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Tharp's Thoughts Weekly Newsletter

December 05, 2007 — Issue #350
  
Article

1-2-3 Model in Red Light Mode by Van K. Tharp Ph.D.

Education

The Ultimate Home Study Course for Traders

Trading Tip

Everybody Hates the Dollar – It’s Time to be a Buyer by D.R. Barton, Jr.

Melita's Corner

Part of the Territory by Melita Hunt

Feature

Tharp’s Thoughts

Market Update for December 2007

1-2-3 Model in Red Light Mode

by

Van K. Tharp, Ph.D.

Look for these monthly updates in the first issue of each month. This allows us to get the closing month’s data.  In these updates, we’ll be covering each of the major models mentioned in the Safe Strategies book:  1) the 1-2-3 stock market model, 2) the five week status on each of the major stock U.S. stock market indices, 3) our four star inflation-deflation model, 4) what the US dollar is doing, and 5) the five strongest and weakest areas of the market.

Part I:  Market Commentary

We’re in for a real ride in the markets right now.  We’ve already had a 10% correction followed by a bounce.  Is this going to be like July when the market almost corrected 10% and then went on to make new highs?  Or is this market going into a major downturn?  I don’t know the answer, except that 1) we are in a secular bear market; 2) we are in a dollar crash; 3) we have a tremendous subprime crisis; 4) real inflation is over 10% and 5) we’re probably in (or close to) a recession even by the government’s standards.  They’ll probably tell us about it in a few months. 

So let’s look at what the market did in November.

Part II: The 1-2-3 Stock Market Model Is Really Borderline but Officially in RED Light Mode.  (I’ll explain why in a minute.  Stocks tend to go down 9% per year in red light mode.)

The 1-2-3 Model is in borderline mode between yellow and red.  The Fed is not in the way and has actually started to lower interest rates.  That’s positive.  However the other two indicators seem to vacillate between positive and negative.  The market has had a 10% correction and then recovered.  It’s flirting with the moving average, but it’s officially below it.  However, that tends to lower the PE ratio of the S&P 500 to near 17, which Steve Sjuggerud considers to be positive.  Also, you only get an official reading of the S&P 500 PE ratio every quarter and its usually long after the quarter has ended.  Based on the latest readings, the PE is 17.1, so it’s officially expensive.  I personally would call the market very borderline.  Both of these could move slightly and we’d be in green light mode, so it’s a very mixed bag right now.  Just remember we’re in a secular BEAR market.

Let’s look at what the market has done over the last five weeks and compare that with where the averages were December 31st last year.  These data are given in Table 1.

 

Table 1:  Stock Performance Over the Last Month

  Dow 30 S&P 500 NASDAQ 100
Date Close % Change Close %Change Close % Change
Close 04 10,783.01   1211.12   1621.12  
Close 05 10,717.50 -0.60% 1248.29 +3.07% 1645.2 1.50%
Close 06 12,463.15 16.29% 1,418.30 13.62% 1,756.90 6.79%
10/26/2007 13806.7   1535.28   2194.59  
11/2/2007 13595.1 -1.53% 1509.65 -1.67% 2213.86 0.88%
11/9/2007 13042.74 -4.06% 1453.7 -3.71% 2034.3 -8.11%
11/16/2007 13176.79 1.03% 1458.74 0.35% 2048.62 0.70%
11/23/2007 12980.88 -1.49% 1440.7 -1.24% 2028.9 -0.96%
11/30/2007 13371.72 3.01% 1481.14 2.81% 2089.1 2.97%
Year to Date   4.65%   2.50%   15.79%

All three averages are still up on the year,  but the DOW 30 and the S&P 500 are only up a small amount – less than the market decrease over the week of November 9th. 

Strongest and Weakest Components of the Market  

I am starting a new feature here, listing the five strongest and the five weakest components in the market at the time of this update.  These can change daily, but the information will be accurate as of the publication of this update.  Table 2 shows the five strongest components this month as compared with last month.

