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Tharp's Thoughts Weekly Newsletter

September 04, 2008 — Issue #388  
  
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The Definitive Guide to Position Sizing Is Here!!!

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Monthly Market Update by Van K. Tharp, Ph.D.

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Trading Tip

Traders’ Business Planning: Protecting Your Tools – Starting with Your Computer by D.R. Barton, Jr.

Melita's Corner

Time to Relax by Melita Hunt

 

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Feature

Tharp’s Thoughts

Market Update for July

Market Condition: Quiet 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 just point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, then you may not find them useful.  I find the market update information useful for my trading, so I do the work each month and I'm happy to share that information with my readers. 

However, if your beliefs are not similar to mine, then the 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 condition (first mentioned in the April 30 edition of Tharp’s Thoughts), 2) the five week status on each of the major stock U.S. stock market indices, 3) our four star inflation-deflation model, 4) tracking the dollar, and 5) the five strongest and weakest areas of the overall market.

Part I:  Market Commentary

August has largely been a sideways month, although it shows up on our classification as a bear month because the 13 week change continued to be large and down.  However, in my opinion these are some of the worst market conditions that I have seen since I’ve been a trading coach.  The last secular bear market was 1966 to 1982, and I think the conditions today are much worse than that.  It’s probably more like 1929 to 1949, which encompassed the Great Depression and World War II.  Why do I say that?  There seems to be no investment opportunities whatsoever.  All of the world markets look bad.  No country’s equity market looks strong.  And when that happens, you can usually find other areas that look good such as gold, commodities, oil, etc., but all those areas are also headed down.

Normally, even that wouldn’t be bad because there would be good markets to short.  But down markets all tend to be so volatile that it’s very easy to get stopped out, so the safest place to be right now is in cash.  But with 113 banks on the FDIC warning list, and FDIC reserves being very low, I begin to wonder if cash is even safe.  However, I’m sure the Federal Government, through the printing press, will bail out bank depositors for the FDIC.

Part II: The Current Stock Market Type Is Quiet Bear 

I have now substituted my new market type for the 1-2-3 model.  The reason I’ve done this is that as soon as the 1-2-3 model goes below a certain PE ratio (which it is poised to do) another component will turn bullish.  However, I expect us to be in a secular bear market until the PE ratios of the S&P 500 reach single digits.  Thus, the 1-2-3 model doesn’t really fit my current beliefs.  For those of you who are still interested, it is in red light mode (unless the S&P 500 PE ratio is now below 17, which could happen any time and that‘s the reason I stopped using the model).

The one thing that is suddenly clear is that the volatile markets that have characterized most of 2008 for the S&P 500 have now shifted to quiet markets.

2008 Market Type

Market Type Week
Quiet Bear 8/29/2008
Quiet Bear 8/22/2008
Quiet Sideways 8/15/2008
Quiet Bear 8/8/2008
Volatile Bear 8/1/2008
Quiet Bear 7/25/2008
Volatile Bear 7/18/2008
Volatile Bear 7/11/2008
Volatile Sideways 7/4/2008
Volatile Bear 6/27/2008
Volatile Sideways 6/20/2008
Volatile Sideways 6/13/2008
Volatile Sideways 6/6/2008
Volatile Bull 5/31/2008
Volatile Sideways 5/23/2008
Volatile Sideways 5/16/2008
Volatile Sideways 5/9/2008
Volatile Bull 5/2/2008
Volatile Sideways 4/25/2008
Volatile Sideways 4/18/2008
Volatile Sideways 4/11/2008
Volatile Sideways 4/4/2008
Quiet Bear 3/28/2008
Volatile Bear 3/21/2008
Volatile Bear 3/14/2008
Volatile Bear 3/7/2008
Volatile Bear 2/29/2008
Volatile Bear 2/23/2008
Volatile Bear 2/15/2008
Volatile Bear 2/8/2008
Volatile Sideways 2/1/2008
Volatile Bear 1/26/2008
Volatile Bear 1/18/2008
Volatile Bear 1/11/2008
Volatile Bear 1/4/2008

Let’s look at what the market has done during the month of August. 

