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

February 04, 2009 — Issue #409
  
Article

Market Update for January by Dr. Van K. Tharp, Ph.D.

Trading Education

FREE Definitive Guide to Position Sizing

Trading Tip

Another Calendar Predictor — December Low Indicator by D.R. Barton, Jr.

NEW  Mailbag

Objective Way to Analyze the Results of a System: Q&A with Dr. Tharp

 

Feature

Market Update for January

Market Condition: Volatile 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, 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 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 edition of Tharp’s Thoughts), 2) the five week status on each of the major U.S. stock market indices, 3) our four star inflation-deflation model plus John Williams’ statistics, 4) tracking the dollar, and 5) the five strongest and weakest areas of the overall market.

Part I: Market Commentary

At the end of 2008, it appeared as if the market was in a consolidation phase and that it could either go up or down. It was on the high side of that range, so everyone seemed to assume that the market had made a V-bottom in November and would be going up 10-15% in 2009. To me that seemed rather ridiculous. I thought the fundamentals behind the market crash were likely to get much worse rather than better. Anyway, January of 2009 was one of the worst months on record, and we’re back in volatile bear conditions.

I’m writing this report from Bangkok, and I’ve just met with a businessman here whose company sells fabric dye to companies all over the world. He says his business is down 80%. Big companies are not making payments, which is very rare, and most of them are not ordering anything. To compound things, he only has two ways to solve the problem: cut cost or increase sales. Thai laws say that an employee who has been with a company over 6 years has to be given 30 days notice and 10 months of severance pay. In some countries in Europe, things are much worse because layoffs are not even possible. If you cannot run your company, then you must turn it over to the workers to run it.  It doesn’t matter if you are the one who is losing money.

Economic models are just beliefs that shape the reality of the people who believe them. Usually under extreme conditions, they all break down. Right now the world still seems to believe Keynesian economics, which says you can restore the economy if you stimulate it. US debt is horrendous. Interest rates are near zero. And the only way we can stimulate the economy is to print money? Does that even make sense?  Not to me. 

The Davos economic conference proved nothing except that politicians, central bankers, and the world’s richest people seem to go together. I found it interesting that CNBC in Europe interviewed a Russian billionaire who was willing to spend $200,000 to attend the conference because of the people he’d meet in a short period of time. However, the overall trend was protectionism (but not as bad as in the 30s) and the overall consensus was no one knew how to solve any of the problems.

Incidentally, the world seems to have the same Barack Obama euphoria that we’re seeing in the US. In Dubai, Bangkok, and Sydney, I see all the same magazines (including foreign ones) celebrating his election. The news seems to be dominated with the euphoric idea that he can solve the US's problems, which will solve the world's problems. Hmm...

Part II: The Current Stock Market Type Is Volatile Bear

My market type calculator is giving me troubles while on the road, so I won’t be showing you the data this month. However, we are clearly in volatile bear market mode. Next month I’ll be back at home, and I’ll publish the market type data. 

In addition, I’m also getting many questions on how I calculate market type. All of that has been given in past issues of Tharp’s Thoughts. However, we are planning to explore some more issues involving market type, and I’ll be doing an article devoted to that topic shortly.

So let’s look at the market changes over the last month as shown in the table below. All four indices are down more than 40% when you add the change for 2008 and the change for January together. 

Weekly Changes for the Three Major Stock Indices

 Date Dow 30 S&P 500 NASDAQ 100
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%
2-Jan-09 9,034.69 2.94% 931.8 3.16% 1,263.70 4.29%
9-Jan-09 8,599.18 -4.82% 890.35 -4.45% 1,223.01 -3.22%
16-Jan-09 8,281.22 -3.70% 850.12 -4.52% 1,198.14 -2.03%
26-Jan-09 8,116.03 -1.99% 836.57 -1.59% 1,184.56 -1.13%
30-Jan-09 8,000.86 -1.42% 825.88 -1.28% 1,180.25 -0.36%
Year to Date 8,000.86 -8.84% 825.88 -8.57% 1,180.25 -2.59%

In addition, the Asian version of the Wall Street Journal had a convenient listing of various world listings over the last year and the results are quite shocking, so I’ve added that information below the US market picture.

