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

  • Article April Market Update: Strong Bull Quiet by Van K. Tharp, Ph.D.
  • Trading Education NEW E-Learning from Van Tharp
  • Trading Tip April 2011 SQN® Report by Van K. Tharp, Ph.D.
  • Workshops NEW! Forex Workshop Offered in June
  • Mailbag Calculating the Volatility Curve

Market Update for the Period ending April 29, 2011
Market Condition: Strong Bull Quiet

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: Van's Commentary—The Big Picture

Qualitative Easing II (QE2) is due to end next month and that could be the end of the bull market. However, right now it’s roaring and those items that tend to prosper during inflation—Gold, Silver, Oil, Commodities—are, indeed, prospering. That is the big picture in a nutshell. If and when the Federal Reserve stops printing money like crazy, the stock market rise will stop. Stay alert and notice what happens in June.

Part II: The Current Stock Market Type Is Now Strong Bull Quiet

Each month I look at the SQN® score for the daily percent changes over 200, 100, 50 and 25 days. On May 2nd, the SQN scores for 200, 100, and 25 days were all strong bull, while the SQN 50 score was just bull. The graph below shows a chart of the SQN 100 calculation over the last year.

chart 1

The 100-day SQN score has been strengthening for about 7 weeks now.

The next graph shows market volatility.

chart 2

Since late May last year, the trend was towards lower and lower volatility. It started to pick up around the first of the year, and it almost reached volatile territory before it started moving down. Right now, it is in the quiet range, and I’m not really worried about a strong market downturn until we get into the volatile range.

Jason Goepert’s Sentiment newsletter suggests that dumb money is 67% confident whereas smart money is 46% confident. He believes these levels are a moderate warning signal for a market downturn. Interestingly enough, these were the exact same numbers as when I did the March report.

Here are the performance figures for the three major U.S. indices over the last month. All of them are up nicely. The DOW and S&P 500 only had one negative week last month, while the NASDAQ 100 had two down weeks. All three indices are up nearly 10% on the year, and most of that gain came in April. You may remember that I said the market was very favorable in the April 6th newsletter. Well, the market seems to be telling us that strong performance will continue in May; however, see my comments below on the US dollar.

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%
4-Apr-11 12,400.03 7.10% 1,332.87 5.98% 2,334.54 5.26%
11-Apr-11 12,381.11 -0.15% 1,324.46 -0.63% 2,314.50 -0.86%
18-Apr-11 12,201.59 -1.45% 1,305.14 -1.46% 2,292.34 -0.96%
26-Apr-11 12,595.37 3.23% 1,347.24 3.23% 2,396.03 4.52%
2-May-11 12,807.36 1.68% 1,361.22 1.04% 2,404.24 0.34%
Year to Date 12,807.36 10.62% 1,361.22 8.24% 2,404.24 8.40%

Part III: Our Four Star Inflation-Deflation Model

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

Date  CRB/CCI XLB Gold  XLF 
Dec 05 347.89 30.28 513 31.7
Dec 06 394.89 34.84 635.5 36.7
Dec 07 476.08 41.7 833.3 28.9
Dec 08 352.06 22.74 865 12.5
Dec 09 484.42 32.99 1,104.00 14.1
Dec 10 629.63 38.47 1,410.25 16
Jun 10 471.37 28.37 1,244.00 13.8
Jul 10 499.05 32.01 1,169.00 14.7
Aug 10 496.73 31.04 1,246.73 13.6
Sep 10 536.12 32.78 1,307.00 14.4
Oct 10 566.28 34.8 1,346.75 14.6
Nov 10 565.96 35.19 1,383.50 14.5
Dec 10 629.53 38.47 1,410.25 16
Jan 11 650.8 39.47 1,327.00 16.7
Feb 11 676.96 39.46 1,411.00 16.9
Mar 11 672.81 40.02 1,439.00 16.5
Apr 11 687.66 40.87 1,535.50 16.4

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
   Higher Higher Higher Higher Higher Higher Lower Higher  
April    +1    +1    +1    -0.5 +2.5

All but one of the measures was higher last month, so unless we have another massive derivatives collapse, we are in an inflationary environment. That inflation could remain subdued; however, unless or until the banks start lending again and then it could become interesting. Notice the huge change in the price of gold last month!

Shadowstats.com estimates the M3 money supply is still smaller than it was 12 months ago. Since the middle of 2010, the money supply contraction has reversed, although shadowstats.com still shows the M3 growth rate below zero. The St. Louis Federal Reserve still shows that the banks are not multiplying the effect of their printed money. Furthermore, the trend for the multiplier effect is moving down strongly and now sits at 0.74—that’s the lowest I’ve seen it. Notice the sharp downturn in the graph that began earlier this year.

chart 3

This is not a good sign for the economy. The stock market is in roaring bull mode because of the Fed’s activities; however, those effects are not flowing into the economy. The economy is a disaster. The Fed’s money is just flowing into the stock market, probably largely through big banks investing the new money. Banks certainly are not lending it like the Fed intended.

Part IV: Tracking the Dollar

The next table shows the US tracking of the dollar index through April.

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
Dec 09 73.82
Dec 10 73.81
Jul 10 76.74
Aug 10 75.93
Sep 10 74.99
Oct 10 72.31
Nov 10 72.84
Dec 10 73.81
Jan 11 73.18
Feb 11 72.22
Mar 11 71.02
Apr 11 69.75

This week, the Fed actually had data for the dollar, but it changed the values for the last four months, so that shows the accuracy of their record keeping. The April figure of 69.75 is the lowest I’ve seen it since the Fed started posting the dollar prices. That’s how serious the price decline is. And the US dollar is now significantly lower than both the Canadian and the Aussie dollars.