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

-3.10%

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%

01-Aug-08

11,326.32 

 

1,260.31 

 

1,826.56 

 

08-Aug-08

11,734.32 

3.60%

1,296.32 

2.86%

1,926.23

5.46%

15-Aug-08

11,659.90 

-0.63%

1,298.20 

0.15%

1,957.56 

1.63%

22-Aug-08

11,628.06

-0.27%

1,292.20 

-0.46%

1,931.47 

-1.33%

29-Aug-08

11,543.55

-0.73%

1,282.83

-0.73%

1,872.54

-3.05%

Year to Date

11,543.55

-14.91%

1,282.83

-14.46%

1,872.54

-11.34%

While all three indices were up and down during the month, all three still stand at double digit losses for the year.

I’m also listing the strongest and weakest areas of the market in this update. The ratings give the most weight to what has happened recently so they can sometimes change rapidly.  However, I’ll only list the strongest areas if they are up for the year and not just strong recently.  The relative strength of each component is given in parenthesis. 

Part III:  The Strongest and Weakest Market Components

Five strongest components, in order:

1)  US Long Term Treasuries (86)

2)  Small Cap Value US (83)

3)  Small Cap Blend US (83)

4)  Small Cap Growth (83)

5)  Real Estate (76)

None of these are really worth investing in right now. You should probably just be in cash.

Five weakest components:

1.      South Korea

2.      India (which was on the weakest, strongest and again on the weakest)

3.      Malaysia

4.      Singapore

5.      Sweden (31)

These are also very dangerous to short right now.  As I said, you should probably be in cash.

Part IV: Our Four Star Inflation-Deflation Model

As I’ve stated many times in these monthly updates, we are in an inflationary bear market.  Well, PERHAPS NOT.  When Steve Sjuggerud and I wrote the chapter on the big picture in Safe Strategies for Financial Freedom in 2002, I presented arguments that we could have a deflationary period ahead of us and Steve presented the inflationary picture.  And with our huge debt and a Federal Reserve that could print money at will, it was hard for me to see this scenario as being anything but inflationary.  How could the U.S. tolerate having such a huge debt in a deflationary time (when money is worth more).  Sure enough, the central banks of the world are printing money like crazy.  M3 for the United States currently stands at $13.8 trillion and M3 for the European Union currently stands at $14.1 trillion (converted to US dollars).  These data are as of May 2008.  These represent one year increases in the money supply of 18.8% and 10.5%, respectively.  Now that sounds like real inflation. 

But what I didn’t consider were the impacts of defaults.  When credit (which is one of the major ways money is created) collapses, it is a major deflationary factor.  How is that happening?  First, house prices in the US are down about 10% over the same time period.  In major markets the situation is much worse.  California real estate has dropped about 40% over the last year.  That value of US real estate is bigger than M3, which offsets about 60% of the money supply.  On top of that, you have to consider write-offs of derivatives and junk debt.  So far, $540 billion of junk mortgages have been written off the books and there is a lot more. Freddie Mac and Fannie Mae are now estimated to have a combined net worth of MINUS $50 billion; however, they still have assets (stock value and the mortgages).  But if the Federal Reserve has to bail them out those assets would become worthless.   Much of those assets are owned by regional banks – many of which are on the FDIC danger list – and that value would be wiped out.  In addition, China owns $376 billion in US agency debt – most of which is in the two FMs.  If the Fed has to bail out the two FMs, then that would also be wiped out and China would not be repaid.  Imagine the international consequences if that happened.  In addition, the credit squeeze is also showing up in the M2 money supply – in which there is now actually a net decrease. 

Thus, the 18.8% M3 increase over the last year could easily be wiped out and be a net decrease.  And that means there is less and less money to invest.  And when that happens prices go down.  That, my friends, could lead to even more deflation and deflation combined with large debt is big trouble.

And by the way, GM had a $15.5 billion loss in the second quarter.  Ford had a $8.7 billion loss in the same quarter.  The auto industry, which has long been the giant of American industry, is about to collapse without a big loan from the government.  My understanding is that Ford and GM are currently asking the government for a $50 billion loan.

Richard Fisher, president of the Dallas Federal Reserve, says that US unfunded liabilities now total almost $100 trillion and that doesn’t include the official debt of the US that has with a current ceiling of $10.615 trillion.  When the Fed published a study saying that the US was bankrupt, it estimated our total debt to only be $67 trillion – but that was in March of 2007 when that study was published.

The US Treasury’s only response to all of this is to spend, spend, spend.  Last month alone, US spending hit a new record.

