecast the market.  This is why it’s imperative that you 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 book Super Trader, which covers these areas and more, 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 opportunities in 2010. 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 February update, this is Van Tharp.

About the Author: 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

by D.R. Barton, Jr.

“May you live in interesting times.”
---- Attributed Chinese Proverb / Curse

Yes, I have used the quote above in earlier articles.  It always seems to pop into my mind when thoughts of “two-handed economists” come along.  Two-handed economists give both sides of the analysis and say, “On the one hand…but then on the other hand…” without ever reaching a conclusion or providing a recommendation.  This must be an everlasting occupational hazard since this notion was immortalized by George Bernard Shaw in the early twentieth century when he said, “If all economists were laid end to end, they would not reach a conclusion.”  But I digress. 

The current market is a prime “two-handed” example for market observers.  On the one hand, almost all of the technical analysis community is looking for an overdue technical pullback.  On the other hand, every down move in this market has been met by more buying.

For the fundamental crowd, it’s a two-handed market as well.  On the one hand, many economic metrics continue to improve, albeit from monstrously horrid numbers in the spring of 2009.  On the other hand, inflation is heating up and unemployment numbers have not significantly improved over the last 18 months.

Which “Hand” Is It?

When faced with conflicting viewpoints, it’s useful to see if narrowing down information to an applicable time frame offers some clarity.  Luckily in this case, I believe it does.

For the short-term viewpoint, the market has spoken.  Despite being technically overbought (by some measures, severely overbought), and in the face of significant political turmoil in the world’s most volatile region, the market shook off Friday’s big drop and in two days hit new 52-week highs.

When the market shakes off bad news (specifically the massive protests in Egypt) and heads the other way, we cannot ignore the signal it provides.  The market is a bull until price action tells us otherwise.

In the intermediate time frame, the data may tell a different story.  Technically, we will need a pullback to relieve the intermediate term overbought condition in the market.  The inflationary pressures of rising commodities prices are starting to affect corporate earnings.  Hershey blamed rising cocoa and sugar prices for their earnings miss and Whirlpool cited the rising cost of plastics (think petroleum) for theirs. 

The threat of inflation is meaningful.  By now, we all know that quantitative easing really means “printing more money.”  Even my third grade economics students know that when there is more money chasing the same amount of goods and services, prices go up.  So all things denominated in dollars have been going up.

A Revealing Chart

The most interesting inflation graphic that I have seen in awhile came from Barclay Leib’s newsletter.  The “Food and Fiber Index” depicts a commodity-based index to its 200-day moving average.  The index tracks cocoa, coffee, sugar and orange juice (the foods) and lumber plus cotton (the fibers).

Again, this chart shows how far the food and fiber index has moved away from its 200-day moving average.  The two times in the past where it rose more than 40 points away from the 200-day MA in the past 15 years were followed by memorable market corrections.  The index hit that level two months before the Asian currency crisis in 1997 and two months prior to the 2008 market highs.  With cotton hitting all-time highs recently and other commodities hitting extreme levels as well, the index has alerted us to  a “red flag” point once again.

Bear in mind that this chart tells a fundamentals story; it’s not a piece of technical analysis.  When prices for consumables get too high, they begin to have a material impact on corporate profits.  So the rosy earnings picture that we’ve seen over the past couple of quarters could be in jeopardy.  Should the Fed decide to slow inflationary pressures, their actions definitely will impact the markets in the intermediate term.

The Traders View

An equities market’s slow and consistent climb higher doesn’t always end when the technical analysis says it should.  Meanwhile, we can’t ignore the bigger forces that continue to work in the intermediate to longer time frames.  These subdued but ultimately stronger forces lend a cautious tone to the equation.

I’d love to hear your thoughts and feedback on this article or about trading and investing in general at drbarton “at” iitm.com.  Until next week…

Great Trading,
D. R.

About the Author: 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 »

SQN Report

by Van K. Tharp, Ph.D.

I now use the System Quality Number® calculation or SQN calculation to measure the market performance of countries, currencies, commodities, and various equity sectors in my world model.  I use the SQN 100, which is the SQN calculation over the daily percent change of the various ETFs we follow over the last 100 days.  A score over +1.45 is strongly bullish; a score below -0.7 is very weak. 

• Green (strongest): Those that are more than one standard deviation above the mean (about 1/6 of the ETFs scanned).
• Yellow (the next strongest): Those above the mean up to one standard deviation (about 1/3 of the ETFs scanned).
• Brown (weak): Those within one standard deviation below the mean (about 1/3 of ETFs scanned).
• Red (very weak): Those more than one standard deviation below the mean (about 1/6 of the ETFs scanned).

The report covers most ETFs currently traded except for leveraged ETFs.

World Market Summary

Suddenly many sectors are mostly green and the US markets are especially strong.  In fact, all of the US sectors have SQN calculations above 2.0.  I haven’t seen this for a long time.

Other strong countries include Taiwan and Mexico.  Right now I’m only including those with ratings above 2.0 because of the large number of strong sectors.

The energy sector has an SQN calculation above 3.0.  Other strong areas include Oil and Gas Equipment, Oil and Gas Exploration (also above 3), Industrial, Semiconductor, and Technology. 

US stocks are booming; however, the U.S. dollar is very negative. Also, only one country is negative (India). 

The next table shows commodities, real estate, and interest rates plus the strongest and weakest areas. 

Sector Summary

Natural gas is negative despite the very cold winter in the US.  Money is flowing out of interest rate products—every single interest rate product above 3 years, is negative—and even the short term ones are not strong.  The only strong area in the debt sector is junk bonds. 

Most commodities are relatively strong, except for gold and livestock.

The strongest areas all relate to energy with seven ETFs over 3.0, most of them over 2.7.  The only strong non-energy in the top list is semiconductors: SMH and XSD. 

My Interpretation

Since I started this report, I’ve never seen results quite like this.  I think this month’s report clearly shows that massive amounts of funds are flowing out of the bond market because of rising interest rates.  Only recently was nearly every category of bonds strong.  Well, that bubble has burst.  I can only hope that not too many people were hurt by that. 

That money has to stay invested; so where’s it going?  It’s going into the only place it can go—the stock market.

It is a crazy world. 

About the Author: 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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