Market Update for October 2007

Look for these monthly updates in the first issue of each month. This allows us to get the closing month 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 new four star inflation-deflation model; and we’ll be 4) tracking the dollar.

Part I:  Market Commentary

So far, the July-August correction has been a minor correction.  The Federal Reserve has stepped in and lowered interest rates and thus far, Mr. Market has seemed quite happy with that.  The market has resumed its uptrend.  Perhaps the graph of EWZ, the Brazilian ETF, best illustrates what happened (shown below).  The market corrected and then resumed its uptrend.

The subprime crisis, however, is far from over.  Furthermore, autumn tends to be a time for price shocks.  If the Federal Reserve keeps lowering interest rates, then what is going to happen to the dollar, which is already at the brink of a cliff (i.e., all time lows) when people start going elsewhere for better interest rates?  It’s a very interesting situation. 

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

Part II: The 1-2-3 Stock Market Model Is In YELLOW LIGHT MODE and that’s good for stocks

The 1-2-3 Model is borderline yellow light.  The Fed is not in the way and has actually started to lower interest rates.  That’s positive.  The market is  acting well again, and that’s also positive.  However, the PE ratio of the S&P 500 is above 17, which is not positive.  Thus, we are in yellow light mode.  I wrote a discussion on the 1-2-3 model in last week’s issue. 

(Editors note: There is a correction in last week's article. The 45 week moving average was inadvertently written as a 17 week moving average. Click here to review the article).

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 below.

 

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		1211.12		1621.12
Close 05	10,717.50	-0.60%	1248.29	-3.10%	1645.2	1.50%
Close 06	12,463.15	16.29%	1,418.30	13.62%	1,756.90	6.79%
31-Aug-07	13,357.74	7.18%	1,473.99	3.93%	1,988.73	13.20%
7-Sep-07	13113.38	-1.83%	1453.55	-1.39%	1958.35	-1.53%
14-Sep-07	13442.52	2.51%	1484.25	2.11%	2000.82	2.17%
21-Sep-07	13820.19	2.81%	1525.75	2.80%	2049.48	2.43%
28-Sep-07	13895.63	0.55%	1526.75	0.07%	2091.11	2.03%
Yr to Date		10.31%		7.10%		15.98%

 

Notice that the market has produced its entire gain for the year in these five weeks, with the S&P 500 being up 10.31% for the year.  It’s also been a return of high volatility in which most weeks have a return of two percent or more. 

Is the pattern having to do with years ending in 7 to continue?  If it is, then we probably can expect a major decline beginning this month.  But presently, the market shows no tendency to do this at all.  We could easily have an up market that occurs in the presence of a declining dollar and strong inflation. 

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.  And the 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 over the pain of the subprime crisis.

Date	CRB	XLB	Gold	XLF
December-05	347.89	30.28	513	31.67
December-06	394.89	34.84	635.5	36.74
January-07	393.89	36.25	650.5	37.08
February-07	410.64	37.45	664.2	35.95
March-07	407.45	37.95	661.75	37.57
April-07	403.54	38.62	677	37.01
May-07	407.58	40.72	659.1	37.69
June-07	410.36	40.5	650.5	36.18
July-07	424.52	39.42	665.5	32.9
August-07	413.49	39.15	672	33.75
September-07	447.57	42.11	743	34.32

 

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	Higher	Higher	Higher	Higher	Higher	Lower
		1		1		1		0.5	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.

Look at what happened to the CRB, Gold and XLB during the month of August.  Those are huge jumps and to me they signal a very strong inflation just ahead of us.  This is a time to be in commodities, and real assets such as precious metals and top quality collectibles.

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
5-Jan	81.06
6-Jan	84.29
6-Feb	85.05
6-Mar	85.01
6-Apr	83.88
6-May	80.63
6-Jun	81.51
6-Jul	81.94
6-Aug	81.18
6-Sep	81.59
6-Oct	82.36
6-Nov	81.49
6-Dec	80.89
7-Jan	82.37
Feb 07	82.07
7-Mar	81.23
7-Apr	79.87
7-May	79.2
7-Jun	78.93
7-Jul	77.51
7-Aug	77.51
7-Sep	75.91

The dollar has broken its important support levels and is starting to plunge.  I’ve been warning about this for some time.  The dollar has now fallen every month since the January close, although it didn’t go any lower last month with the subprime crisis.  Since January 2007, the dollar has fallen 7.8%, that's nearly as much as the S&P 500 rose last month.  If your wealth is in the dollar, then you’ve lost real value during 2007.  Think the stock market is up on the year?  No, with respect to the fall in the dollar, you are not even covering inflation if you are matching what the overall market indices are doing.

 

Until next week, this is Van Tharp.

 

 

An elite group of traders and technical analysts gathered in Las Vegas last weekend to educate and enlighten several hundred attendees of the 21st annual TAG (Technical Analysis Group) conference. For two and one-half days, these respected market watchers shared their trading secrets and strategies.

