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The Market Outlook for 2017 By Dr. Van Tharp Trading Education Institute
I'm currently writing my next book. It's called Systems Thinking: Moving from Force to Power and Awakening. The premise of the book is that we create our own reality through language and through our thinking process. That's actually great news except probably only 1-2% of the population has any awareness of this. The rest of the population just thinks that life is happening to them - not that they are creating it. You can get a glimpse of how this occurs by reading my last book, Trading Beyond the Matrix. Understanding how language and thinking processes create reality is great news because once you realize your creative power, you can create internal maps that make the world really work in your favor, and that's the stuff of genius.
Reality and Science
Most people, of course, believe that there is a reality. Do you want to know what that reality is? Scientific evidence says what it is, but in my just finished chapter on the Scientific View of Reality, the bottom line is that Science doesn't really know. To see how Science doesn't know, let's just look at one concept over the years - gravity.
Aristotle's worldview was predominant for almost 2000 years - the earth was the center of the universe and things tended to fall toward the center of the universe. Copernicus, Galileo, and Kepler, however, showed that the earth wasn't even the center of our solar system, much less the universe.
Next came Newton's law of universal gravitation which stated matter attracts matter in the force proportional to the product of their masses and inversely proportional to the square of the distance between them. This is still what most of us believe about gravity today although that view has been obsolete since Einstein came up with General Relativity.
General Relativity says that gravity is essentially warped spacetime so any massive object generates a gravitational field by warping the geometry of the surrounding spacetime. Einstein generated his theory about 100 years ago but scientists are now changing their theories about things as fast as every 25 years.
Modern physicists are trying to generate a theory of everything by reconciling the four forces of nature. These theories are all over the place and are constantly changing but the latest idea about gravity is that it's a particle called a graviton.
If you'd like to know more about how science cannot explain reality, then listen to The Great Courses course entitled "Science Wars: What Scientists Know and How They Know It" by Professor Steven L. Goldman. He has the same conclusion that science probably can never know reality but then of course, tries to justify what they do know.
The bottom line is that science progresses by first making some assumptions that seem logical and that seem to describe the real world. Then someone develops a theory that seems to explain and predict what is known and observed. Someone comes along later, however, and shows that the basic assumptions behind the current theory are no longer valid and they need to be replaced. Someone else then comes up with new assumptions and a new theory and if it predicts well, then the new assumptions/theory becomes the new standard for reality - until it too is replaced eventually.
Theories and Markets
Somewhere around 2000, I read two excellent books that predicted the start of a new secular bear market. The secular bear was going to be characterized by declining PE ration and would last 10 to 15 years. I recently looked up what those two authors have been saying lately.
One of them was Michael Alexander, author of the book, Stock Market Cycles. The last article I saw by him still said we were in a secular bear market and he was predicting a 10,000 point decline in the Dow Jones Industrial Average within the next few years. The other author was Ed Easterling, head of Crestmont Research. As of one week ago, Ed is still saying we are in a secular bear market. The following graph shows his position quite well. PE ratios have declined in the secular bear cycle (that he says started in 2000) to the levels where most secular bear markets start. The PE ratios, however, haven't gone down to the 5-10 level (the green band in the chart below) where most secular bears end and secular bull markets start.
Easterling said secular bear markets could be wild with huge bull and bear fluctuations within. For example, the next table shows the fluctuations in both the 1965-1981 secular bear and the fluctuations in the 2000 through 2016 secular bear.
The only problem with this table is that gains of +94% and +180% are not expected in such markets. This makes me think that, just like science, some of the assumptions in the theories of these two men might have become obsolete. For example, no matter what the inflation rate is and what investor psychology is, when the Fed injects money into the stock market, it will go up.
People who hold theories tend to cling to their theories and just adjust them to fit the conditions. A good case in point is the Elliot Wave people. They can explain anything but when things don't happen according to their predictions, they just adjust their interpretation of the waves. Robert Prechter's forecast in the late summer/early fall of last year called for a pending unprecedented decline in the market.
Forces Affecting the Market
In the market, my tendency has always been to have a slight bias toward the large secular market type but to base my trading on the Market SQN® score, which tells me what the market has been doing over the last 100 days. It's not a predictor of what the market will do but rather what the market is doing now - which in my belief system is important.
The market is up about 180% since 2009 and the whole market boom has been a result of the Fed printing new money. The Fed has added liquidity to the financial system through near zero interest rates but the banks have not been lending out this liquidity. It has gone into the stock market instead. There has been almost no place else to put money because interest rates have been at historical low points - some countries even have negative interest rates (i.e., it cost an investor money to be in "safe" long term bonds).
Since 2008, individual investors have stayed on the stock market sidelines. They are generally scared and have stayed away from the market. They are not buying trading books or attending conferences any more. The bottom line, however, is that the market is up 180% since 2008. It's sad. And who is making money? It's those who already have a lot of money.
If you'd like some other input on stock market behavior, look at the interest rate chart below.
The chart actually shows the reverse of the stock market prices quite well. The stock market was in a huge secular bull cycle from 1982 until 2000 when PE ratios got insane. And look at the huge drop in the Fed Funds rate over that period.
The Secular bear market started in 2000 because of the pressure on PE ratios in the 50s.
And if you want to look at what's happened to the market since 2009, just look at what's happened to interest rates. On a relative scale, that's the biggest drop on the charts.
Unless rates were to go negative, however, there is only one direction for them to go - and that will occur someday (when our debt crashes) but it's probably not going to happen for a while. With a US federal debt of 20 trillion dollars that keeps rising, interest rates will have to stay low - and they will stay low until something (other than the Federal Reserve) pushes them up. As long as they stay low (which is easy to monitor), I'm going to have a bullish bias on the market - and I will continue to pay attention to the Market SQN.
