Employment Report

Yesterday morning's employment report was, at first glance, disappointing. While payroll employment was expected to show a net change of about 125,000, the actual change was only 56,000, less than half the expectation. A good story describing this is in Money.com. While the payroll employment change was disappointing, the unemployment rate fell slightly from 5.1% to 5.0%. All of this is detailed in the official report by the Bureau of Labor Statistics.

A few things to note. Virtually all newspaper/Internet articles describing this are WRONG -- they state that the 56,000 number was the addition to employment. It was actually the net change in employment -- the difference between jobs added and jobs lost. In a post-manufacturing economy like ours, job loss occurs every month (unfortunately). About 15 or 20 years ago, what the newspapers described would have been accurate.

Note also how much of the discussion about this report centered on the unemployment rate. Did you hear anyone say (or write) that the labor force fell last month? A falling unemployment rate caused by a lower labor force (the unemployed dropping out of the labor force) is little cause for celebration! More importantly, the unemployment rate is a lagging indicator.

One last point. Average hourly wages rose more than expected, providing fuel to "inflation hawks," part of a bond market sell off yesterday. I wonder how much of this is caused by the fact that a number of the persons no longer employed as the result of the hurricanes had low and below-average earnings (tourism workers, etc.). Hmmm.

Returning to the bond market, the 10-year bond rose by 1.3 basis points yesterday to 4.66%, the dollar strengthened, and the stock market continued its recent rally. As an extra credit exercise (due at the beginning of class on Tuesday), graph the ten-year bond using daily data for the last year. Add comments, support/resistance, and indicator information, etc. with the StockCharts annotation tools (Note: when adding comments, leave a space after the last character before closing the box). Then do the same thing with two years of weekly data on the 10-year bond. In a short paragraph (a Word document where you can also paste the two graphs) contrast what the daily and weekly charts are showing.

GDP Report

Friday morning, the preliminary Q3 GDP report was released. While the growth rate, 3.8%, was slightly higher than expected, the media has attributed the large stock market rally to this report.

Screen the media in a situation like this. Everyone knows that Q3 is history and Q4 growth will be slower than the Q3 value. Why the stock run-up then? Partially it was a short-covering rally, where shorts, persons who are betting that the market and individual stocks will be declining, sell borrowed shares of these stocks from their brokers. IF all goes as planned, and the stock prices decline, they can then purchase the shares of these stocks to replace their borrowings at a lower price, giving them profit. On rally days like yesterday, stock prices rise, meaning they will have to pay more to buy the replacement shares, either limiting profit or resulting in an outright loss. So, they often "pull the trigger" and purchase the stocks, leading to further increases. If you graph the Dow-Jones Index ($INDU), you will see two major resistance hurdles for the next couple of weeks: the 50-day MA at 10,437 and the 200-day MA at 10,500. Beyond this, the declining resistance line is at 10,640. Will another bounce off this resistance occur? Stay tuned.

Look at the dollar on days like this. The dollar was higher, and both stock and bond prices rose. What does this indicate? A capital inflow from overseas investors whose overall fears about the future course of the US economy were temporarily pushed aside (remember, they are still unsure about Fed Chair designee Bernarke).

Read about the Q3 GDP report, and remember the "tricks" I showed you about how to summarize all of this data. Look for the significant changes in items from last quarter (Table 1 is % changes, Table 2 notes contributions of individual elements). Remember: this is a preliminary report, where inventories are estimated (September data is not in yet). The same is true for Net Exports.

Keep an eye on Government -- its contribution rose significantly in Q3 as Gulf Coast relief efforts began. This will intensify in Q4, helping that quarter's final value. For durable goods, especially auto sales, sales were higher in Q3. I doubt they will do as well in Q4 as the big discount programs are largely over and they "borrowed" some sales that would have occurred in Q4.

Assignment #1 Answers

I will provide a brief overview of questions #1 and #2.

#1) The MPC falls, so the MPS rises. This causes AE to be less steep, lowering the equilibrium value of Y. Also, the multiplier falls. With a flatter AE curve, monetary tightening, which raises r and lowers autonomous C and Ip, will cause smaller declines in equilibrium Y.

#2) As foreign income rises relative to that in the US, this stimulates US exports to these countries. At the same time, US equities become relatively less attractive, depressing equity prices here. This results in the dollar depreciating relative to foreign currencies (whose economies are growing more rapidly than the US). The capital outflow will also affect fixed income markets here, resulting in a sell off, and higher interest rates.

Inflation and Earnings

Today on CNBC I saw something very interesting. In light of high inflation rates implied by both the CPI and PPI (today), Steve Liesman noted (correctly) that publicly traded companies generally report earnings, etc. without taking inflation into account (translation: they report NOMINAL values not REAL values). I have been saying this for years in my MBA class. I guess when earnings growth is far above inflation, it isn't so bad to overlook real values.

