Included in the book is a great strategy for determining stock market performance, which Tharp calls the “1-2-3 model.” It takes its name from the three factors that Tharp believes affect the market most: the valuation of the market, the interest rate climate as determined by the Fed, and the price of the market.

The model is very simple to follow. If all three factors are in your favor, it’s time to buy. If only two factors are in your favor, it’s time to hold. If two out of the three factors are against you, it’s time to sell. Think of it like a basic traffic light system:

Green light – buy

Yellow light – hold

Red light – sell

According to Tharp, under green light conditions (going back to 1927) stocks have risen on average 19.5% a year; under yellow light conditions stocks have risen on average 10.7% a year; and under red light conditions stocks have lost 9.7% a year.
To put it another way, the three most important questions to answer about the stock market are:

1. Is the stock market too expensive?
2. Are the Feds in the way?
3. Is the market going up?

There’s a rumor going round, that’s someone’s underground, no wait, there’s a rumor going around that Ireland had requested aid from the IMF… Whoa there Partner! I know that things in Ireland have turned around on a dime from boom to bust, but I wasn’t aware of a problem that would run that deep… The rumors were denied, of course, but you know me… Where there’s smoke, there’s fire… I’m reminded of an email I received 2 weeks ago from a reader in Ireland, that talked of a major slowdown in the economy. The writer, was very adamant about how bad things had gotten that he compared Ireland to a banana republic! I responded to him, and said, no… That can’t be, because we’ve got a corner on being a banana republic right here in the U.S.A.!

You should have seen the sell off in euros when this rumor hit the streets! It was scary how fast a currency could lose a handle! But, after the rumors were denied, the single unit rallied back nearly as fast as it fell, and is now trading, as I write at 1.3225. The dollar is swinging a mighty hammer once again…

Talk about a flight to Risk Aversion! This rumor has the Risk Aversion campers battening down the hatches and heading to the cellars! Risk Aversion is NOT good for currencies and commodities.

Another reason for the Risk Aversion campers to batten down the hatches is the report from yesterday that Citigroup is going to sell their brokerage arm, Smith Barney, to Morgan Stanley for $2.7 Billion in cash… This to me, sounds like a fire sale, and that Citigroup is in deep dookie once again… Citigroup has already received $45 Billion from the Gov’t in TARP money, much more than any other bank has received, for sure!

This news scares the bejeebers out of me, as Citigroup has always prided themselves on the fact that a customer could do “one-stop investing”… I guess, we’ll have to wait-n-see if Citigroup announces a sale of another unit somewhere down the line, eh? But for now… This news is not good for any asset!

Well… Today, we’ll see the color of the Retail Sales for December. We all know that December Retail Sales should be kicking rear and taking names later… But… And that’s a BIG BUT… Not last month, unfortunately. As we get ready for the printing of Retail Sales, the experts say that Retail Sales will have fallen -1.2%, following a -1.8% in November. The Butler Household Index (BHI) tells me that while Christmas shopping was good, it wasn’t on scale with other years, and I believe the Retail Sales will be very disappointing this morning.

OK, what do we have here? A Fed Head talking about our ZIRP (zero interest rate policy). I know, we’re not quite at zero yet with the official rate, but the Fed Funds people would tell you differently! So, in my book, I say ZIRP! Well, this Fed Head, Lacker, thinks that interest rates will stay very low for some time… Say it ain’t so, Joe! I don’t want to see rates at zero for a long time, folks! That’s part of the reason we’re in this mess to begin with!

Oh, and yesterday, Big Ben Bernanke, was speaking over in London, and kind of threw some cold water on Obama’s $800 Billion stimulus plan… I can hear Obama saying… “Hey! He backed all the other stimulus plans, but now he’s throwing cold water on mine!” Well… I said “kind of threw” I didn’t say he DID throw cold water on the plan… I’ll let you decide… Here’s Big Ben… Fed Chairman Ben Bernanke said the “stimulus package being crafted by Barack Obama and Congress could provide a “significant boost” to the sinking economy. But he warned that such a recovery won’t last unless other steps are taken to stabilize the shaky financial system.” And what is he talking about in the “other steps”?

Here’s more Big Ben… “There will be no lasting recovery without further government action and funds to strengthen the financial system, with the timing of an economic recovery “highly uncertain.” OH GREAT! More Government action! That’s Central Bank parlance for “we’re getting our hands deeper into the cookie jar”!

OK, I’ve gone this far, and have not mentioned the huge drop in the Trade Deficit that showed up in the print yesterday… The Trade Deficit fell from $56.8 Billion in October to $40.4 Billion in November! WOW! This fabulous! Or is it? Let’s take a closer look at the numbers… U.S. exports fell $8.7 Billion and imports fell $25 Billion. Lower oil imports accounted for more than half of this drop, but ex-petroleum imports also fell $10.5 Billion.