In addition to the bullish force of low interest rates, there are many more positive things going on in the economy as of late. First of all, whether you like it or not, we now have a rarity - a businessman as our president. Wall Street Legend, Bill Ackman supported Clinton but stated the following on CNBC recently, "I've said for years that if we could actually have a businessperson run the country, that would be a wonderful thing for America. So I woke up bullish about America. … he's going to launch a major infrastructure program. He's going to take corporate taxes down to a sensible level and get rid of loopholes… that's bullish for growth."
Economic Growth Factors
Let's look at a few more of the potential growth factors that now exist:
Except for certain places like New York City and much of California, if you want to buy a home, you can afford one. Interest rates are still at lows that haven't been seen before in the USA so you can borrow cheaply. In many parts of the country, homes remain a great value. You can get a decent house in many parts of the US for under $150,000. Compare that to an apartment in London, Paris, or Moscow, Shanghai, Sydney, or Geneva, just to name a few places. A 2,000 square foot house for $150,000 at around 3% interest rates is an amazing bargain. Our company's retirement plan has actually invested in a fund that buys really inexpensive houses and then rents them out or resells them. There are still huge opportunities in residential real estate.
Low interest rates impact much more than the ability of Americans to buy a house. They also enable businesses to invest cheaply, however, low rates also can lead to leveraged buyouts of other companies.
If Donald Trump follows through on his tax promises, he will cut corporate tax rates to 15%. In case you don't know it, corporations now pays taxes at 39% on any income over $100,000. The tax rate actually goes down when profits exceed $335,000 according to the following table from Wikipedia.
These numbers are actually quite insane but they really impact a small business. Why should a company want to make over $100,000 in profits when the government gets 39% of everything after that? And why is it that the government takes 38% from $15 million to $18.3 million while the biggest corporations pay only 35%?
So what is one result of this tax structure? Big international corporations keep most of the money they have earned overseas in locations with great tax rates.
Trump's next promise is to give corporations a 10% tax rate for those that bring back their overseas hordes of cash. 10% of some of that money is better than 0% of everything that stays overseas now. And that money coming back into the US economy could act to really stimulate it.
And lastly, the Fed is raising interest rates, but it cannot afford to raise them too high for several reasons, including:
Two minor rate hikes have had little impact on borrowing but they have sent the dollar to multi-year highs against other currencies. The US government cannot afford to have the US Dollar valued too high or it will impact our ability to export to other countries
We have a huge debt at about $20 trillion dollars. At 2% interest, we must pay $400 billion in debt payments. At 4% interest, debt payments grow to $800 billion which is about 25% of the government's annual revenues. So don't expect to see interest rates reach as high as 4%, unless something happens beyond the control of the Federal Reserve.
Next, let's talk about oil. The chart below shows the price of oil over the last 50 years. When oil was over $100 per barrel, the US became one of the largest oil producers in the world because of fracking. We were basically energy self-sufficient using fracking technology. Then Saudi Arabia started to drive down the price of oil and at about $30 per barrel, many US oil companies went out of business. The Saudi's exhausted most of their financial reserves doing so and can no longer afford to continue the practice. So expect oil to return to much higher levels than it is now.
Learning From an Excellent Forecaster
Probably the best forecaster of what is going on in the markets since 2009 has been Steve Sjuggerud. Steve said buy in March of 2009 and has been extremely bullish since that time. And he is even more bullish now that Donald Trump is president. I haven't totally bought into all his assumptions but he has been accurate in his forecasts. So when he made some forecasts recently for 2017, I paid attention. I still pay the most attention to our Market SQN™ readings, but I think I'll give Steve's predictions as a slight bias in the back of my mind.
What method does he use? Steve actually studies three areas for his forecasts and where to put money. First, he attempts to zero in on the one thing that is most critical to the investment climate right now. What is the major overriding factor in the market? Get that right, he said, and you will probably do well. We discussed this factor above - it's historically low interest rates.
Steve believes the Fed will keep interest rates lower than you might think possible for a lot longer than you might think possible because of our huge debt. Do you get it? The Fed will not raise rates any significant amount - it cannot afford to. And this will cause stocks and real estate to soar.
Second, Steve looks at sentiment. What is hated? Now I hadn't thought about it in this way but the individual investor is very afraid of the stock market. They've been burned and look what's happened to the stock market since 2008.
Interestingly enough, right now investor sentiment is extreme in the belief that we will have much higher interest rates so - don't expect them. Perhaps we'll even see negative interest rates within the next year or two. At the very least, don't bet on interest rates going much higher. (And if the interest rate chart means anything - expect a boom in the stock market.)
And the third factor is also a basic Tharp Think principle. No matter how hated something is or how undervalued it is, don't buy it until it starts to go up.
Unfortunately, many traders will not make money in the markets because they will do the opposite of what they should be doing. Even traders that have made the decision to stop trading for the time being have the opportunity to continue to broaden their knowledge of the market by studying investment books, or by attending workshops and conferences.
We basically watch what the market is doing as measured by the Market SQN™ readings and let that guide us - but we can have an overall bias. Rather than have that bias shaped by theories that say we are in a secular bear market, let's use instead the following principles -
What's the overriding thing influencing the market? (interest rates);
What's hated or way undervalued? and
Don't buy until the market proves you right. That is, don't buy until the market is going up or at a strong base, where you know that if it drops through the base, your risk is very low.
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