Update for the Week Ending October 30th, 2009
Condition: Normal Bull
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 five strongest and weakest areas of the overall market.
Part I: Van’s Commentary—The Big Picture
This is the first time in history that the S&P 500 has rallied 60% in just six months. It’s unprecedented. So what is going on?
Matt Taibbi of Rolling Stone has provided a few interesting insights. On October 14th, Matt posted an article at Rollingstone.com (http://www.rollingstone.com/ politics/story /30481512/wall_streets_naked_swindle/print) that, in my opinion, really says what is going on in the market. Now this only applies to a few curious incidents, not the whole market. However, when put in perspective, I think it starts to show a little glimpse into the big picture. Here’s a brief summary of some of the events according to
On March 11th a meeting was held at the Federal Reserve Bank of New York. Timothy Geithner and Ben Bernanke headed the meeting and every investment bank was represented except Bear Sterns. None of the participants will comment on what was discussed.
On that same day, some mysterious trader spent $1.7 million on options that would only pay off if Bear Sterns lost half of its value in nine days or less. At that time Bear Sterns closed at $62.97, and the options were the right to sell the stock at $25 and $30 a share, respectively. So Bear Sterns would have had to drop to $24 in nine days for this trader to make money on all of his options. The size of this trade made no sense unless somebody knew something (perhaps attended the meeting?).
Bear Sterns started a free fall the next day and was forced to sell itself for $2 a share to J.P. Morgan by the end of the week. The trader buying the options made about $270 million.
The SEC has issued more than 50 subpoenas to Wall Street firms trying to find this mysterious trader. They investigate insider
trading profits of only $2,000, but as of October 14th, at least, nothing has surfaced on this mysterious trader. Why not?
Bear Sterns fell because credit markers were pulled, rumors were spread through the media, legitimate short sellers pushed the market down, and a huge amount of illegal naked short selling occurred. And the SEC has done nothing about that either.
Six months later the same thing happened with the collapse of Lehman Brothers, although Taibbi didn’t mention anything about a mysterious option trader in the case of Lehman.
The bottom line is that this is not a normal market. It’s a market run by big trading firms, using government money. Almost three fourths of NYSE trading is program trading with about 16 firms running all market trades. And banks, brokerage firms and insurance firms are leveraging the funds they’ve received from the U.S. treasury and dumping them into the market. That’s what this rally is really all about.
From a technical fundamental perspective, does it make any sense that the bear market is over? Is this really a new bull market? I don’t think so.
I’ve said many times, a secular bear
market ends with stocks at single digit PE ratios and dividend yield of 6% or better.
This market hasn’t come close to that.
In fact, right now PE ratios are at unbelievable numbers. In 2007, when the Dow was at new high levels, the PE was 18.8 and 20.3 on actual earnings. Today, it’s at above 140! In contrast, before the Oct 1987 crash, it was just 20.3 times earnings.
For the past six weeks, stock funds have had a net outflow of capital. Insiders at corporations are selling at a much faster pace than they are buying. Insiders are not optimistic at all… and who would be at current PE ratios?
Pension funds are generally selling the stock market. CALPERS now only holds 49% equities, its lowest percentage since 1993. And it appears that the character of pension plans is beginning to change. They are being realistic and, given the state of the economy, they may no longer be willing to bet large amounts on the stock market.
We’re still in a secular bear market, and if the Fed stops channeling money directly into the market, we could see another severe down leg soon. But who knows for sure when that will happen.
Part II: The Current Stock Market Type Is Normal Bull
The SQNTM for 100 days has dropped down to a normal bull market, even thought it has been bullish since July 21st. The 25 day SQN is neutral for the last six market days. And the ATR as a percentage of the close is normal.
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.
All three indices are showing nice gains. Notice that all three markets are up on the year with the NASDAQ 100 up impressively.
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 one of Ken’s workshops, which are held several times each year. The next one will be held in New Zealand in February (details about those workshops are available on our website). Ken explains how these numbers are derived in this workshop, and he covers numerous systems that have System Quality Numbers™ above 5.
The November 2nd data are given below.
The areas in green are strongest (the total rating is at least one standard deviation above the mean); those in yellow are the next strongest (above the mean). Those below the mean are in brown, and those more than one standard deviation below the mean are in red. I’ve taken out all the double leveraged funds from my database, which means that the top and bottom funds are not devoted entirely to those groups.
The strongest countries are Sweden (63), Russia (60), Malaysia (60), and Brazil (60), with three other world areas coming in at 58. The strongest sectors are the Internet (78), Australian Dollar (63), world consumer
staples (62) and the British Pound (61). The weakest countries are the US (small caps and micro caps), Thailand (34), and Canada (40). The weakest sectors are Biotech (24), Biotech and Genome (32), Gaming (32), metals and mining (36), and semiconductors (36).
The next chart shows the futures, real estate, bonds, and the strongest and weakest
Here base metals (75), oil (71), commodities (65), gold (64), livestock (62) and Chinese real estate (62) are doing well. The weakest are natural gas (14), small cap value (15), biotech (24), and semiconductors (27). I hope you are not holding any of those.
Part IV: Our Four Star Inflation-Deflation Model
Once again, we are in credit contraction mode, so this is not the inflationary bear market I once thought we were going to get six or seven years ago. But I suspect that we’ll be in one by the end of 2009. Gold is certainly suggesting that.
We’ll now look at the two-month and six-month changes during the last six months to see what our readings have been. The CRB is at its yearly high for a month end and so is gold.
Part V: Tracking the Dollar
The dollar is heading down again with its weakest showing since August last year. However, part of the weakness is because of a massive carry trade in the dollar, people are borrowing the dollar and using it to buy assets (like gold, oil, commodities) at very cheap prices. In addition, they are profiting from the fall in the dollar. However, this massive “carry trade” will reverse one day—just like the yen carry trade did—and that could be an interesting time.
Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. But this doesn’t happen by just opening an account and adding money. You probably spent years learning how to perform your current job at a high skill level and the same goes for trading. But trading also requires massive self-work to produce consistent, large profits under multiple market conditions.
Next week, Florian Grummes will update us on gold. Until the November update, this is Van Tharp.
Van Tharp: Trading coach, and author, Dr. Van K. Tharp is
widely recognized for his best-selling books and his outstanding
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