So… Here’s the problem folks… As I tried to explain yesterday… A narrowing Trade Deficit because of less spending and larger exports would be manna from heaven… But a narrowing Trade Deficit because spending was slashed, and exports also fell, is not a good thing for the economy. It simply means that 1. The U.S. consumer has dried up and with consumption at least 70% of GDP, we’re in for a long recession… And 2. that the dollar is too strong, otherwise exports wouldn’t be so far off too. Yes, I’m quite aware of the fact that the recession is hitting all over the globe, but come on, we still buy Chinese and Japanese and even German exports even in a recession don’t we? These same countries would be doing the same with U.S. exports…

And then there’s this… News of the weird… Chris Gaffney saw a story yesterday that he sent to me, that qualifies for this category… Here’s a snippet of the story… “The Bank of England will be able to print extra money without having legally to declare it under new plans which will heighten fears that the Government will secretly pump extra cash into the economy.” Oh boy! Just what the pound sterling needs as a stabilizer eh? NOT! This is awful news for the pound folks…

I’ve said for months now that the Bank of England (BOE) was following in the Fed’s & Treasury’s steps, which could be to ruin, but following nonetheless! This is just another step in the Fed’s & Treasury’s direction. The free use of a printing press… The story went so far as to say “this will spark comparisons with the Weimar Germany and Zimbabwe, were uncontrolled use of the printing press ultimately caused hyperinflation.” This is where they’re getting a little out of control with the sensationalism… I prefer to say that it should compare to the U.S…. Which may still see hyperinflation in the future… But not the kind of Germany and Zimbabwe! YIKES!

So… As I get ready to head to the Big Finish… It looks as though that Trading Theme is back in force again, and the dollar will benefit any time the data shows the recession to be deeper, darker and more dangerous… Makes no sense to me! But that’s the work of the mental giants these days… So… If Retail Sales is as disappointing as I suspect it to be in about 15 minutes, then the dollar should be supported today…

Currencies today 1/14/09: A$ .6670, kiwi .5440, C$ .8185, euro 1.3190 (slipped back again), sterling 1.4535, Swiss .8925, rand 10.0450, krone 7.14, SEK 8.30, forint 210.20, zloty 3.1420, koruna 20.42, yen 89.45, sing 1.4920, HKD 7.7570, INR 48.83, China 6.8350, pesos 13.83, BRL 2.3140, dollar index 84.15, Oil $38.87, Silver $10.76, and Gold… 826.50

Source: The Dollar Swings A Mighty Hammer!

“Now more than ever, the Fed’s decision could turnaround the currency and equity markets,” wrote Kathy Lien, of GFT Forex. “The recent strength of the U.S. dollar will add pressure on the Federal Reserve to make a larger interest rate cut but everyone needs to realize that the rate cut by the Fed this week will not be their last.”

Perhaps not, but if the expected cut of half to three-quarters of a point materializes, there won’t be much further to go. Some are even saying the rate could go to zero a la Japan, in a desperation move to pump up the economy.

That the economy needs plenty of pumping was confirmed by yesterday’s report from the Conference Board that consumer confidence plunged to 38 in October from 61.4 in September. That far exceeded economists’ expectation for a drop to 52, and marked an alltime low in the index’s 41-year existence.

Expectations turned “significantly more pessimistic,” the board said, with the percentage of consumers expecting business conditions to worsen over the next six months rising to 36.6% from 21%, and those expecting fewer jobs rising to 41.5% from 26.9%.

Consumers’ “earnings outlook, as well as inflation outlook, is also more pessimistic, and this news does not bode well for retailers who are already bracing for what is shaping up to be a very challenging holiday season,” said Lynn Franco, director of the Conference Board Consumer Research Center.

Source: Euro rallies against dollar -  All eyes on the Fed

As noted, Bernanke’s words gave a big boost to the buck. The weak U.S. currency has “contributed to the unwelcome rise in import prices and consumer-price inflation,” Bernanke told an international bankers forum.

The Fed is “attentive to the implications of changes in the value of the dollar for inflation and inflation expectations, and will continue to formulate policy to guard against risks” to price stability and sustainable growth, Bernanke said.

“Bernanke’s defense was about as strong as he could make it, given the U.S. policy of letting only the U.S. Treasury Secretary speak about matters concerning the dollar,” said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co.

However, as Peter Schiff, president of Euro Pacific Capital, points out, only imposing sharp interest-rate hikes and curbing the rate of growth in the money supply will strengthen the dollar and cut inflation. And those could kill off any economic recovery.

