Q: I recently read Safe Strategies for Financial Freedom, which I found very useful. Regarding the 1-2-3 model, the last reference I can find is the newsletter dated March 5, 2008. Has the 1-2-3 model been discontinued? If so why, and what has it been replaced with?
I also want to understand the Four Star Inflation/Deflation Model published in the monthly market updates.
I reviewed the relevant section of Safe Strategies, which outlines the methodology using four components: commodity prices, consumer prices, gold prices and interest rates. The monthly update tracks four items, two of which appear to be the same (CRB/CCI and gold) but two items (XLB and XLF) appear to differ (unless these are proxies for CPI and interest rates). I suspect since the publishing of Safe Strategies there has been a revision to the methodology, and I am keen to understand the logic behind the revision.
Can you please advise?
A: Van did change the model he uses to monitor the big picture in his monthly market update. In an article from April 30, 2008 Van wrote,
“I’ll now be reporting market type regularly in my monthly update of the markets. In fact, this market type filter will replace the 1-2-3 model because I believe it is much more useful. The 1-2-3 model, in my opinion, will soon fail because the valuation portion of it will start signaling “buy” even though we are in a secular bear market in which valuation (i.e., PE ratios) could go down to the single digit range.”
Regarding XLB and XLF, it would be easier for Van to answer this question but he is traveling in India this month with minimal connectivity to us here back in the office. Since he’s not around, I pulled out the Safe Strategies book and did a little reading online. I’ll try to interpret what Van uses in the model now.
Van exchanged XLB for the CPI or consumer price index. Van has become completely distrustful of all government statistics. It doesn’t surprise me that he wanted to use the basic materials ETF to track prices directly rather than use fudged figures from the federal government. As you have read in his updates, he much prefers the numbers that www.shadowstats.com reports.
As for XLF, I believe Van thinks this financial sector ETF is a more useful measure for inflation/deflation rather than the short-term rate alone. Van probably believes the extraordinary governmental actions in the debt markets have made the short term rate much less useful in recent years for measuring the presence of inflation or deflation. The price of XLF reflects well multiple inflation-sensitive factors beyond the short-term interest rate to make it a better measure of inflation.
Those are my best guesses for the changes in Van’s inflation/deflation model since he wrote the Safe Strategies book in 2003. More important than understanding Van’s logic, however, is understanding your own beliefs about inflation, deflation, and how you will assess the environment for them. Have you written down what you believe about inflation, deflation, their effects on the economy and financial markets? Van continually advises traders to get their beliefs down on paper so you can examine them. Once you do this, then you may be able to effectively utilize Van’s model or you could develop one of your own that fits you well.
RJ Hixson