Still, remember what we talked about in class: WHEN WORKING WITH DATA OVER LONG PERIODS, NEVER RELY ON NOMINAL VALUES. ONLY REAL VALUES ARE COMPARABLE OVER SUCH A TIME SPAN.

So, with inflation currently running around 2.5%, any company whose year-over-year (nominal) earnings growth (or revenue growth, etc.) is below 2.5% is experiencing a decline in its real earnings or revenue.

How Strong is the Economy?

There are many ways to gauge the economy's momentum. GDP reports are important, but dated -- we won't have the data for Q3 for another month, and that will be a "first pass." There are other indicators used: the Index of Leading Economic Indicators; Consumer Confidence; Retail Sales; and many others.

A very good real time read on this is given by the Cyclicals Index ($CYC). We have discussed ways to look at short-term and intermediate-term trends. How can we determine the long-term trend? The way I will suggest here is to look at daily data using a very long moving average. How long? Long enough to capture the current trend without having many "bounces" below or above in the short-term. In the diagram of Cyclicals, the MA that works for this is the 400-day (=80 weeks).

The potentially startling result using the 400-day MA, is that the long-term trend has just recently turned negative (early October). Note this on the graph. Also, short-term support has also been violated in the past few days. So, no matter what you hear on CNBC, or Bloomberg, the rosy picture painted by my fellow economists is not shared by asset markets. The message of the Cyclicals is that we are already experiencing a "soft patch." And, as asset markets are leading indicators, this paints a not-so-rosy picture for the upcoming months. Note that this is consistent with what the bond market has been saying for some time now (the bond markets are saying the Fed is tightening too much).

The interesting thing now is to see if the markets are right or whether the optimistic TV "talking heads" are correct.

Q: What do you think is the likelihood of being invited to Larry Kudlow's 5:00 show if you believe what the Cyclicals chart is saying?
A: DUH!

A Troubling Combination

Over this past week, we have observed several days where stock prices fell, interest rates rose, and the US dollar index also fell. From our discussions in class, this should be part of a reasonable and easy to understand sequence -- foreign investors moving some of their money out of US asset markets.

If foreign investors see better investment opportunities elsewhere, they will liquidate some of their US investments. This causes a selling of US stocks and bonds. As a result, stock prices fall as do bond prices. Recall that lower bond prices mean higher interest rates. As these foreign investors then convert their dollar balances into other currencies, the US dollar weakens. Thus the combination we have been witnessing.

Will this continue? Think of what will make US asset markets attractive, as well as the likely changes in interest rates that will be occurring.

CPI Release

At 8:30 the CPI numbers were released. While the overall number was a bit of a surprise (+1.2%), the highest rate in 25 years, the core inflation rate (which excludes both food and energy) was very tame (+0.1%). A good reference for market reaction is at MarketWatch.com. An article on the report itself is also at that site. The initial reaction by the fixed income market was very favorable -- the 10-year bond rate fell by 5 basis points.

As I watched CNBC, I was amused by the reaction to the CPI number by both Mark Haines and Becky Quick -- both refused to believe the number. They cited how high the levels of prices have become, and cited the obvious examples in their lives. Steve Liesman, the economics person (but not economist) correctly pointed out that inflation reflects the rate of change in prices, not their level. This is a critical and often midunderstood point. So, if prices rise to a "high" level and remain there, the inflation rate from that point would be 0%!

The critical issue here is called "pass-through." While the core inflation rate nets out the direct changes in food and energy prices, the overall effects of energy and food prices can and do spill over into core inflation. Note the recent price hikes by shipping companies (UPS and FedEx). The Federal Reserve pays the most attention to pass-through. They are betting that there is enough underlying strength in the economy to allow them to fight the inflationary effects in motion (pass-through) without causing a recession. I have some serious reservations about their strategy. Read about today's release on Industrial Production -- hardly cause for celebration. The Consumer Sentiment Index also showed weakness.

For the Fed, they still see a problem because they want to contain core inflation at below 2% annually. Even with the favorable report this morning, core inflation is running around 2.1%. Remember from our multiplier discussion yesterday, that there are lags in monetary policy. So, as spending is hurt by monetary tightening, it takes time, about 2-3 quarters, for the multipliers to work. This means that for the Fed to head off future inflation, it must act ahead of time. This fact is what confuses so many people.

Before the CPI Release

A look at the stock market yesterday revealed some depressing techncial trends. The major markets were all trading below their 200-day moving averages (MA). For the Dow Jones Industrial Average ($INDU), the 50-day moving average moved below the 200-day moving average. That is a very negative development. For the NASDAQ and the S&P 500, the 50-day MA is still above its 200-day MA, but both are trading below these two MA's.