That leaves the Fed to walk the tightrope between the rock and the hard place. Some observers were speculating that the tough talk could be followed with Washington intervening in currency markets by buying dollars and selling other currency, a prospect one analyst believes could happen as early as today.

Source: Bernanke Talk of Inflation Vigilance Supports Dollar – Fed Teetering on the Tightrope

That’s not an exaggeration. Interest-rate policy normally only affects the world economy at the margin, but it has now been so expansionary for so long that the Fed’s interest-rate strategy has turned into a moral dilemma of sorts. In short, the central bank’s monetary policy will likely determine whether millions of U.S. homeowners lose their homes or millions of the world’s poor starve.

Let me explain…

Expansionist Policies Lead to Market Bubbles

The Federal Reserve has been pursuing an expansionary monetary policy – growing the M3 money supply much faster than Gross Domestic Product (GDP) – since 1995. This has yet to result in U.S. consumer price inflation because a very powerful deflationary force – the introduction of cheap and readily available global communications through the Internet – has counteracted it.

Even though prices of domestically produced goods were increasing, the prices of many goods and services dropped as they became sourced from India (software services, for instance) and China (clothing, for example).

The result has been asset bubbles in both U.S. stocks and then U.S. housing, but without an accompanying big increase in consumer price inflation. Since last September, the Fed has moved to make monetary policy even more expansionary, cutting the benchmark Federal Funds rate six times to bring it down to 2.25% from its starting point at 5.25%, and pumping massive amounts of money into the banking system to bail out the banks that had lost money on subprime loans.

Most experts believe the central bank will cut rates again tomorrow (Wednesday), most likely taking the Fed Funds rate down another quarter point, to an even 2.0%, upon which the central bank will take a rate-reduction breather.

From the point of view of the U.S. housing market, Fed Chairman Ben S. Bernanke should keep cutting interest rates. Low short-term interest rates have a doubly beneficial effect on housing:

• First, low-level short-term rates tend to reduce long-term mortgage rates, while at the same time making banks more profitable. This increases banks’ readiness to lend for housing and reduces the interest rate on mortgages, making finance easier to get and cheaper for prospective homebuyers.

• Second, lower interest rates cause inflation. Consumer-price inflation is currently running at an annualized rate of about 4% over the last 12 months, so interest rates at about 3.6% for 10-year Treasuries and 2.25% for the Fed Funds rate are now significantly below the U.S. economy’s inflation rate. That means savers are getting an even worse deal than they usually get. It also means inflation is almost bound to accelerate: By definition, if borrowing costs are actually less than zero, people will find ways to borrow and then will waste the money they have borrowed.

The bottom line: Inflation is likely to rise rapidly towards the 10% level in the months to come.

The Fed’s Inflation-Fueled Rescue Plan

In most quarters, inflation is viewed as a four-letter word. But in a housing market where home prices are locked in a downward spiral, inflation is actually very good. For instance, should inflation spike to 15% and stay there for all of 2009 – while the U.S. economy remained in decent shape – then wages and prices could be expected to increase by 15% in 2009.

Additionally, the dollar would drop in value against other currencies that did not experience this burst of inflation. That would make housing relatively cheaper both for U.S. homebuyers (house prices would be a smaller multiple of earnings) and for foreigners (fewer European euros, Japanese yen or Chinese Renminbi needed to buy U.S. houses). The decline in housing prices would stop – and probably reverse – and the tsunami of mortgage foreclosures also would slow. The reason: Home mortgages would cease entering the “negative equity” situation in which it is cheaper for borrowers to walk away from both their home and mortgage than to keep making the payments.

If we’re only considering the housing market, Bernanke should lower interest rates as fast as possible. It will cause inflation, but he may well believe that a further series of home-price declines would cause so many problems in the home-mortgage market that moderate inflation is preferable.

Unfortunately, we don’t live in an economic vacuum, and Bernanke and his fellow Fed policymakers have much more to consider than just the travails of the U.S. homeowner.

You see, in addition to U.S. inflation and housing, Bernanke’s monetary policy has affected the world commodity and energy markets – and in a huge way. That’s why oil is now five times more expensive than it was in 2002, and is likely headed higher, still, before consumers get a reprieve.

But it was the rate-cutting campaign the Fed embarked upon last September that’s inflicted the real damage. Fed policymakers fired their first shot at the Fed Funds rate on Sept. 18, when it took short-term rates from 5.25% to 4.75%. On that day, oil closed at $82 per barrel, gold at $770 per ounce and the Reuters-CRB Index (CCI) of commodity prices was at 435. The flood of money poured into the system by the Fed and other central banks in the last seven months has had the anticipated impact: As I write, oil is at $118, gold is at $890 and the CCI Index has reached 544.