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

Market Update for the Period Ending June 30th, 2011
Market Condition: Neutral Normal

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.

If your beliefs are not similar to mine, then this information may not be useful to you. Thus, if you are inclined to perform 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. Know that I acknowledge that these are my beliefs and that your beliefs may 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: Commentary—The Big Picture

Quantitative Easing II (QE2)* just ended and Bernanke says, for now, there won’t be additional monetary easing from the Federal Reserve. Also, the European Union successfully dodged the Greek default bullet (and their multiple sovereign debt crises) for one more month. The S&P 500 tested its March low, did not fall through it, and recovered dramatically in the last week of the month. Precious metals and commodities remain below their May highs.

Part II: The Current Stock Market Type Is Again Neutral Normal

Each month Van looks at the market SQN® score for the daily percent changes over 200, 100, 50 and 25 days. For his purposes, the market is defined as the S&P 500 Index. After teetering back and forth between neutral and bear during the month, on June 30 the market SQN 100 was in the same basic spot as the 50- and 25- day periods SQN scores—right above the line between neutral and bear. Below is the graph of the 100-day market SQN score for the last year.

chart 1

The next graph shows market volatility over the last year.

chart 2

You can see that we are in normal volatility territory after a slow steady rise out of the quiet volatility zone back in April. With normal volatility, the market SQN 100 could easily slip into bear territory but unless volatility spikes, we will stay out of bear volatile or strong bear. Bear volatile and strong bear periods are the worst for those long in the markets.

Here are the performance figures for the three major US indices over the last month.

Weekly Changes for the Three Major Stock Indices
  Dow 30 S&P 500 NASDAQ 100
Date Close % Change Close %Change Close % Change
Close 04 10,783.01   1,211.12   1,621.12  
Close 05 10,717.50 -0.60% 1,248.29 3.07% 1,645.20 1.50%
Close 06 12,463.15 16.29% 1,418.30 13.62% 1,756.90 6.79%
Close 07 13,264.82 6.43% 1,468.36 3.53% 2,084.93 18.67%
Close 08 8776.39 -33.84% 903.25 -38.49% 1211.65 -41.89%
Close 09 10428.05 18.82% 1115.1 23.45% 1860.31 53.54%
Close 10 11,577.51 11.02% 1,257.64 12.78% 2,217.86 19.22%
6-Jun-11 12,089.96 4.43% 1,300.16 3.38% 2,274.48 2.55%
13-Jun-11 11,952.97 -1.13% 1,270.98 -2.24% 2,222.28 -2.30%
20-Jun-11 12,080.38 1.07% 1,271.50 0.04% 2,204.36 -0.81%
27-Jun-11 12,043.56 -0.30% 1,268.45 -0.24% 2,252.24 2.17%
1-Jul-11 12,582.77 4.48% 1,320.64 4.11% 2,361.39 4.85%
Year to Date 12,582.77 8.68% 1,320.64 5.01% 2,361.39 6.47%

All of the indexes were down for the first half of the month and then returned to levels close to the month's opening level in the last two weeks. If you look at the price charts for June, they look like a big U. (Are the markets smiling?)

Part III: Our Four Star Inflation-Deflation Model

Here is the data from our four star inflation-deflation model.

Dec-05 347.89 30.28 513.00 31.67
Dec-06 394.89 34.84 635.50 36.74
Dec-07 476.08 41.70 833.30 28.90
Dec-08 352.06 22.74 865.00 12.52
Dec-09 484.42 32.99 1,104.00 14.10
Jun-10 471.37 28.37 1,244.00 13.81
Jul-10 499.05 32.01 1,169.00 14.71
Aug-10 496.73 31.04 1,246.73 13.55
Sep-10 536.12 32.78 1,307.00 14.35
Oct-10 566.28 34.80 1,346.75 14.56
Nov-10 565.96 35.19 1,383.50 14.46
Dec-10 629.53 38.47 1,410.25 16.00
Jan-11 650.80 39.47 1,327.00 16.74
Feb-11 676.96 39.46 1,411.00 16.85
Mar-11 672.81 40.02 1,439.00 16.52
Apr-11 687.66 40.87 1,535.50 16.38
May-11 656.42 39.75 1,536.50 15.84
Jun-11 632.23 39.37 1,500.30 15.35