In general, when a market (or stock) is trading below its 50-day MA, its short-term trend is negative. When it is below its 200-day MA, the intermediate term trend is also negative. For some large institutional buyers, a movement of a stock or index below its 50-day MA is a sell signal.

RECOMMANDATION: before making a final determination on trends, EXAMINE THE WEEKLY CHART.

For the Dow-Jones, the weekly chart is far less negative than the daily chart. $INDU has just recently moved below its 50-day MA, but remains above its 200-day MA, so while the short-term trend is negative, the intermediate-term trend remains positive. More importantly, the price relative (to $SPX) has just turned up -- so on a weekly basis the Dow-Jones is beginning to outperform $SPX.

Post announcement reaction by 10-year bond (click to enlarge).

Post-announcement 10-year bond market (click to enlarge). Graph courtesy of StockCharts.com

Employment Data -- First Look

The employment data were released at 8:30 and the change in employment, -35,000, was far better than expected. Read two articles about this, one from MarketWatch, the other from Money.com.

A few things to note.
(1) The payroll employment number is derived from a sample of employers. The unemployment rate is based on a survey of households.
(2) The payroll employment value, -35,000, does NOT indicate that only 35,000 jobs were lost as the result of Hurricane Katrina (Rita's effects are in next month's report). The loss is the difference between what the job total would have been, around +200,000, and this morning's number of -35,000 -- Katrina-related loss of around 165,000.
(3) Jobless claims (released on Thursdays) have painted a very different picture of the job loss from Katrina, indicating around 300,000 jobs lost. Will this show up next month? Was today's number a "bad" estimate? Stay tuned.
(4) The unemployment rate, which is derived from a survey of households, rose only slightly, from 4.9% in August to 5.1% in September.x

The early reaction to the job data is that it indicates more strength to the economy than what many thought, raising the likelihood that the Fed will continue to raise rates, up to the current view of 4.75% (my value is still 4.5%). As I am writing this, the stock market (DJIA) is up 38 points, a bullish response to the data, while the fixed income (bond) markets are less than thrilled, with the 10-year bond yield rising to 4.42% - taking out initial resistance. Next stop for $TNX - 4.65%.

For those doing the mortgage rate as their forecast topic, note that even before today's numbers, the 30-year fixed rate mortgage had risen to just under a 6% national average.

Oil Head and Shoulders?

A look at the price per barrel of oil (symbol $WTIC) since the beginning of August (in the diagram below) strongly suggests that this market is in the process of completing a head and shoulders pattern. Notice how the 50-day moving average has acted as support for quite a while now (since June).

As a way to practice the material we covered the other day in class, see if you can draw in the neckline and find the lower price target. In order to evaluate the likelihood of the possible breakdown, look at other information in the diagram (below) and decide whether or not this pattern is likely to complete.

Oil Price per Barrel (click to enlarge). Graph courtesy of StockCharts.com 

A Riddle

As I watch the progress of Hurricane Rita, as has been true for the last month or so, as oil prices rise, interest rates (ex: 10-year bond rate) actually fall. Most people would think that since higher oil prices indicate higher future inflation, that should cause interest rates to rise.

Extra credit due at the beginning of class Tuesday: explain the underlying basis for this "strange" interest rate behavior.

Discretionary Spending -- Another Look

The size of individual bars, as well as where low and high values occur convey a great deal of information. The chart below shows XLY for the past few weeks.

Note September 6. Open is at the low, close is at the high of the day and trading occurred over a very large range. That is what a strong day looks like. Who won, the bulls or bears? Clearly, the bulls had control all day.

Now look at the bars for September 8, 15, and 16. Here, the market was indecisive. Trading occurred over a small range, and the opening value was almost identical to the closing value. Who was in control on these days? Nobody. A bar like this signals indecision by the market. In candlestick charting, these are called Dojis. A Doji at resistance points to resistance holding.

Now look at the last few days. Large bars, so there is a battle between bulls and bears moving price over a wide range. But, these days open near the high and close at or near the low for the day. Ouch!! That reflects weakness, with the bears clearly in control (remember from the earlier post that these also had large volume -- another sign of bear dominance here).

The only good news, and I must say potentially good news, is that the last bar was not as long as the earlier ones. This usually indicates that the downward momentum is weakening. It is not a guarantee that the market will reverse, however.

Further evidence for the downward momentum to be near an end would be an RSI in oversold territory (below 30), or a bullish divergence (price declining, but the RSI rising).

Another possible indicator of a bottom is large "tails" on the bars, where the daily low is far below the closing value, so the bulls had some ability to prevent the market from reaching much lower by the end of the day.

