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

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• Article September Market Update: Normal Bear by Van K. Tharp, Ph.D.
• Trading Education $700 Discount and Free Offer Expires Next Week
• Trading Tip The Flash Crash Revisited by D.R. Barton, Jr.
• Mail Bag Tying Together Weekly and Monthly Reports

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Feature Article

Market Update for Period Ending October 1, 2010
Market Condition: Normal 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 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 strongest and weakest areas of the overall market. Note, the methods I now use for the market update replace methods I used in the past such as the 1-2-3 model from my book Safe Strategies.

Part I: Van's Commentary—The Big Picture

I’ve been in India for most of the month of September.  This was my first trip to India that was partially assisted by one of the directors at Karvy.  They actually sponsored a free talk for about 100 people in Mumbai and got me on an interview on an Indian financial television channel, which will actually be the topic of a Tharp’s Thoughts newsletter this month.  The Indian market is approaching new highs and was up tremendously during the month I was there. (I’ll discuss this more later on in the update). 

I returned from India yesterday.  My flight in Hyderabad was delayed 90 minutes, which caused me to miss my 2AM flight in Dubai to JFK. I spent the entire evening in Dubai airport’s business class lounge.  That lounge is basically open to the entire airport (2nd floor); there was no way I could sleep.  I then took an 8:30AM flight to JFK that arrived an hour late.  I had already missed my RDU flight, but the hour delay caused me to miss a substitute flight that my wife had booked for me.  I arrived in JFK at about 3:30PM and managed to get a standby seat on the American Airlines flight at 7:40PM.  However, the flight was delayed until 9:40PM and I arrived at home at midnight.  The good news is that I fell asleep right away and got a normal night’s sleep, so perhaps no jet lag. 

Part II: The Current Stock Market Type Is Now Normal Bear

Each month I look at the SQN® of the daily percent changes over 200, 100, and 50 days.  On October 4th, the market volatility was neutral, which suggests no immediate bearish action. 

On August 31st, the volatility was volatile and both the 200- and 50-day SQN® were neutral.  The market condition, based upon the 100-day SQN, which we rely on the most, was normal bear on the close October 4th.  However, there has been a nice uptrend in the market type from just touching strong bear moving to neutral and back into bear territory.  The trend is definitely up volatile right now, but volatility is low enough that I’m not too worried about the bear for a while.

The 100-day market type (our primary focus) is displayed  in the chart below.  I believe this presentation of the data is much easier to interpret than the table format that I have been using for the last year or so.  The graph is not as clear as it could be, but it is automatically drawn by Excel.  However, the overall trend is very clear.  You shouldn’t need to know whether it’s exactly bear or strong bear.  You can see what’s going on simply by looking at the trend.  This is part of what I mean by trading in the now—don’t let your internal chatter get in the way of the market telling you what’s happening. 

The market volatility is normal, which makes the bearish movement seem a little less ominous.  Strong bear markets are usually associated with volatile and very volatile markets.

Market volatility, as show by the next graph, has clearly been getting less volatile since June and it’s now firmly in normal territory.  Bull markets seldom occur 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.

All three indices are up for the year, although not tremendously.  The weekly changes in the NASDAQ have been over 3% for two weeks this month.  That’s a good sign for the NASDAQ.   

Part III: The Strongest and Weakest Market Components

As I’ve mentioned over the last few months, I decided to use SQN® to measure the market performance of geographies, countries, currencies, and sectors in my world model.  I use the SQN 100, which calculates the SQN over the daily percent change of the various ETFs we follow over the last 100 days.  A score over +1.45 is very strongly bullish; a score below -0.7 is very weak.  I have kept the same color scheme:

• 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 below the mean and within one standard deviation (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).

I removed all the leveraged funds from my database, which means that the top and bottom funds are devoted to the true strongest and weakest performers rather than to leveraged instruments.

