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Market Update 
for Period Ending December 2005

Look for these monthly updates on the first issue of each month. This allows us to get the closing month data.  In these updates, we cover each of the major models mentioned in the Safe Strategies book:  1) market commentary; 2) the 1-2-3 stock market model; 3) the five week status on each of the major stock U.S. stock market indices; 4) our four star inflation-deflation model; and 5) tracking the dollar

Part I:  Market Commentary.

So, how did the stock market do in 2005?  The Dow Jones Industrials closed down 0.34% on the year.  The S&P 500 closed up 3.5% on the year, while the Nasdaq was up 4.8% on the year.  We were in red light mode for the entire year and this behavior is pretty typical for red light mode.  Most of you could have the same amount of money in a money market account and that account was safer.

However, many of the world markets did quite well in 2005.  Latin America, Brazil, South Korea, and Japan all did very well in 2005.  So did oil, gold, and most other commodities in 2005.  I think we�re clearly in an inflationary bear market, with the inflation being masked by the way the government keeps its statistics.

I was quite delighted to learn that Ken Long�s mutual fund strategy was up 27.73% in 2005 and that involved very few adjustments.  Congratulations, Ken.  By the way, Ken teaches that strategy at our ETF workshop, scheduled for April 5-7^th in 2006.  His track record is up 98.1% in 1999, up 20.6% in 2000, up 9.88% in 2001, down 8.6% in 2002, up 22.7% in 2003, up 2.5% in 2004, and up 27.7% in 2005.

Part II: The 1-2-3 Stock Market Model IS IN RED LIGHT MODE.  

The Federal Reserve has now increased interest rates 13 times since it began doing so in 2004.  This year I expect those increases to have a significant effect on the real estate market and perhaps even bring a recession into the U.S. economy.  I�d be very surprised if 2006 only has a single digit change in the stock market.  We�re due for some big changes, but let�s wait and see what happens.

Let�s look at what the market has done over the last five weeks and compare that with where the averages were December 31^st last year.  This is given in the next table. Incidentally, this data is calculated by hand based upon last Friday�s close (i.e., December 30, 2005), so there is always a possibility of human error in the numbers.

Efficient stocks.  The markets are quite deceptive right now.  As I mentioned last month, the markets were showing about 2/3rds positive efficiency ratings and it was difficult to find a good negative efficiency stock to short because all of them were in slight uptrends.  However, during the month of December I got stopped out of the two negative stocks and about five of the positive efficiency stocks.  The market was very hard on this particular strategy in December.  Yet December ended up with a similar picture � with 2/3rds of the market showing positive efficiency and only 1/3 showing negative efficiency. Yesterday was a huge day for efficient stocks and that may continue throughout January.

Many of the better positive efficiency stocks are very low priced stocks such as SA, TRE, MEH, and BTJ.  Others that have been around for some time include RES, PZZA, SKP, and IVX.  And, as I mentioned, on the negative side, I don�t see any I like.  However, you probably could have done really well last month shorting some of the most efficient stocks like TIE that I mentioned.

Incidentally, since I trade this strategy, I may or may not, have positions in the stocks that I mention.  However, these examples are given for educational purposes and you should do your own due diligence if you decide to trade them. 

Part III: Our Four Star Inflation-Deflation Model.

I now strongly believe that we are in an inflationary bear market and that our inflation rate is simply masked by government statistics.

So far our models have been telling us that inflation/deflation is pretty steady, with a slight inflationary bias and that�s where secular bear markets tend to start. 

So what�s our new indicator telling us about inflation?

1)      The CRB index

2)      The price of Gold

3)      The CPI and

4)      The trend in interest rates.

Since the description of the model we�re now using is not in any of my books, I�ll continue to give it here. 

1)  The CRB Index.  I believe that the CRB index is the one we have currently that is the least manipulated by the government.  But what�s the best way to measure it.  For consistency, I plan to give two measurements. 

�       Is the CRB index higher than it was six months ago?  If it is, we are on track for inflation.

�       Is the CRB index higher than it was two months ago?

Now there are several ways to monitor these two indices.

�       If both differences are higher, we�ll count one star for inflation. 

�       If the six-month change is higher, but the two-month change is not, then we will only count � star for inflation. 

�       And if both the two and six month changes are lower, then we�ll be minus one for inflation.

�       However, if the six-month change is lower, while the two-month change is higher, then we�ll be minus � star for inflation.  Obviously, the two minus scores will point to deflation.

2) The Basic Materials Sector ETF (XLB).  In an inflationary environment, basic materials will definitely go up and this sector, to the best of my knowledge, is not manipulated by the government.  Thus, we will use this sector to monitor inflation and we�ll use the same measurements use for the CRB.  (1) Is the XLB higher than it was six months ago?  (2) Is the XLB higher than it was two months ago?  These two measurements give us four possible results.