So with that in mind, let’s now look at our measure of inflation/deflation.

Date

CRB/CCI

XLB 

Gold 

XLF

Dec-05

347.89

30.28

513

31.67

Dec-06

394.89

34.84

635.5

36.74

Dec-07

476.08

41.7

833.3

28.9

Jan-08

503.27

38.62

923.2

29.14

Feb 08

565.65

40.87

971.50

25.83

Mar 08

516.68

40.17

934.25

24.87

Apr 08

536.23

42.31

871.00

26.61

May 08

541.30

44.51

885.75

24.76

June 08

595.98

41.64

930.25

29.12

July 08

548.86

39.75

918.00

21.63

Aug 08

516.47

40.38

833.00

21.42

We’ll now look at the two-month and six-month changes during the last six months to see what our readings have been.  Notice that Gold is now flat for the year 2008 and commodities are only up slightly.

Date

  CRB 2

  CRB 6

XLB2

XLB6

Gold2

Gold6

XLF2

XLF6

Total Score

 

Lower

Lower

Lower

Lower

Lower

Lower

Lower 

Lower

 

 

Aug 08

  

-1

  

-1

  

-1

  

+1

-2

 

For the first time since I’ve been calculating these figures, they are showing the potential for deflation.  Even energy prices are now going down.

Meanwhile at www.shadowstats.com, John Williams tells us that the government is increasing the money supply, (M3, no longer reported by the government) to over 15%, unemployment (the government doesn’t count people after their benefits run out) is at 14%, the CPI is running at over 13% (the old CPI the way it used to be calculated), and all that means is that we are  in a severe recession with the inflation adjusted GDP growth and -2%+.  And banks are folding with 113 currently on the FDIC warning list.

Part V: Tracking the Dollar

Okay the Tharp effect on the dollar showed is first contrary indicator that I can remember.  The dollar went up almost the entire time I was in Europe.

Month  

Dollar Index  

Jan 05  

81.06

Jan 06  

84.29

Jan 07  

82.37

Jan 08

73.06

Feb 08

72.57

Mar 08

70.32

Apr 08

70.47

May 08

70.75

Jun 08

71.44

Jul 08

70.91

Aug 08

74.09

Notice that last month, most of which saw me in Europe, the dollar rose to a value higher than at the end of January this year.

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. 

Workshops

Fall Workshops 

September 20-21-22 Peak Performance 101 with Van K. Tharp
Monday, Sept 22 Dinner at Dr. Tharp's House
September 24-25-26 Advanced Peak Performance 202 with Van K. Tharp and Libby Adams
Coming in October
October 11-13 Blueprint for Trading Success
October 15-17 ETF 101 Workshop

 

Trading Tip

Traders’ Business Planning: Protecting Your Tools – Starting with Your Computer

by
D. R. Barton, Jr. 

  "If builders built buildings the way programmers wrote programs, the first woodpecker that came along would destroy civilization." --Author Unknown

**Special note:  Important business planning steps are listed below!  Please read through the computer-based rant!

I spent part of my family vacation (too large a part, might I add) battling computer gremlins.  Viruses and Trojans.  Back-up program quirks.  Vista / Office 2007 incompatibilities.  And the list goes on.

Now is the time for all the Mac OS / Apple users out there to chuckle and say, “We don’t have those problems.”

Except that in the same breath, those users have to say, “We also can’t use an exhaustingly long list of programs.”  Most of the trading programs in the world cannot be run on Mac OS.  But wait! You can run Windows based software on a Mac now.  Right again, but in doing so we’re back to the issues inherent with running Windows (virus protection, etc.) regardless of the hardware being used.

Now, before I get inundated with letters of fury from the Mac faithful, let me say that I believe Macs offer superior design and hardware.  They just can’t run all of the software I need.  I bought a maxed out MacBook Pro just a few short months ago, gave it a go and decided that living in a two operating system world just isn’t for me.  And I was a dyed-in-the-wool Mac user from 1986 until 1996, so I do appreciate the Mac.

But alas, most of us traders and investors must spend at least part of lives living in the Windows world.  So let me talk about a few of the things that I have discovered over the last six weeks that might help make your business plan for trading more robust.