Table 2: Strongest and Weakest Market Component

Five Strongest Components

Market Nov Strength Market Oct Strength
India 87 Oil 95
China 71 India 73
LT  Treasuries 66 Commodities 66
Hong  Kong 66 Brazil 66
Spain 60 Gold 65

Five Weakest Components

Sweden 21 Real Estate 7
Canada 22 US Sm Cap Value 12
Taiwan 25 Mexico 15
Real Estate 25 US Sm Cap Blend 16
S. Korea 28 Sweden 16

Perhaps you can begin to understand why the Japanese are starting to focus their assets on emerging markets instead of the U.S. Also notice how some of the strongest markets can drop dramatically.  Oil is now 38 and commodities are now 50 after being in the top five at the end of October.  This is because short term swings have a lot more play in the rating scale than long term swings.  By the way, this information is for educational purposes only, so you can understand the big picture and its importance.

Incidentally, some of you have asked how all of this is calculated and other details.  This is pretty similar to Ken Long’s world model, which he covers in detail, including calculations, in our ETF workshop.

Part III: Our Four Star Inflation-Deflation Model

As I’ve stated many times in these monthly updates, we are in an inflationary bear market.  The bear market is not necessarily reflected in prices, but in PE ratios.  PE ratios will continue in a downtrend even though the Dow is making new highs.  Inflation is obvious, but simply masked by government statistics.  Okay, so now let’s look at the results for the last six months.  And remember that the Fed has now chosen to produce inflation and a strong dollar devaluation over the pain of the subprime crisis.

Date

CRB

XLB

Gold

XLF

Dec-05

347.89

30.28

513

31.67

Dec-06

394.89

34.84

635.5

36.74

May-07

407.58

40.72

659.1

37.69

Jun-07

410.36

40.5

650.5

36.18

Jul-07

424.52

39.42

665.5

32.9

Aug-07

413.49

39.15

672

33.75

Sep-07

447.57

42.11

743

34.32

Oct-07

453.26

43.86

789.5

33.73

Nov 07

451.26

41.65

783.50

31.00

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

October

Higher

Higher

Lower

Higher

Higher

Higher

Lower

Lower

 

 

 

+1

 

+1/2

 

+1

 

+1

+3.5

The results of this model are much more sensitive (I believe) than the model I presented in Safe Strategies for Financial Freedom.  The model once again shows that inflation is winning slightly.  Click here for more information on the model.

Both Gold and Commodities fell over the last month, but I suspect this was due to the subprime crisis starting to liquidate their holdings.  Gold stocks, for example, took huge hits (much more than gold). 

Last month I mentioned John Williams' web site, www.shadowstats.com. John Williams looks at the real statistics the government doesn’t want you to know about.  For example, the CPI (if calculated the way it was in 1990) currently suggests that inflation is running over 10% per year.  And M3 (which the government stopped publishing because they said no one looks at the data) suggests that inflation might be as high as 14%.  I suspect that 14% is probably more accurate because even the government’s old way of looking at the CPI was not particularly accurate.  However, the data clearly suggests that we’re in an inflationary bear market in which the stock market is not even keeping up with real inflation (much less the decline in the dollar as discussed below).  In such a market we could easily see a DOW of 20,000, but that would probably be worth about 5,000 in today’s market (plus the dollar could easily have lost real value versus other currencies as indicated below).

Part IV: Tracking the Dollar

With the Federal Reserve lowering interest rates, I would now expect currency traders to start selling the dollar and moving to currencies that pay a better interest rate.  Look at the data in the chart because it really says it all.

Month 

Dollar Index 

Jan 05 

81.06 

Jan 06 

84.29 

Jan 07 

82.37 

 Feb 07 

82.07 

Mar 07 

81.23 

Apr 07

79.87

May 07

79.20

Jun 07

78.93

July 07

77.51

Aug 07

77.51

Sep 07

75.91

Oct 07

73.93

Nov 07

72.20

When last month’s issue was written in early November, the dollar was just under 73.  The dollar is still in a plunge, and I wouldn’t be surprised to see oil valued in Euros at some time in the future.  The dollar’s status as the world’s reserve currency will be very much in doubt in the near future.  But the problem is that there is not really a sound currency to take its place.  So what would take its place?  Gold?

And remember that crisis always implies that an opportunity exists somewhere. 