Discretionary Spending -- Another Look (click to enlarge). Graph courtesy of StockCharts.com  

Discretionary Spending -- Forecast??

The graph of discretionary spending (XLE) below shows a head and shoulders formation. This is a reversal formation (but there is no guarantee this will complete). To determine the "target" for completion of this pattern follow these steps:

1) Find the difference between the top of the head (here = 34.97, I will call it 35) and the neckline below it (=32.5). The difference is 2.5.
2) Subtract the difference of 2.5 from the right end of the neckline (=33 in the graph). This gives a downside target of 30.5.

This target implies that discretationary spending will test its late April low, which was almost identical to the current target value.

How likely is this to occur? Add support and resistance lines and over the next week or so, track whether a breakout above resistance occurs. That would imply the likelihood that the pattern will fail to complete.

Also, look at the two circled areas in the graph. What do these indicate. More importantly, note that the dramatic declines in the past few days have occurred with very large volume. That is usually consistent with more downside ahead.

Discretionary Spending (click to enlarge). Graph courtesy of StockCharts.com  

A Good Reference (for now)

Not much happening on the economic data front. Data on import and export prices that was not paid much attention to as it was BK -- Before Katrina. There is, however, a very good article I came across that I would like you to read and use as a reference for detailing the likely after-effects of hurricane Katrina.

As we continue to build your macroeconomic proficiency this semester, it will be very informative for you to see how the post-Katrina assessments change and the factors that are responsible for these changes (in essence a forecast each time). This should also help with getting you ready to do your forecast papers.

Sector performances last week (click to enlarge)
Graph courtesy of StockCharts.com

Where are the markets going?

After an interesting but confusing week, the question of market direction remains. This is critical for your forecast papers that are due in a couple of weeks.

To provide some further resources for looking at this question, I have found a new resource: a section of Barron's Online. The section of interest is called: "Getting Technical" by Michael Kahn. I suggest that you read his most recent article. There are two others (at least) of interest as well. One of these (from 4/13) concerns whether a signal had been missed at that time. The second, from February, while dated, gives good information and insights on how sector rotations can relate to the potential of a market top.

This last article can help you to better understand StockCharts.com's PerfChart tool that I illustrated in class on Thursday. Which sectors are outperforming? Are these defensive or cyclical? As you track this through time, keep an eye on the sector roations that are occurring. What do these imply about the strength of the economy?

REMEMBER: a slowdown can either be in the rate of economic growth (what we are now experiencing) or a full-fledged recession, where growth turns negative. The media often takes the second definition as being the case. Don't you make that mistake!

I strongly suggest that you read the articles referenced above and keep up with the newer articles from Mr. Kahn as they are written.

Fed Releases Prior Meeting Notes

Just after class finished today (at 2:00) the Fed released the notes from its most recent meeting. These indicated a less troublesome perspective on inflation than had been previously thought. As a result, inflation expectations dropped, pushing interest rates sharply lower. The chart below shows a 5-minute graph of the 10-year rate. Note the sharp decline at 2:00. If you look on a daily chart, you will see that we have now "breached" the prior up gap from a short time ago, and today's action saw the 10-year bounce off its 50-day MA.

Overall, this was an eventful day for the stock market. This morning, a record balance of trade deficit for FEBRUARY was released, sending stocks and the dollar lower, but strangely, the 10-year bond rate lower (so its price rose). Then came 2:00, a decline in inflation worries (and less agressive future rate hikes expected by the Fed), leading to a bond rally, then the price of oil dropped sharply. The Dow-Jones average went from about -80 to +59, a turnaround of almost 140 points on high volume.

For the day, the dollar ended higher, in spite of its rocky start with the release of the balance of trade deficit. If you graph $USD and annotate to include Fibonacci Retracement (the high of September 2004 and the most recent low in the beginning of this year, you will see the dollar caught in a trading range between support at 38.2% retracement and resistance at 50% retracement. We should see a breakout from this range pretty soon.

Fed Notes and 10-Year Bond (5 minute) 

Thoughts for Current Assignment

The assignment is to use asset markets trends to determine whether real GDP growth increased or decreased in 2005:Q1. To start, read about real GDP and how it is determined, specifically what the four expenditure categories are. Based on this, you will need to find market and/or sector performances that provide relevant insights into the GDP growth value we are likely to see in a couple of weeks.

Refer back to the online syllabus, specifically the Using StockCharts.com downloadable notes. On the last page, I have listed abbreviations needed to get graphs for a number of indexes and sectors. If you wish to find others, use the Symbol Lookup in StockCharts.com. If you still can't find something, e-mail me with your question and I will see if I can find a symbol for you to use.