Three Items for Every Trader’s Business Plan

Both Van and I have been writing about the importance of business plans for many years.  I wrote the business planning chapter in Van’s book Financial Freedom Through Electronic Day Trading (which he wrote with Brian June).  The only area that was left out in that chapter was contingency planning for problems that might arise.  And computers are one of the most important areas for all traders and investors, since that is one of our most used tools.  Here are three things that all of us need to think about:

•   Back-up. Back-Up. And Back-Up Again.  Hard drives will fail.  It’s not a matter of if, but when.  I have had two laptop drives fail in the past 20 months.

In my recent virus attack, I was finally able to recover fully because I had a shadow image of my drive saved on a local hard drive.  There are many good back-up programs that create such a drive image.  And hard drives are really cheap these days.  A high quality 1TB drive (1000 Gigabytes) can be found for $200 dollars or less, and many of them ship with very functional back-up and imagining software included.  Having a local back-up is critical because most retail online back-up solutions (see next bullet point) limit the rate at which you can upload or download, so to get back up and running quickly, you really need to have this low cost protection (a physical local hard drive) in place.

•   Back-Up Offsite.  What if something happens to your local hard drive(s)?  I was convinced I was protected with a back up hard drive and a nightly synchronizing with another computer until I thought about my office – what would happen in case of fire (or a flood, tornado, etc.)?  What if all of my back-ups are in one room?

So I did some research and picked out Mozy (mozy.com) as the best for my situation.  As with most of the lower cost small business solutions (Cabonite, XDrive, iBackup) the rate of data transfer is throttled to reduce to cost of operations.  I don’t keep a full drive image on Mozy, just my essential files (documents, e-mail, trading files, etc.).

•   Anti-ViRus and Spyware.   I won’t go into any particular companies and their shortcomings in this areas, but I will share my research.  Some companies have done independent research on the major anti-virus packages (zdnet.com has a good compilation).  The findings are that Kaspersky is currently tops in effectiveness.  Norton is not too far behind.  All of the other packages are lagging these top two at the moment.  But remember that no package catches 100% of intrusion attempts.  And in this area, a little common sense on what to click on and what to avoid will go a long way!

Make sure your business plan has contingency plans for things that can knock you out of action.  And protecting your computer data (and usability) should be on the top of that list!  As always, comments are welcome: drbarton “at” iitm.com.

Until next week…

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.  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”. 

Melita's Inspirational Corner

Time to Relax

by
Melita Hunt

Last week I wrote about energy and where that energy comes from. Who are the people, the places and what are the things that give you a sense of renewal and power? And how can you ensure that those things continue to be a daily part of your life?

This week in the same vein, I am going to talk about relaxation. Do you take sufficient time to relax and enjoy your life or are you always in a hurry moving from one thing to the next? Do the days pass you by in a flurry, leaving you wondering when you will eventually get time to relax? Is life moving really fast? Does another day seem to pass you by without any time taken out for yourself? Do you collapse into bed and then drag yourself out again the next day?

Right now I am craving relaxation. On a daily basis my body is constantly telling me to slow down and be kind to myself and that is exactly what I am doing. This has, of course, come about because of the illness that I am enduring and the subsequent treatments that go with it. But it can also be a good lesson for you if you are willing to learn it. Don’t wait until an illness or accident slows you down; be conscious of the pressure that you are putting on yourself before it becomes a problem. Be aware of it now and give your body and mind the well earned break that it deserves. 

I believe that relaxation is as much about the mind as it is about the body. Incessant chatter and thoughts running through our brains can cause just as much exhaustion as engaging in something that is physically demanding.

When is the last time that you really relaxed? Was it on a vacation? Did you get a massage or sleep a few extra uninterrupted hours? Perhaps you can’t even remember what true relaxation feels like. 

What seems so important that you believe that you don’t have time to relax? What do you think you will miss out on if you slow down and turn off your computers and phones?

Take the time now to come up with three or four ways that you truly feel you are letting go and relaxing. Perhaps when you are aware of the activities, you’ll take more time to engage in them. 

Mine are simple: an afternoon nap, a full body massage, laying out on a water float, listening to a meditation tape, walking around my lake. 

It doesn’t take a whole lot of time to give back to your mind and body, and in return you may just find that life becomes a little bit easier to handle each day. 

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita’s progress regarding her lung cancer (she is a never-smoker). Please feel free to read her blog at www.myleftlung.com. You can contact Melita at mel@iitm.com

 

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