 No. Country 12 month 
Change
1 Russia 72.80%
2 Pakistan 61.50%
3 Brazil 54.20%
4 China 53.50%
5 Finland 52.70%
6 Indonesia 49.70%
7 India 48.30%
8 Italy 48.20%
9 Argentina 47.30%
10 Thailand 46.00%
11 Hong Kong 45.00%
12 Netherlands 45.00%
13 Taiwan 44.60%
14 Philippines 44.60%
15 Euro Zone 43.70%
16 France 42.40%
17 Singapore 41.80%
18 Turkey 41.70%
19 Japan 40.80%
20 Wilshire 5000 40.70%
21 Denmark 39.70%
22 Australia 39.40%

Notice that of the 22 countries listed, the U.S. broad market ranks as the 20th worst performer.

Part III: The Strongest and Weakest Market Components

I have a new model in which we track the relative strength of the various ETFs representing the economy of the entire world. I will be publishing this once a month. Ken Long, who developed the algorithm we use, publishes a similar report every weekend at www.TortoiseCapital.com. If you’d like more information, then I’d suggest you attend our ETF workshop, which is held several times each year. Ken explains how these numbers are derived in this workshop.

The areas in green are strong and those in brown are very weak. By the way, I usually consider strong to be in the 70s, and there is obviously nothing in that range on this particular chart. My entire world view is continued in the charts below. You have to be an ultra ETF (i.e., leveraged) to be rated in the 70s.

Here are the top areas of the world as of January 30th:

1) Silver 76
2) Gold 69
3) Chile 65
4) US Dollar Bullish 61
5) Yen 59
6) Biotech 57
7) Rupee 56

View Larger Chart

The next part of the chart shows commodities, real estate, and interest rate products. It also shows the top and bottom 15 ETFs. We don’t list those individually because most of the top and bottom performers are leveraged at least 2 to 1.

The whole world is weak and, except for short funds, none of the markets are anywhere near their 12 month highs, so don’t get too excited about jumping into green areas. Remember in my overall world assessment I said that the next bubble to burst would be interest rates. If you look at the top performers for the last two months, they were dominated by bonds. Now, only the short term bonds show up as being green.

Part IV: Our Four Star Inflation-Deflation Model

Once again, we are in a credit contraction mode, so it is not the inflationary bear market I once thought we were going to get six or seven years ago. The entire world is experiencing a credit contraction. We’re in a second stage deflation, which typically is supported by governments and ends when the governments fail. Iceland has now collapsed and the new joke is “What is the capital of Iceland?” The answer being $25.

Yes, the Federal Reserve and other central banks are printing money like crazy, but they cannot print it as fast as money is disappearing in the credit crunch. What happens in a credit crunch is that cash is king. Once again, cash is king, but it must be safe. When all of the bankruptcies play out, then money will be printed like crazy to stimulate what’s left of the economy. And at that point, gold is the king and that’s already showing up. This is my personal opinion. 

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
Dec 08 352.06 22.74 865 12.52
         
Jul 08 548.86 39.75 918 21.63
Aug 08 516.47 40.38 833 21.42
Sep 08 452.42 33.4 884.5 19.89
Oct 08 369.56 25.92 730.8 15.53
Nov 08 361.74 23.05 814.5 12.66
Dec 08 352.06 22.74 865 12.52
Jan 09 364.5 21.06 919.5 9.24

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 the financials have now hit the single digit mark.

Date CRB2 CRB6 XLB2 XLB6 Gold2 Gold6 XLF2 XLF6 Total Score
  Higher Lower  Lower  Lower Higher Higher  Lower  Lower  
Jan     -0.5    -1    +1    +1 +0.5

Our model is suddenly swinging back to inflation. However, much of this is because gold is very strong. It’s not in new high ground in terms of the dollar, but remember that the dollar has been one of the strongest currencies in this crunch.

Part V: Tracking the Dollar

The dollar is continuing its uptrend because of deleveraging.

Month Dollar
Index
Dec 00 104.65
Dec 01 109.51
Dec 02 101.48
Dec 03 86.21
Dec 04 80.1
Dec 05 85.65
Dec 06 80.89
Dec 07 73.69
Dec 08 80.69
   
Jul 08 70.91
Aug 08 74.09
Sep 08 75.51
Oct 08 80.39
Nov 08 82.74
Dec 08 80.69
Jan 08 80.91

The dollar is strong, but only because of the move from July through November. Over the last two months it actually has fallen as the Federal Reserve interest rates have shrunk to virtually zero. Let me restate what I said last month: I think we’ve seen the peak on the dollar. How is the US going to fund its massive debt with interest rates at zero? Expect the U.S. dollar to stop being the world’s reserve currency in 2009 or 2010 at the latest. 