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

Date   CRB2    CRB6 XLB2  XLB6 Gold2 Gold6 XLF2 XLF6 Total Score
   Lower Higher Lower Higher Lower  Higher Lower Lower  
June    +1/2    +1/2    +1/2    -1 +1/2

We are still in an inflationary environment—although inflation seems to have subdued some in June with the fall-off of commodity prices over the last two months. As Van has mentioned, inflation could remain tame unless or until the banks start lending again.

Speaking of bank lending, the money multiplier situation deteriorated further in the last month. The St. Louis Federal Reserve still shows the downtrend continuing and the multiplier now stands at 0.719 in their graph below.

chart 3

A lack of lending is a deflationary force in the economy and without a reversal in the trend, it’s hard to imagine an economic recovery, let alone a sustained recovery.

Part IV: Tracking the Dollar

Rather than depend on the Federal Reserve to report figures, why don’t we just look at the US Dollar Index futures price chart to see what is really going on.

chart 4

So far, the dollar has had higher highs off of its May 4 low, although it has yet to break above its late May highs. Surprisingly, since Van left in early June, the dollar is about even with the Euro. Has the Tharp Effect abated temporarily? (Van has documented that the US dollar weakens every time he travels abroad. The pattern was so consistent over many years that he started referring to the phenomenon as the Tharp Effect.)

It would be hard to say the dollar has reversed its long decline but if the European debt issues blossom, it could gain strength as a safe haven currency—even if for a short term.

General Comments

Risks in the big picture abound: the end of QE2 and recent softness in US Treasury auctions, the multiple debt crises in Europe, the US debt ceiling/deficit reduction negotiations in Washington, and the ambiguous health of many major national economies. These macro risks leave many market participants hesitant, which may be an appropriate stance.

Richard Russell, however, made an interesting point recently in his newsletter, which I’ll paraphrase. He said so many people want a scenario, any scenario they can believe and they’d rather have the wrong scenario than experience the uncertainty and confusion that the current market offers. Does that fit you or anyone you know? If so, does that offer you an opportunity? A trade?

Van believes the secular bear market has a number of years left, which means a long term and dramatic reduction in equity valuations. Eventually, we can expect to see S&P 500 price earnings ratios reach the single digits. We could arrive at that end with an inflationary or deflationary environment or even some mix of the two; that’s why Van monitors inflation and deflation measures because you would trade those market conditions with different systems.

Once again, it’s Van’s opinion that you should use the information in these monthly updates to determine which trading systems will work best rather than try to forecast the market. Which of your trading systems fit the current market type? The question implies that you have multiple trading systems and that you know how they perform under various market conditions. If you haven't heard this before or the other ideas mentioned above, read Van’s book Super Trader, which covers these areas and more so you can make money in any kind of market conditions.

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 August update, this is Van Tharp.

About the Author: R.J. Hixson is a devoted husband and active father. At the Van Tharp Institute, he researches and develops new products and services that will help traders trade better. In the spirit of the company's mission, he recently transformed his personal appearance. He can be contacted at “rj” at “”.  


*Editors Note. At first publication, Quantitative Easing II (QE2) was mistakenly written as "qualitative". Thanks to a quick reader for pointing this out.

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Trading Tip

SQN® Report June 2011

Van has been using his System Quality Number (SQN ®) score to measure the market performance of countries, currencies, commodities, and various equity sectors in his world model. He uses the SQN 100, which calculates the SQN score of the daily percent change for a 100-day period of the various ETFs we follow. Typically, a score over +1.45 is strongly bullish; a score below -0.7 is very weak. He uses the following color codes to help communicate the strength or weakness of the ETFs he tracks:

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

Van’s World Market Model spreadsheet includes most currently available ETFs—including inverse funds—although he includes no leveraged ETFs.