REMEMBER: You are looking at 2005:Q1, so the most important part of the graph to be contrasting with past data is from Jan. 1, 2005 through March 31, 2005. Don't pay attention to April data for this assignment.

IRONIC FACT: The first release of real GDP for 2005:Q1 will be a preliminary one, based on a lot of guessing about what March values were for both inventories and the balance of trade (net exports). So, your conclusions might appear to be contradicted by the first relase of the GDP data. But, the second and third releases (in each of the two following months) will have more accurate inventory and net export data, so that is what you can evaluate your accuracy in terms of. SO, DOES THIS PROVIDE US WITH REALLY ADVANCED DATA VALUES OR WHAT?

THOUGHT: Knowing the above, how might you as an investor use the asset market trend information, well ahead of what actual GDP reports indicate? Hopefully you can now begin to appreciate why "following the crowd" is so often self-destructive behavior when it comes to asset markets!

Will this Upleg Continue?

The Dow-Jones has now improved for three consecutive sessions. Some are concluding that with the strong economy (based on GDP report, and to a lesser extent the employment report) the market's minor correction has now ended.

A look at the Dow-Jones chart below raises several questions. Yes, there are several positives:

(1) A bullish divergence based on the RSI (I used SharpCharts2 Beta to superimpose the RSI on $INDU); and
(2) The relative strength of the Dow-Jones compared to the S&P500 has just turned up.

BUT, this move is not being supported by rising volume. The green bars (volume on higher close days) corresponding to the recent higher closes are declining. In fact, there has only been one green bar that was larger than the red bars (volume on down days) in the last several weeks. This is typically a bearish indicator, reflective of lack of enthusiasm by those bullish about the market. If the bulls are tepid, it might not be very difficult for the bears to come in and turn things in the other direction.

Those doing their forecast paper on $INDU should keep tracking this in the next few weeks to see if the volume signal is indeed "for real."

Does this Move Have Legs? (click to enlarge)
Graph courtesy of StockCharts.com

Elliot Wave Theory (Advanced)

An important concept in technical analysis is Elliot Wave Theory. According to this theory, markets tend to move in waves with specific patterns based on Fibonacci theory: five waves in a bull market like the ones we are now in followed by three waves as the market corrects. An excellent and accessible reference for this is from StockCharts.com.

The recent behavior of the NASDAQ is consistent with Elliot Wave theory, as the chart below shows. Starting in late 2002, we began the first wave in a bull market. The fifth wave, or what appears to be the fifth wave, was just completed as 2005 began. The current correction appears to be "a," the first of a three down-wave cycle.

To generate the lines in the StockCharts graph, go below the graph to Price Overlays and select ZigZag (Basic). The default parameter that is chosen doesn't always give waves that correspond closely enough to the actual graph. I changed the value to 12 (from 9) in the chart below, which appears to fit the data fairly well.

IF we have just completed wave #5, then the NASDAQ will move sideways to down for much of the remainder of 2005. I believe this is likely based on technical considerations. Add to this higher gasoline prices and a recently declining 10-year bond rate, and at the present time, the evidence is consistent with Elliot Wave Theory.

Elliot Wave Theory can theoretically be applied to all three of the forecast paper topics for this semester.

Elliot Wave Theory (click to enlarge)
Graph courtesy of StockCharts.com

HELLBOY's Quote of the day (click to enlarge) 

MY NEW ASSOCIATE

I want to introduce you to my new economic advisor, my daughter's kitten Booger. While technically his name is Booger, based on his daily conduct, I refer to him as HELLBOY.

He and I often discuss relevant macro trends. I am continually amazed by the relevance and clarity of his insights. So, starting today, I will occasionally provide you with his most prescient (or as he would say, prrrrrrrescient) quotes as they occur.

The picture above gives his insight today, about stagflation, which we saw discussed on CNBC.

Exercise

For extra credit - must be handed in at the beginning of class next Tuesday (4/5). No late assignments will be accepted:

The stock market is a leading indicator of the overall economy. So, if we can find indexes that lead the stock market, they can be used as real-time leading indicators of the US economy.

In StockCharts.com, go to the bottom left and click on SharpCharts2 Beta (this allows you to overlay graphs).

First, make the graph for Discretionary Spending (XLY). Below the graph:
- Change the style to Line (dashed)
- Change the size to 700
- Eliminate both moving averages (in the Overlays section)
- Under Indicators, Change the selection from MACD to Price. Keep the default selection that pops up of the $SPX. Under Position, change to Behind. Now UPDATE to get the graph.
You can now choose an option under the graph (ex: annotate or print) to get this into your document.

Repeat the above using Financials (XLF) in place of XLY.