Below you'll see a near-term perspective on a possible opportunity in D.R.'s tip. He believes that opportunity lies in the dollar itself. I'm a trend follower...while D.R. likes to pick stretch points near tops and bottoms with bands (and other tools like sentiment analysis). 

I'm a long- term player (and I still think the dollar could go a long ways down long term) and DR is a short- term player (he’s looking for the dollar to have a temporary reaction up... in the long term downtrend).

We're not here to give recommendations, just to show you the facts as we perceive them, so that you can make an informed decision based on your own belief system and what fits you.

Until next month’s update, this is Van Tharp.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling book Trade Your Way to Financial Freedom 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.

Trading Education

Van Tharp's Trading Masterpiece
The Peak Performance Home Study Program

The Ultimate Home Study Course for Traders. How you think when you make and lose money. Stress reduction. How not to repeat your mistakes. Trading unemotionally. Contains five books and four CDs.

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Trading Tip

Everybody Hates the Dollar – It’s Time to be a Buyer

by D.R. Barton, Jr.

My favorite sentiment indicator triggered over the weekend.

I believe that financial analysis can be broken into three broad categories:

  • Fundamental Analysis: The belief that the price of a stock is directly related to the time-discounted value of all future cash flows.  This valuation has to do with evaluating financial statements and trying to understand the future direction of a business given its management team, future products, competitive environment, etc.  For commodities, the supply and demand of the underlying asset are the primary drivers of fundamental analysis.

  • Technical Analysis:  This is the study of price.  It assumes that the current price of the stock represents a balance in the supply and demand of that instrument and that all known information is included in that price.

  • Sentiment Analysis:  This is the least well-known form of analysis.  The simplest definition of sentiment analysis is the measurement of pessimism or optimism in the markets.

Since sentiment analysis is not that widely followed, let’s review this branch of financial research.  There really are many different ways to measure market sentiment:

  • Put/Call Ratios measure sentiment by determining the balance of options bought.

  • Breadth Ratios give a read on sentiment by describing the extent of market participation in a move.

  • Sentiment Surveys tell the degree of bullish or bearish sentiment among groups of investors, analysts, newsletters, etc.

These are only a few of the broad categories of sentiment tools that are used.  Others include short sales reports, commitment of traders’ reports, insider buy vs. sell ratios and mutual fund asset flows.  There are certainly lots of ways to determine the sentiment of market participants.  But one of my favorite sentiment indicators is a broader and more easily accessible one.

Checking mainstream magazine covers has been a widely used and sometimes disparaged form of sentiment analysis for years.  In short, by the time the mainstream media has decided a financial topic is “newsworthy” enough to make a cover story, the move that caused the story is most likely at its exhaustion point.

This was the case in February of 2005, when I wrote in this same space about the Newsweek cover story “The Incredible Shrinking Dollar”.  I stated in that article that, “I smell a bottom in the dollar”.

And I sense that the dollar has hit an intermediate term bottom again.

Before I get into last weekend’s magazine cover, let’s put some academic “umph” behind magazine covers as sentiment indicators.  As reported by Nicolas Vardy on Seeking Alpha, three finance professors at the University of Richmond did a study of 20 years of covers at three mainstream magazines.

The conclusion? Positive stories generally indicate that the stock's price performance has topped out. Negative stories often come right at the time of a turnaround.

The study confirms that it is better to bet against journalists than alongside them. It would be easy to jump to the self-congratulatory conclusion that journalists are incompetent. But that conclusion misses the point. Journalists aren't writing cover stories to make investors money. They are writing cover stories to sell magazines. And "hot topics" sell. But it also means that when a company or financial trend is featured on a magazine cover, the chances are that the trend is already widely known, and universally accepted.

So why am I bullish on the dollar now?  The cover from The Economist magazine this weekend features the dollar bill portrait of George Washington piloting a plane that is going down in flames.  The headline:  “The panic about the dollar”.

I believe that my good friend Steve Sjuggerud has it right – when something is universally hated, that’s a good time to start looking to invest.  The dollar is universally hated and has even shown a few days of rebound.  It’s time to get bullish on the dollar.

Great Trading!

D. R.

About D.R. Barton:  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 where he is one of the most widely read and followed traders and analysts in the world.