Right now, the strongest country is Chile, followed by Hong Kong and Thailand.  All of the Asian and European markets are at least yellow, which is more than I can say for the US markets.  Thus, our markets, although positive on the year, are hardly keeping up with other areas of the world.  Chile and Thailand have done very well for a while, so we’re beginning to see some longer term trends in the world markets.  Chile’s 2.39 SQN is about as high we will usually see from a country ETF.

According to data, the Indian market is up 32% over the last 12 months, although it only has a 1.34 SQN. While the countries look pretty good, the US and European sectors don’t look that strong at all.  The highest SQN for sectors is in world building materials at 0.46.

The Japanese Yen is very strong among currencies, while the US dollar is very weak. (See our section below on the US dollar).

The next table shows commodities, real estate, interest rate instruments, and the strongest and weakest areas of the overall market.  Commodities, after being weak last month, are starting to pick up a little.  Silver and agriculture are the strongest areas, with oil and livestock being weak.  Interest rate products are still in a frenzy, which I think is a dangerous trend.  The small investor is retreating to interest rate products, which he thinks are safe even though they are not paying great returns.  And unfortunately, this is probably the next bubble that will burst and destroy the wealth of many who cannot afford it.

If you look at the top and bottom ETFs, it’s not too surprising.  The interest rate sectors tend to dominate with the top bond funds having SQNs over 2.0.  The weakest funds are banking, the US dollar, natural gas, and building.  Small cap funds are not doing well at all.

Part IV: Our Four Star Inflation-Deflation Model

Inflation looks a little weaker this month, but it’s basically because XLB, which is one of the weak sectors, is still showing inflation.

We'll now look at the two-month and six-month changes during the last six months to see what our readings have been.  These are the strongest results I’ve seen since I’ve been doing this.  That’s good for a country with the debt we have.

Shadowstats.com still calculates M3, which is the total money in circulation.  And M3 has been shrinking dramatically, currently just bouncing off -6%.  That’s certainly not an inflationary sign.  However, inflation, as measured by the calculating the CPI the way it was originally intended, is still at about 8%.

In addition, the GDP, adjusted for real inflation, still shows that we have been in a recession since 2000 with just one quarter (in 2003) being positive.  And real unemployment continues to be about 22%.  For more information go to shadowstats.com and see John William’s fine work.

 Part V: Tracking the Dollar

This time I have up-to-date numbers from the Fed, but I don’t think the monthly closes show prices nearly as well as the Futures chart.  We’ve had some dramatic swings in the dollar in the last year.  And the current trend is clearly down again.

By the way, I got lucky with the Tharp effect when I was in India.  With the help of some friends in high places, I changed a sizable amount of money into Indian Rupees.  The actual rate was 46.11 and I got 46.  The next day the dollar dropped 1% and the tourist rate at the airport in Chennai was 41.85 (42.35 at the hotel).

General Comments

We’re in a secular bear market.  A long term trend will mean dramatic reductions in valuations, taking the S&P 500 PE ratios into the single digits.  Fundamentally, things certainly support that trend even though in some secular bear markets the economy can actually be doing quite well. 

The next down phase looks like it has been put off.  I don’t expect much in the way of down markets while we have normal volatility.  However, most of America has been fleeing to bonds that are paying miserable returns.  And as soon as rates start to go up, which they must at some point, another great bubble will burst and Americans will see more of their wealth disappear.  These are trading markets only.

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, attend our upcoming How to Develop a Winning Trading System Workshop. If you can't attend the workshop, 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 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? Most people spend years learning how to do their professional work.  Doesn’t it make sense to put the same kind of effort into learning to trade?    

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 October 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.

Something is rotten in the state of Denmark.
                              -- Marcellus to Horatio in Shakespeare’s Hamlet

When “something smells fishy” it means that something suspicious is happening.  The written use of the term dates back to 1840; however, most linguistics would agree that the idiom was born from the above quotation.