Paste the two graphs into a Word document. Give a fairly short (but concise) discussion of which market (XLY or XLF) is a leading indicator of the stock market ($SPX). Include as part of the discussion an underlying basis (beyond discussing the graph alone, dig into what XLY and XLF represent, etc.) of why this is the case.

Intra-day Action in the 10-Year

Yesterday's action in the stock and bond markets was unusual, to say the least. While the early action was dominated by the disappointing employment report, which seemed to indicate less inflationary pressure and less agressive future rate hikes by the Fed, this was "trumped" by the release of the Prices Paid component of the Institute of Supply Management report at 10:00.

In the chart below, which is a 5-minute interval chart, note the large jump down in the 10-year rate as the employment report was announced at 8:30. The rate fell below the prior gap range from last week. Then, at 10:00, the Prices Paid results were announced. This survey's results were consistent with higher future inflation, sending the 10-year rate sharply higher to 4.54% (see the chart).

Why did the rate then fall for the remainder of the day (ending at 4.45%)? Oil prices set a record. Apparently, the market concensus was that the effects of higher oil prices in terms of slowing the economy would be more than sufficient to control for moderate the inflationary pressures indicated in the Prices Paid report.

NOTE THE DIFFERENT HEIGHTS (HIGH vs LOW) OF THE 5-MINUTE PRICE BARS. THESE SHOW HOW TRADING RANGES VARIED THROUGHOUT THE TRADING DAY.
- LARGE BARS OR BARS RISING IS SIZE INDICATE DEFINITE MARKET SENTIMENT WITH ONE GROUP (BULLS OR BEARS) IN CONTROL
- WHEN THE BARS GET SMALLER, THE DECISIVENESS OF THE MARKET IS BECOMING LESS CLEAR, RAISING THE POSSIBILITY OF A CHANGE IN DIRECTION (INCLUDING UP/DOWN TO SIDEWAYS)

Intraday 10-Year Bond (click to enlarge) 

Re-Rising Interest Rates

At 10:00 am, the Institute of Supply Management (ISM) released a report that includes a prices-paid component which is correlated with inflation (more so to inflationary expectations). While initially reported incorrectly, it was subsequently corrected to a value of 73 (see story),which promptly ended the bond market rally. The 10-year rate promptly returned to above 4.51 percent as of 11:15 am. Oil prices also rose, intensifying short-term inflation fears.

Dollar-Euro Rate and Interest Rate
Graph courtesy of StockCharts.com

Filling in the Gap? (click to enlarge)
Graph Courtesy of StockCharts.com

Job Report Effects

Now, about one hour after release of the March job market data, the 10-year bond rate has fallen by about 5 basis points from yesterday's close (but moved up off the low thus far). As the graph above shows, today's low has breached the prior gap zone. The question for today is whether the rate will CLOSE in or below the gap zone.

The immediate effect of the decline in the 10-year rate is a boost to home builder stocks. Does a housing bubble exist? If so, is it about to pop? Today's interest rate changes could mean an answer of yes to both questions -- but at different times in the future.

The Employment Report

The March employment report came in well below expectations at 110,000. Along with this was a drop in the unemployment rate (from 5.4% to 5.2%) and hourly wage gains of 0.3 percent (as expected). So much for my expectation (under the consensus of 250,000) of 200,000! The payroll employment figure was almost equal to the standard error (remember yesterday's lecture) of 100,000.

Just after this was announced, the 10-year bond yield dropped from 4.50% to 4.41%, and the dollar fell. Remember, that the gap-up support for the 10-year is right around the value NOW.

With this report, the view is that the Fed will not be more aggressive in raising rates as had been feared. The "measured" pace can be sustained,and the likelihood of 50 basis point rises is dead -- for now.

As I am writing this, Larry Kudlow is already making apologies for the number and saying all is well, don't worry, the number is not statistically significant.

Cyclicals -- Up or Down?

The final GDP report for 2004:Q4 was released today, indicating 3.8 percent growth. Examine the tables in this release and the chart of cyclicals (below). In the GDP tables, consider the elements most closely tied to real GDP growth that are cyclical.

Using this information answer the following question: Is the bounce off of 200-day MA support a one-time event, or is there reason to believe that the double top will not ultimately form? This is excellent practice for your final paper.

Double Top for Cyclicals? (click to enlarge)
Graph courtesy of StockCharts.com

Dow-Jones Retracement (click to enlarge)
Graph courtesy of StockCharts.com

Short-Term Target for Dow-Jones

Today the Dow-Jones Industrial Average had a very good day, rising 135 points. Support at the 200-day MA has held.

IF $INDU is to keep rising, how high is it likely to go in the near term? To answer this, the Fibonacci retracment tool from StockCharts.com was used. The next target range is a 38.2% retracement, which occurs at 10,625 (see chart above). This is just below the 50-day MA at 10,660. After that, the target is 50% retracement at around 10,700.