�       If both differences are higher, we�ll count one star for inflation. 

�       If the six-month change is higher, but the two-month change is not, then we will only count � star for inflation. 

�       And if both the two and six month changes are lower, then we�ll be minus one for inflation.

�       However, if the six-month change is lower, while the two-month change is higher, then we�ll be minus � star for inflation.  Obviously, the two minus scores will point to deflation.

3) The London PM Gold price at the end of each month.  Although the government can manipulate Gold, I still like to look at monthly gold prices.  However, to be consistent, we�ll use the same two measurements that we�ve used for the other indices that we are monitoring.  1) Is the price higher than it was six months ago and 2) is the price higher than it was two months ago.  Again, these two measurements give us four possible results.

�       If both differences are higher, we�ll count one star for inflation. 

�       If the six-month change is higher, but the two-month change is not, then we will only count � star for inflation. 

�       And if both the two and six-month changes are lower, then we�ll be minus one for inflation.

�       However, if the six-month change is lower, while the two-month change is higher, then we�ll be minus � star for inflation.  Obviously, the two minus scores will point to deflation.

4) The Fourth Measurement we�ll use is related to the Financial Sector of the S&P 500.

The financial sector (XLF) tends to do well when we have deflation and poorly when we have inflation.  Martin Pring, in fact, has used an index in which he divides the XLB by the XLF.  Since we already use the XLB, we�ll use the XLF by itself as well.  Again, we�ll use the change over six months and over two months.  However, the four possible outcomes will give us a different interpretation.

�       If both differences are higher, we�ll count one star for deflation. 

�       If the six-month change is higher, but the two-month change is not, then we will only count � star for deflation. 

�       And if both the two and six month changes are lower, then we�ll be plus one for inflation.

�       However, if the six-month change is lower, while the two-month change is higher, then we�ll be plus � star for inflation.  Obviously, the two minus scores will point to strong inflation.

Okay, so now let�s look at the results for the last six months. 

We�ll now look at the two-month and six-month changes during 2005, to see what our readings have been.

The results of this model are much more sensitive (I believe) than the model I presented in Safe Strategies for Financial Freedom.  The model seems to be signaling a struggle between inflation and deflation with inflation winning slightly.  Notice that the increase in the price of gold over the last six month is quite dramatic and this has occurred while the dollar has been fairly strong (see below).

Part IV: Tracking the Dollar.

Before I get into a discussion of the dollar, I want to look at U.S. debt and repeat a little of what I said two months ago.  The debt has now passed $8 trillion.  In Safe Strategies for Financial Freedom, I showed the government statistics which included future obligations, giving us a debt of $31 trillion.  Well, in February of 2005, Professor Kent Smetters during a congressional testimony said that our off budget debt was now $65 trillion.  We�re now approaching a future debt by our government of about $700,000 per household.  Is your family�s net worth over $700,000?

What does this mean?  Well, our economy is growing at about 3-4% per year.  Our debt is growing at between 7-8% per year.  This basically means that the dollar will eventually collapse or be inflated out of existence.

Look at the next table showing the dollar index over the past year.

The dollar is now much higher than it was at the start of the year.  This is because U.S. interest rates are starting to get higher and money is attracted to currencies with high interest rates.  However, don�t expect too many more increases from the Federal Reserve or we will see a big time housing and stock market collapse. 

What this all means.

Notice that gold has been going up (15% since May) while the dollar has been rising since March.  This is certainly an interesting picture that suggests inflation. 

Our big picture still suggests a long-term BEAR market.  The secular bear began in 2000, but conditions are ripe for one to start even at current levels.  Plus debt continues to grow faster than the economy.  So something must happen to correct it all.  However, who knows when that will happen.  This is not about prediction, it�s about looking at conditions influencing the economy and seeing what happens.  There will always be good ways to make money if you are willing to work on yourself to get past your fear, greed, and other emotions to just see what is going on in front of you.  So let�s continue to watch the market for more signs.  Until the end of January update on the market�this is Van Tharp. 

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Trading Tip 

Trading Tip

Does General Motors Have a Chance?

by D. R. Barton, Jr.

Long-time readers will know that I�m not a huge fan of fundamental analysis.  I know that it has a very important place in trading and investing.  But for me, it is a useful, but subordinate discipline.

With that said, all of the analysis disciplines, including technical, sentiment and fundamental analysis are lining up against GM.  As if GM shareholders needed further bad news.

On the technical side, the stock chart shows the price heading from the upper left corner to the lower right corner.  Hang almost any technical indicator you want on the chart and it won�t paint a very encouraging picture.

Fundamentally, GM announced today that domestic sales are down 10%, at a time when Toyota and Honda are announcing large increases (Toyota up10%).  GM�s obligations in terms of pensions and other benefits are well known and are sadly keeping them from making sufficient capital expenditures to keep up with their Asian competitors.  Revenues are dropping and earnings are negative.  Cash flow is negative before cash borrowed is considered.