World Market Summary

sqn 1

The predominant color in June for US market segments (top center) is yellow, which is weaker than last month (and last month was weaker than the prior month). Keep in mind that yellow is still above average and considered “strong” by the model measurement system. There was one hint of good strength with green in the small caps although micro caps remained the weakest of all sectors this month and turned brown.

As we compare the US Market segments to the rest of the world, we don’t see high strength in the other regions either. There are only three green countries in the model: Malaysia, Switzerland, and Chile. Every other country is yellow or brown—brown means below average and weak. So in the last 100 days, the markets around the globe have shown only moderate strength by the SQN measure. That’s probably not surprising to attentive traders. For some time, Van has been watching India’s SQN score, which is now back in the yellow zone after having been brown and red for the last few months.

The Swiss Franc continues to remain the strongest currency among a group of weakening currencies. Last month, there were more currencies in the green than this month.

As a group, the industrial sectors’ strength is waning compared to last month. We can find some remaining strength with Food/Beverage, Healthcare and Biotech at the top of the list. Overall, however, we see the same here as in other areas: a lot more yellow and brown this month compared to last and compared to two months ago when the report showed nearly all sectors as green. On the weak side, Broker/Dealers and Networking companies are the weakest of all sectors and two of the weakest of all ETFs this month as indicated by their red color.

The next table shows the relative performance of commodities, real estate, and interest rates, plus the strongest and weakest areas of the all of the ETFs.

sqn 2

Gold continues to remain in the strongest category though it has a lower SQN score than last month. All of the other commodities are now either brown or yellow.

The US real estate sector strength declined some last month though it still remains green. In a move in the opposite direction, China real estate improved slightly coming out of brown into yellow.

Most of the bond funds were already green last month and then strengthened in June, except for junk, which weakened a bit to yellow. Though they may not be yielding much as a result of their price strength, as a category, bonds are the strongest area of the capital markets on a SQN score basis.

While healthcare was in a number of the top spots last month on the strongest 15 ETFs list, this month bond funds are almost all you can find there. You do see the Swiss Franc up there again as well.

The worst performing funds list has an assortment of various ETFs. There are a few alternative energy ETFs and financial oriented ETFs there, but it’s hard to find a common thread for the bottom 15 like you can easily do on the strongest list. The long dollar fund continues to show up on the weakest list and for the first time in a while, India didn’t make the bottom list.

Van’s Interpretation of What Is Going On

Van has been saying that the Federal Reserve was printing money like crazy for QE2 and the banks were not (and are not) lending it. Instead, it probably found its way to the stock market.

Now that QE2 is complete, what will happen next in the markets? No region of the world is doing great and commodities seem to be holding at the levels off their May peaks. Van’s world model hints at investors seeking temporary shelter in bonds. Should the uncertainty continue, however, bonds may remain the strongest area for some time.

Regardless of where the money flows in the short term, this is a market in which you should be a trader, not a long term investor. But to be a trader, you MUST know what you are doing.

Van will be back with his analysis of the world market model next month.

About the Author: R.J. Hixson is a devoted husband and active father. At the Van Tharp Institute, he researches and develops new products and services that will help traders trade better. In the spirit of the company's mission, he recently transformed his personal appearance. He can be contacted at “rj” at “”.  


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Why Invent the Short ETF?

Q: If it is possible to go short in a long ETF, why did the financial organizations invent the short ETF?

A: I am not aware of the specific origins of the inverse ETFs but the underwriters had some initial market research that indicated they would be popular.  They are very popular with two groups that control a lot of money: IRA account holders and managers of retirement plans.  Typically (by regulation) retirement money cannot hold short positions.  With inverse ETFs, however, these groups can go short without shorting. 

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July 06, 2011 - Issue 533

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