Will the stock market resume an upward trend? To answer this, it will be necessary to also factor in economic data and trends. To the extent that inflation rises (the GDP consumption price deflator was revised upward in today's release) and this passes through to input costs, the profitability of production will be adversely affected. In that situation, what we witnessed today is merely an oversold bounce.

Foreign Stock Market Symbols

For those of you interested in tracking foreign stock markets, here are the StockCharts.com symbols for selected markets (those usually reported on CNBC and Bloomberg):

$AORD - All Ordinaries Index (Australia)
$CAC - Paris CAC Courant
$DAX - German DAX Composite
$FTSE - London Financial Times Index (England)
$HSI - Hang Seng Index (Hong Kong)
$NIKK - Tokyo Nikkei Average (Japan)

Note: the behavior of these indexes will generally be diferent from country ETFs (for example the Japan ETF is EWJ, which behaves differently from $NIKK)

NASDAQ Range

The chart below shows the NASDAQ. To determine support/resistance in the near-term, you can use Fibonacci retracement, but this doesn't always work well when the high-low values are fairly far apart. As an alternative, I have used the Raff Regression Channel Lines tool from StockCharts.com (this is sixth top button from the right on the annotation screen).

Absent the Raff Regression Channel tool, the next possible target for NASDAQ is its 200-day MA at 1992.85. The Raff Regression Channel indicates a slightly different support level, the Raff lower bound of about 1960, which is fairly close to the short-term top from early October of last year.

Note that the RSI is displaying an oversold reading at present, as oversold as in late January. So, it remains to be seen whether we will be testing support. Also, the NASDAQ continues to underperform the overall stock market (S&P 500).

According to the Raff Regression Channel, resistance is currently around 2080 (its upper channel). A prerequisite for moving there is that the NASDAQ begin outperforming the overall stock market in the next few weeks.

How can you determine if this is likely? Examine the performance of some of the major components of the NASDAQ. Right now, the semiconductor stocks (SMH) might be ready to break out, which would bode well for the NASDAQ.

Examing the chart of SMH and see if you think it will likely break out. Follow its actual behavior over the next week or two and track the interrelationships between the SMH and NASDAQ over that period.

NASDAQ Range (click to enlarge)
Graph courtesy of StockCharts.com

Investigating ETFs

To see the stocks that are included in XLP, XLY, or any ETF, go the the American Stock Exchange web (www.amex.com ) site section for ETFs (on the left) and type in XLP or whatever symbol you are investigating in the upper right-hand box for symbol look-up. Move to the bottom of the resulting page and you will see the major stocks/industries represented in this ETF. Examine these and convince yourself that these are indeed the stocks/sectors of firms related to this type of spending.

Exercise

For extra credit - must be handed in at the beginning of class next Tuesday (3/29). No late assignments will be accepted:

Go to StockCharts.com and recreate the graph for each of the two EFTs discussed in the earlier posting below (XLP and XLY). Add annotations to each and provide a brief write-up (using Word) that evaluates whether the empirical expectations concerning these two ETFs from the earlier posting (a decrease in discretionary spending and a rise in non-discretionary spending) appear to be valid for the short-term. Use technical analysis along with current events and whatever is relevant to combining economics with technical analysis in your write-up.

Consumer Staples (click to enlarge)
Graph courtesy of StockCharts.com

Consumer Discretionary Spending (click to enlarge)
Chart Courtesy of StockCharts.com

Gauging Consumer Spending At Present

As gasoline prices have been (generally) rising, we can use generalizations from microeconomic theory to create some macroeconomic predictions.

In the short-term, the demand for gasoline tends to be price inelastic (see: http://www.uri.edu/artsci/ecn/lardaro/lectures/Elasticity_of_Demand.pdf ). As a result, when gas price rises, total spending on gasoline tends to increase (other things being equal). Given income in the short-term, this means more of total income will be devoted to gasoline and less will be available for other purposes (of course the level of income must be considered as well). As a result, income available for discretionary purchases can be expected to fall, lowering discretionary spending.

This microeconomic effect has the potential to slow the rate of economic growth, causing a decrease in discretionary spending and a rise in non-discretionary spending. NOTE: this is a TESTABLE HYPOTHESIS, not a statistical certainty. Also, the magnitude of the change in not necessarily large. We can gauge the actual impact by examining two ETF': Consumer Staples (XLP) and Consumer Discretionary (XLY). More about these in the next few postings.

Moment of Truth for 10-Year

To examine the long-term trend in a variable, it is often advisable to go beyond merely extending the range of daily charts or using weekly graphs. The chart below shows monthly data from 1995 to the present on the 10-year bond. Notice that at the present time, the 10-year rate continues to range within a symmetrical triangle based on resistance from 2002 and support from 2003. The most recent monthly high is touching the upper line (longer-term resistance). Also, the 9-period RSI is not yet in oversold territory.