Following are some trading and technical tidbits this writer picked up from this year's TAG 21 conference, which was put together by Tim Slater, a respected technician in his own right, and was sponsored by INO.com.

1. * One of the themes coming out of this year's conference was the increased volatility in the stock market, and how traders with a futures-related trading background have used their experience with volatility to obtain better entry and exit points in stock trading. Most agreed that whether one trades stocks, or financial futures, or commodity futures, there are key trading techniques and tenets that apply to all three. 

2. * All the speakers heard by this writer pointed out that successful traders must have a specific trading plan before they execute a trade--and show keen discipline in following through on the plan. This includes entry points and potential exit strategies--including setting stops. Always set a stop when trading.

3. * Keep a diary when trading. This helps identify any trading mistakes, or trading successes, in future decision-making on trades. 

4. * Have a money-management plan. This is a must. Know what your financial risk tolerance is and trade accordingly. 

5. * Don't add to a losing position.

6. * If you are in a trading slump, take a break for a few days or weeks, in order to reflect upon your trading methodology. 

7. * Do not overtrade. This is a common mistake among many traders. 

8. * Take advantage of market trends. "The trend is your friend" saying rings true. Use extra caution when trading against the prevailing trend of the market.  Don't try to pick tops or bottoms. 

9. * Let your profits run and cut your losses quickly.

10. * The fundamentals in any given market are always most bullish at market tops and most bearishat market bottoms.  This is where the "buy the rumor, sell the fact" anecdote sometimes comes into play. 

11. * There is no Holy Grail in trading. There is no "free lunch." Trading successfully is hard work. 
    

* Most speakers said their methodologies should be used as one "tool" amid a variety of tools in
your own trading "toolbox."

That is it for this week. You can also visit my daily blog at www.traderblogs.com. Have a great weekend!

 

European currencies was the dominant short-term market influence, expecially with the key monthly employment data at the end of this week.

The US ISM index for the manufacturing sector weakened to 52.0 from 52.9 previously while the services index dipped to 54.8 from 55.8. Within the services index, both the employment and prices components were stronger over the month.

The ADP data recorded a 58,000 September increase in private-sector employment from a downwardly-revised 27,000 the previous month.

The monthly employment data recorded an increase of 110,000 for September and the August data was revised up to 89,000 from the previous estimate of a 4,000 decline due to a big revision in government jobs. The unemployment rate rose to 4.7% from 4.6%.

Housing data remained weak with pending home sales falling by a further 6.5% in August to give a 21.5% annual decline.

Estimates suggested that direct investment flows have increased to over US$250bn for the first three quarters of 2007.

The ECB left interest rates on hold at 4.0% following the latest council meeting. In the statement following the decision, Trichet reinforced the commitment to curb inflationary pressure. The bank did not refer to the need for vigilance while the bank also declined to state that policy was accommodative, but rejected claims that policy was now neutral.

The ECB comments, overall, reinforced market expectations that the bank would not increase interest rates in the near future.

Euro-zone officials expressed increased levels of concern over the Euro’s strength against the dollar and effectively called for greater US backing for a strong US currency.

The dollar found support beyond the 1.42 level against the Euro and strengthened to highs near 1.4040 after the payroll data in choppy trading.

The Bank of England left interest rates unchanged at 5.75% following the latest MPC policy meeting. The central bank did not issue a statement following the decision.

The UK CIPS index for the manufacturing index fell to 55.1 in September from 56.3 the previous month. The services-sector index also fell to 56.7 from 57.6 which was the lowest reading for 12 months.

HBOS reported that house prices fell 0.6% in September, the first monthly decline for 2007 to give a 10.7% annual increase.

Sterling found further support weaker than the 0.70 level against the Euro with gains back towards 0.6940. The UK currency remained volatile against the dollar with selling pressure above 2.04.

Commodity currencies again had a firm tone over the week and challenged higher levels against the US dollar. The Australian dollar strengthened to new 18-year highs against the US currency while the Canadian dollar pushed to new 31-year highs around 0.9850 after strong employment data. 

The Reserve Bank of Australia left interest rates at 6.50% following the latest monthly policy meeting.

Retail sales growth was firm with a reported 0.7% for August after an upwardly-revised 0.8% increase in July. Private credit growth, however, fell 1.7% in August to give a 0.1% year-on-year decline which raised some concerns over the housing sector. The trade deficit widened to AUD1.61bn in August from AUD0.76bn the previous month

The Canadian PMI index weakened to 56.0 in September from 58.5 the previous month which raised some unease over growth trends.

The labour-market data was strong, however, as unemployment fell to 5.9% from 6.1% while there was a 51,100 increase in employment for the month.

Oil prices continued to have a significant impact on the currency with the underlying strength of prices still providing solid support.

The government announced the nomination of Carney as Bank of Canada governor to replace Dodge who is not serving another term.