He is a regularly featured guest analyst on both Report on Business TV,  and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio.  His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at drbarton@iitm.com.

 

Melita's Inspirational Corner

Part of the Territory

by Melita Hunt

This week I have decided to write about something that is on my mind, which I also shared in my blog last week. It isn’t particularly inspirational and may not “perk you up,” so I’ll apologize in advance; however, I do hope that it is a helpful reminder to some of the readers out there. 


When diagnosed with a so-called terminal illness, there are many things that need to be dealt with and one of them is ensuring that everything is "in order." It is just part of the territory. It has been a matter of much discussion between Mum and me this week. Regardless as to whether I live another 2 years or 50 years, these things need to be handled, and who knows when any of us are going to die anyway?


Many of our clients are professionals (i.e., doctors, engineers, attorneys etc.)  and I would hazard to guess that you have done some type of estate planning and preparation. But then again, I could be wrong. Van talks a lot about the need for worst-case contingency planning for traders. How many of you have actually taken the time to do that?


I hope that this is a wake up call to everyone, especially those of you who have children. There are some very basic things that should be IN WRITING and addressed every year, so that if anything happens to you, you are not leaving disaster in your wake. I mean after all, what and who are you doing all of this trading for? 


Once you have put in the initial effort, you could create a simple checklist that you look over each year and then update the things that need to be changed, added or deleted.


I always thought that I was fairly on top of all of that stuff. My estate planning was done and my will was written, but the truth was, my will had been written years ago and the cobwebs really needed to be dusted off because circumstances and situations change. I just hadn’t taken the time to do it. I also have a life in the States and a life in Australia, so I need to ensure that things are handled in both locations.


And this is just one small part of getting things “in order.” The list is actually much more comprehensive. Your will and living will (i.e., what your medical wishes are if you are unable to fend for yourself) are important documents, and I use solicitors/attorneys in both the US and Australia for them, but they are just the tip of the iceberg. I don’t profess to be an expert in any of this; I’m just reading and learning new things as I go along. Having this illness has obviously brought it to the forefront of my mind.


I bought three books last week (because I don't want to miss anything or be uninformed) that I am currently working through. They specifically ask about EVERYTHING in your life (not just division of assets) and are prompting me to think of things that wouldn’t have crossed my mind. And, I am recording everything about me by filling in a CD template. Oddly enough, it gives me peace of mind. 


It is basically an "organization" of records, so your family won't have to stumble around trying to unravel your life. 


No one knows everything about any of us: our thoughts, wishes, desires and even the practical things like our pin numbers, memberships, contact information for friends, family & associates, asset register, direct debits, charitable contributions (I sponsor children who are very important to me), location of documents, etc. Yes, I know we are not supposed to "write down our pin numbers" - so if this bothers you, come up with a code, or lock them away in a safe deposit box. 


And with the advent of technology,  what information is "somewhere" on your computer that may need to be accessed? What are your codes or sign in names and passwords? And what if there are items that you would prefer to be deleted? I have private journals that I would prefer others didn’t see. They are therapeutic for me to write and help me to work on myself, but they are not for others’ eyes. Perhaps you don't care, but it is all food for thought.


I just want to encourage you to really think about your plan for communicating and organizing the essential information that your family needs should you happen to kick the bucket or be injured. 


My intention isn't to sound morbid or to make it seem difficult or like a big job. I just want to encourage you to pick a day and make the time to do it. There are some wonderful books and CD Roms available where you can just fill in the blanks.


This is not tempting fate. Everyone leaves this planet eventually. Planning ahead may not be important to you, but it is commonsense to me. Maybe I’m just saying that because of the circumstances that I find myself in. But do you really need a sledgehammer moment to make it important? 


All of this stuff can even be useful if you find yourself in the hospital or sick for an extended period of time. It will help to make things easier to handle.


As I said earlier, it is certainly giving me peace of mind by doing it, and I am amazed at just how many "little things" make up my crazy, fun life. 


Now, who on earth gets all of my shoes? 

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita’s progress regarding her recently diagnosed lung cancer. Please feel free to read her blog at www.myleftlung.com.

You can contact Melita at mel@iitm.com

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