Examine the graph and analyze it. (1) What is the likely path of the 10-year rate in the next month or two based on technical considerations? (2) Adding economic analysis concerning the way the "pieces" are moving and fitting together (remember our theoretical discussion of interest rates), does this conflict with your technical analysis conclusion or is it consistent with it?

This is the type of thing you need to be doing as you get farther along in the process of writing your forecast paper.

Moment of Truth for 10-Year (click to enlarge)
Graph courtesy of StockCharts.com

Dollar-Euro Range

The $XEU chart below shows the Dollar-Euro exchange rate. I have added Fibonacci analysis starting from the high at the close of 2004 and the low in September of 2004. The Fibonacci retracement analysis suggests that $XEU will be testing 50% (at $1.284) retracement fairly soon. While the RSI (I used 9 periods here) is in oversold territory, is is less oversold at the present time than it was in early February.

An interesting chart pattern emerged as part of this analysis: note how the recent higher highs in February and March didn't see a bearish divergence in the RSI. Instead, the RSI showed a DOUBLE TOP, which is the moral equivalent of a reversal signal for the $XEU here.

Dollar-Euro Range based on Fibonacci (click to enlarge) Chart courtesy of StockCharts.com 

RSI SETTING

In Stockcharts.com, the default setting for the RSI is 14 periods. I have found that in most situations, using 9 periods captures more of the correct overbought and oversold situations, and I recommend that you consider this.

Where 14 is preferable is often on stock indexes or some of the other aggregate indicators we refer to in 327. So, just check to see if 14 is working well or if it needs to be modified.

To change to 9 periods, simply overwrite the value of 14 next to the RSI row below the graph.

Interest Rates and Exchange Rates

Looking at the actual relationship between interest rates and the dollar exchange rate over the last ten years, it is evident from the chart that these have been inversely related for much of the time period (contrary to what theory indicates). This is a good example of how EMPIRICAL relationships such as this can differ from the THEORETICAL relationship. Why is this true? The chart is only looking at these two variables. Other factors relevant to the exchange rate are also changing over this time period. Note, however, that these variables are not perfectly synchronized. This is readily apparent with the most recent bottom in interest rates, which occurred before the recent dollar bottom (and it is not clear at the present time whether this bottom will actually hold).

US Dollar and Interest Rates (click to enlarge)
Graph courtesy of StockCharts.com

DJIA Bearish Divergence (click to enlarge)
Graph courtesy of Stockcharts.com

RSI as leading indicator

While macro courses always refer to a traditional set of variables as being the only leading economic indicators considered, one of which is the stock market, we recently saw a leading indicator of the stock market. The $INDU chart shows the recent daily behavior of the Dow-Jones Industrial Average. Notice that a declining RSI that was occurring as the DJIA attained a higher peak. This BEARISH DIVERGENCE is a leading indicator of future stock price declines.

Dollar Bounces

As interest rates are rising (perhaps too dramatically in light of events this week), this should help the dollar exchange rate to appreciate since actual inflation is not a problem yet (it could very possibly become a problem). The recent strength in the dollar can be seen in a longer-term context as well: it recently bounced off support from its levels all the way back to 1991 (see graph).

US Dollar Fighting Support
Graph courtesy of StockCharts.com

Ten-Year Bond
Graph courtesy of StockCharts.com

Dow-Jones Industrial Average (Click to enlarge)
Graph courtesy of StockCharts.com

Fed Rate Hike

Just as the Fed raised the federal funds rate by another 25 basis points Tuesday (3/22), to 2.75 percent, the stock and bond markets adjusted abruptly. Clearly, the change in wording indicated of the Fed's statement (http://www.federalreserve.gov/boarddocs/press/monetary/2005/20050322/ ) showed a greater concern about inflation (something we had already noted in class). The following day (today), the CPI release showed higher inflation than what was expected. This time, however, the stock and bond markets did not react as they did the previous day. The Dow-Jones average closed around 10,450, the Euro closed at $1.30, down from $1.34 just a few days ago, and the 10-year bond rate was almost unchanged from yesterday (at 4.61%).

For those familiar with candlestick charting, today's market activity formed a "shooting star," which occurred at a resistance level, when the RSI was in overbought territory. From a technical perspective, this set of occurrences points to the likelihood that the 10-year rate may be resting at its current level in the short-term.

Only a few days ago, the Dow-Jones tested resistance at 11,000. That seems like a long time ago, even though it was a short-time ago.

Finally, oil prices dropped sharply again today. Had this not occurred, would the decline in the Dow-Jones been as small?