Now we’ll look at a futures chart of the US Dollar Index. Remember that futures prices are usually a little higher than cash prices.

chart 4

Look at the huge decline in the US Dollar over the last four months. It’s no wonder Gold is going up so much. Basically, if you were invested in the S&P 500, whatever you’ve made in that index has been offset by the fall in the value of the dollar.

General Comments

We’re in a secular bear market, which means a long term and dramatic reduction in equity valuations. Eventually, we can expect to see S&P 500 PE ratios in the single digits. Fundamentally, conditions certainly seem to support that trend even though the economy can do quite well in some secular bear markets.

Here is what is going on in my opinion:

  1. The US economy is in a shambles. The debt is so big that the government cannot fix it. It is only a matter of time before it caves in. Expect the government to default on a lot of its contracts, especially social security.
  2. The Federal Reserve is printing massive amounts of money to stimulate the economy, and usually that should work because the banks normally lend out three or more times as much money as they get from the Fed. But right now the rate of lending is at 0.74. The banks are not lending their money; they are putting it into the market…the big banks at least.
  3. US interest rates are very, very low right now because the government, due to its debt, cannot afford high interest rates (nor can the economy). Low interest rates, the US account deficit and our massive debt have crashed the dollar. Expect things to get even worse because one day the world will not accept the US dollar as the world’s reserve currency.
  4. While the market is in a strong bull period, the overall gain in the major indices this year is not as big as the fall in the dollar.
  5. In this climate, long term investing does not work. You must be a trader, and you must have your psychology together in order to succeed. Trading is not easy; you need to educate yourself and exercise your discipline.

Once again, it’s my opinion that you should use the information in these monthly updates to discern when to switch trading systems and not to forecast the market. This is why it’s imperative that you know how your system will perform under various market conditions. If you haven't heard this before or the other ideas mentioned above, read my book Super Trader, which covers these areas and more so you can make money in any kind of market.

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 May update, this is Van Tharp.

About the Author: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books 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.vantharp.com.  


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vanTrading Tip

April 2011 SQN® Report

I now use the System Quality Number® score or SQN® score to measure the market performance of countries, currencies, commodities, and various equity sectors in my world model. I use 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.

  • 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).

My spreadsheet includes most ETFs currently available, but I do not include any leveraged ETFs.

World Market Summary

sqn1

Once again, the US markets look very strong. Look at the top center box. All market segments of the US stock market are light or dark green, except for the small caps. However, on a relative strength basis, they are getting weaker.

Now compare the US Market scores with the rest of the world. With the banks not lending money, a weak US dollar and housing are getting worse. I’m really surprised at the US market strength. Enjoy it while it lasts.

The European countries are gaining strength, with some of them being ranked higher than the US indices. Belgium and Switzerland look particularly strong. Here are April’s five strongest countries:

  1. US Dow 30 1.97
  2. Switzerland 1.78
  3. Belgium 1.67
  4. South Korea 1.52
  5. Netherlands 1.48

India is the only negative country at minus 0.61. It’s interesting that India shows up weaker than Japan after what Japan has been through.

The industrial sectors for health care, consumer staples, biotech and energy dominate everything else. However, this is different from last month when the energy related sectors were where all the action was.

This chart also suggests that there was a lot of interesting action in the Forex market last month. Here are April’s strongest currencies:

  1. Swiss Franc
  2. Inverse US Dollar
  3. Australian dollar
  4. Mexican Peso
  5. Euro (right as I’m getting ready to go to Europe)
  6. Brazilian Real and the Canadian Dollar are also worth watching.

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

sqn2

Notice that healthcare now dominates the list of top ETFs and the inverse funds dominate the bottom funds (notice where the long dollar ETF is in the this list).

Silver, commodities and junk bonds have done fairly well in this climate—at least in April. And I would expect gold to be up there with last month’s huge climb, but gold’s SQN 100 score indicates only strength recently.

Chinese real estate is the weakest real estate area to have been in. Bonds, natural gas and livestock are all very weak areas, but not negative. Base metals and steel (Japan is probably not going to be producing cars for a while) are also quite weak.

My Interpretation of What Is Going On

The Federal Reserve is printing money like crazy and the banks are not lending it. Instead, they are probably putting it into the stock market. The bond bubble burst and that money has also been flowing into the stock market. The dollar is collapsing faster than the US stock market is going up and inflationary products are doing fairly well.

It is a crazy world.

About the Author: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books 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.vantharp.com.  

 


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Mailbag

Calculating the Volatility Curve

Q: I watched your YouTube video on the the six market types, and I was taken with the idea of applying the SQN® score to a stock index in order to measure the current market type. I tried to do this in Excel and it worked straight away—it gave me the exact same curve that you showed in your video (at least it looked identical).

But I didn't quite figure out how you calculated the curve for the volatility. Is it ATR expressed as percentage of the close? Or something similar?

By the way, at the moment I'm devouring your books, and I have to say that I'm absolutely fascinated by all of those secrets you share with us. Everything you say makes sense and opens my eyes. Thank you so much!

A: Yes, the volatility curve is the ATR percentage.  To calculate it, divide the daily ATR by the daily close.   


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May 04, 2011 - Issue 524

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