On the sentiment side, while the broader market rallied substantially yesterday, GM lost ground.  Granted they received another in a series of downgrades to start the Tuesday trading session.  But anytime the market gives a rally cry and a stock fails to answer, it is cause for concern.

From a trading and investing standpoint, you have to go back 20 years to find support levels below 20 for this venerable stock.

Management seems to be doing as much as can be expected given the handicaps and handcuffs they have inherited on the both the capital and labor fronts.  The bottom line seems to be that it�s not prudent to fish for a bottom on this stock in the near future.

D. R. Barton, Jr. is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching, and teaching in the markets since 1986.  D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through  Electronic Day Trading.

Listening In...  

From Van Tharp's Mastermind Forum

End of Year 
Author: Craig
Date: 12-18-05 19:21

Every year, as December 31st approaches, I wonder how do I value my total portfolio? My current approach is to take the year end values of all positions in total and begin the new year with that portfolio total while keeping all cost basis going forward. I have this need to measure performance on a calendar year basis (maybe I should lose this need). 

The reason I wonder stems from several years now where my portfolio was worth x on Dec 31 and x-10% on Feb 1 (for example) yes, that's simply a drawdown . . . . but here's the catch . . . . the portfolio, in spite of being down 10% from Dec 31 was still positive on a cost basis. 

The problem of dealing with a portfolio that has diminished from an arbitrary annual end date is one I can't resolve. do I just forget about the performance aspect and concentrate on making sure expectancy is positive and keep making winning trades?? do I "rebuy" the portfolio on Jan 1?? (This requires a more complex spreadsheet than I care to burden myself with. any thoughts would be greatly appreciated. in fact I could share my spreadsheet with any of you to compare the process.


Reply To This Message 

Re: End of Year 
Author: Terry
Date: 12-18-05 21:07

Craig,

Calendar dates are interesting time demarcation lines, but they tell you nothing about the value of your portfolio.

You ask yourself the question about your portfolio, "do I forget about the performance aspect and concentrate on making sure expectancy is positive?" My answer to that is, your performance aspect IS your positive expectancy! 

Calendar dates in essence are immaterial. They may not be from an I.R.S. point of view, but from a value point of view, that is another thing.

Regards, Terry


Reply To This Message 


Re: End of Year 
Author: PMK
Date: 12-19-05 08:21

Craig,

Although end of calendar year is a good time to do a review of your trading performance, the IRS is the only one really interested in how your portfolio performed for that particular (arbitrary) 12 month period.

If you consider your equity curve to be a (hopefully) upward sloping wave, then it is more useful to consider the trend of the LOWS to be representative of your portfolio value, rather than the current value at some point in time; unless a point is an equity low (which we only know with hindsight) your portfolio will generally not be worth in the immediate future what it is right now.

As for retaining cost basis, that is important so you know which of you current positions are winners or losers - and can have rules to treat them differently if you want to.

As for 'rebuying' the portfolio on Jan 1 - my belief is that I am 'rebuying' my portfolio every single day the market is open because I am making the decision to keep my current positions in preference to any other positions I might take - each day is a new day and a new decision.

Hope this helps

Paul


Reply To This Message 


Re: End of Year 
Author: Level 7
Date: 12-19-05 10:58

I also track my year end portfolio and think very similarly to both Terry and Paul. (I totally agree with Paul's excellent rebuying comment since I review all open positions every day before market open to develop my plans for that day.) 

I track a weekly performance as well every Saturday. In all cases I use the closing position balances on the day I am measuring it - just like you described I think.

The reason for performance tracking is simply a regular stick in the sand to see how I am doing against alternative investments. Therefore the actual number is not that important, but the number compared to other investment choices I could have made that year. A bad year can happen but a series of bad years (or weeks in my case) should be looked into. Consistently poor performance means I should fire myself!

Your method should be consistent and then the numbers should iron out in the long run. Also, it is important to know why you are measuring it in order to "tune" it. 

For example, I have a weekly target as my recent goal has been consistency over absolute returns. That is the purpose of the new weekly tracker.

Hope that helps.


Reply To This Message 


Re: End of Year 
Author: Craig
Date: 12-19-05 11:23

I also mark my portfolio to the market at the end of every day. It's just that it's a little perplexing knowing that at the end of the year, the portfolio has lost value from the previous end of year value while at the same time total trading has been profitable. Thanks for your comments. 

Editors Note: As Always...read the complete and unedited thread  at the link below. Look for the title, "End of Year" to read many more posts on this topic.

Special Reports By Van Tharp

Click below to read page one of each report, or to order. 

Self  Sabotage - Two Reports of Self Sabotage

Does Your System Still Work In Changing Markets?

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