Until next month, 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

DEFINITIVE GUIDE TO POSITION SIZING

Because Size Really Does Matter in the Markets, 

Van Tharp's Definitive Guide to Position Sizing

Position sizing is that portion of your trading system that tells you “how many” or “how much.”  How many units of your investment should you put on at a given time? How much risk should you be willing to take? Aside from your personal psychological issues, this is the most critical concept you need to tackle as a trader or investor.

Trading Tip

Another Calendar Predictor — December Low Indicator

by
D. R. Barton, Jr. 

 

“A complex system that works is invariably found to have evolved from a simple system that worked.” – John Gall

Two weeks ago we looked at the January First Five Days indicator.  I characterized it as an indicator that attempted to understand a complex system (the stock market) in overly simplified terms.

I gave a rather scathing analysis of the indicator.  (The “First Five Days” in January indicator holds loosely that the direction of the first five trading days of the year is a valid predictor of the direction of the market for the remainder of the year.)  I said in the article that I didn’t agree with the underlying belief system or the statistics used to support the strategy.

Several folks wrote with very thoughtful comments on my analysis—some folks also chimed in with analysis of their own.  And I must say, all the comments received were well reasoned and made excellent points.  Several deended the First Five Days indicator, with the thought that even if you combined the results for the less favorable down indication with the much-ballyhooed up indication, you’d still have an indicator that has been 72% right over 50+ data points.  Fair enough.  But I still think it’s more a statistical anomaly than an insightful descriptor of market activity.

A Better Way to Look at Market Activity Early in the Year

My good friend and market maven Christopher Castroviejo passed an article to me this week that talks about a different Calendar predictor: the “December Low Indicator.”  Apparently, 1970s Wall Street analyst and Forbes contributor, Lucien Hooper had similar misgivings about the “First Five Days” indicator or using the whole month of January as a bellwether for the year’s stock price activity.

According to the Stock Trader’s Almanac, “Hooper dismissed the importance of January and January's first week as reliable indicators. He noted that the trend could be random or even manipulated during a holiday-shortened week. Instead, said Hooper, “Pay much more attention to the December low. If that low is violated during the first quarter of the New Year, watch out!”

Hooper’s indictor seems to me to have much more merit.  First of all it is based on sound market pattern and behavioral patterns.  End of the year tax selling often drives prices to temporary lows in December. At the beginning of the year re-investment cycle should provide a lift for stock prices that should last through the first quarter if the market conditions are healthy.  If this follow-through doesn’t occur, then it’s a good indication that the market will continue to struggle.

The indicator has shown that of the 38 times (since 1952) that the Dow December low has been eclipsed in the first quarter of the following year, the market has gone on to make significant new lows.

And major new lows were made only three times when the December low was not breached in the first quarter in 1974, 1981 and 1987—all years that had significant market trauma.

For those market watchers out there, the 2008 December low was pierced on both an intraday and closing basis on Inauguration Day this year.  So those who are hoping for a rapid recovery off of recent lows may have to wait a bit.  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”. 

Mailbag

Objective Way to Analyze the Results of a System: Q&A with Dr. Tharp

Dear Dr. Tharp and Mr. Barton,

Thank you both for your excellent articles.  I have enjoyed reading them for the last several years.

I have become one of the largest option market makers in the little country I moved to.  It's a wonderful feeling being able to take my skills with me where ever I go.  And making money is an added bonus! Your articles and courses have helped me do both.

In testing various systems, the performance is always good on some stocks/commodities and not so good on others.  I have always wondered do I just average the results?  Do I hope my actual trading turns out more like the "good ones" and less like the "bad ones"?  Or do you know of a more objective way to analyze the results of a system that trades multiple stocks and/or commodities?

From Dr. Tharp: In answer to your question, you need to understand your system very well so that you totally know how it works.   Once you know how it works, then you can select the markets (or stocks) to fit the qualities that make it work.   If you get hugely different expectancies on different stocks, then I suspect that it is due to your system working well on some and not on others.   But if you understand how your system works, then you should be able to preselect the stock that it will work on.

In addition, you also have to remember that your system expectancy will be different for different market types. If the market type changes to something in which your system doesn't work well, then you need to select a system that does work well in that market type.   And market types could also be the reason for different expectancies. If the market type is actually changing when you switch to a different stock, you'll get different results.

 

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