In fact, the phrase “something smells fishy” is so prevalent, and Shakespeare is so often quoted, that the two have morphed in common usage to “something smells fishy in Denmark.”  Indeed, Google found 5,070 instances of this exact phrase.  In fairness to common culture, it’s not a far stretch from “rotten” to “smells fishy.”  And something certainly smells fishy in the recently released report on the flash crash.

May 6th was one of the wildest trading days that I can recall.  It is unrivaled in sheer velocity of price movement.  In less than 45 minutes, the S&P 500 dropped more than 4.5 times its average daily range.  It then regained almost 90% of that abrupt drop in the following 25 minutes.  It was quite a wild ride.

This market movement rocked the faith that investors had in the system (at least temporarily). And it left many people who had been stopped out of positions at very bad prices shaking their heads and wondering what freight train had run over them.

Clearly, this extraordinary market swing demonstrated the lack of certain structural necessities—unless you believe the new regulatory agency report that came out this week.

Back in May, all of the regulatory agencies declared that no one incident or trade caused the flash crash.  But this week, a 104-page report issued jointly by the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) named one trade as the “key contributing factor” to the flash crash.

I must say that I find their conclusion a bit flimsy.  It fails my two main tests for these types of reports: the “smell test” and “common sense test.”

Two Tests, One Conclusion

Let’s look at the smell test first.  In this test we ask, “Does something smell fishy?”  That is to say, does it seem that the report is drawing a simplified conclusion as a way of defending the status quo?

The answer to this question is a resounding, “Yes!”  Every article that I have read on this report had either an implicit or explicit reference to the feeling that the report justifies the regulations and oversights in place, and that it was just one ill-timed trade and some subsequent reduction in high-frequency trading that caused this monster market anomaly.

This begs the question, “If one fairly large trade really can destabilize the system, is all really well?”

Now let’s look at the common sense test.  The report suggests that an order to sell 75,000 S&P 500 e-mini futures contracts broke the proverbial dam.  In our next installment, we’ll investigate this level of volume to see whether or not it passes the common sense test as an order size that triggers something close to financial Armageddon on a global scale.  (Spoiler alert: not a chance!)

I’d love to hear your thoughts and feedback on this topic 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 >>

Mailbag

Tying Together Weekly and Monthly Reports

Q: While completing the Peak Performance Course I have learned quite a lot about myself and have found some great references.  I tend to miss some of the big picture aspects of the market place and am interested in learning more about economic data.  I need to gain a better understanding of how the various weekly and monthly economic  reports tie together to paint a picture of the underlying  trends that will impact the marketplace.  Are there any good references that you could recommend I read to gain a better understanding of this topic?

A: I find that the challenge is not so much locating data but more specifically deciding what data you want and how will you use it.  First, think in terms of what you want to measure and monitor.  How will it influence your trading?  Once you have written out your answers, then go look for that information that would be useful to you. 

As for me, there are two sources of regular information that I find generally useful for assessing the big picture. 

The first is Van’s monthly market update, which he publishes in the newsletter usually on the first Wednesday of each month (see above).  The information itself is useful but so is Van’s construction of the report.  If you don’t care about part (or all) of his report, you can drop that and create your own. 

The second source I find very useful is John Mauldin.  Mauldin publishes a free newsletter each week where he writes about complex macro-economic matters in an easy to understand way that economists typically have a hard time doing.  Interestingly, Mauldin has no economics PhD. Mauldin regularly cites other writers and reports that you can look at yourself to see if they would be useful to monitor on a regular basis for your big picture process. 

You can sign up for his newsletter here: http://www.frontlinethoughts.com/gateway.asp

Remember, consider the objectives for your big picture first and then go look for the information. 

RJ Hixson

Everything that we do here at the Van Tharp Institute is focused around helping you improve as a trader and investor. Therefore, we love to get your feedback, both positive and negative!

Feel free to click below to leave us any comments so that we can serve you better. Or, send Van a question that you would like for him to answer.

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