Employment Report Effects

The February employment report was released yesterday at 8:30 am. The stakes for the markets were high: too low a number and recession fears would re-emerge, which would hurt the stock market but help the bond market; too high, and the opposite would be a problem, with a reduced likelihood of the Fed easing in the near term.

The payroll employment number that emerged was +97,000, which was high enough to remove recession fears, but not so high that worries of overheating would emerge. This scenario has come to be called the Goldilocks Scenario. Read the following article about all of this. Also, read the chapter on the employment report in the Carnes and Slifer text (The Atlas of Economic Indicators).

The stock market began the day with a healthy rise but gave much of this back by the end of the trading day. This often happens when markets get what they were hoping for (this is a variant of the old saying: Buy on the rumor, sell on the news). So, SUPPORT AND RESISTANCE BOTH HELD.

The principle items that caused a reaction in the bond market were a higher-than-expected rise in average hourly wages and a decline in the unemployment rate to 4.5%. In addition to these, the prior months' employment numbers were adjusted upward (this has been occurring for a while now). So, it is very likely that today's somewhat tepid payroll employment increase will be revised higher with the release of next month's data. All of these factors heightened inflation fears, causing a bond market sell off. The 10-year bond rate rose to just under 4.6%, an increase of 8 basis points for the day. Clearly, the bond market wants the Fed to lower interest rates, and the employment report dashed those hopes (for now at least). I guess the bond market's view of the world should be referred to as "The Three Bears," given the stock market's view.

So the "wildcard" for now is the mortgage market. How far will weakness in the sub-prime market reach higher tiers? It has already impacted the "Alt A" market, and with the tightening of lending standards, it will very likely creep somewhat into the market for prime mortgages. The different perceptions of the future state of the economy held by the stock and bond market centers largely on the answer to this question. For now, at least, it appears safe to say that "all's quiet on the carry trade front." Stay tuned.

An interesting article for you to read is by Jeremy Siegel. He attributes part of the recent volatility in stock markets to "trend following" by technicians. These traders (myself included) often place automated "stop loss" orders below the trend so they can insulate themselves from potentially large losses. Here's how a stop loss order works. You choose a price level at or below which you want to get out of a stock (or index like an ETF). Hopefully your choice is based on where support is. You should place the "stop" a bit below support, so that if a false breakdown occurs you don't get "stopped out," after which the stock begins to rise again. You then place an order stating this with your brokerage account. To automate this, specify the time frame for your order as "Good Till Cancelled," or GTC. Normally, this will remain in effect for several months. If, instead, you specify market day, you are only covered for that trading day, after which the order no longer exists. Specifying GTC thus automates this process so you don't have to remain in front of your computer all the time.

So when trendlines are finally broken in sustained uptrends, many of these stop orders kick in, potentially causing large sell offs, and magnified price declines. Hence the volatility aspects. I doubt that stop loss orders played the major role in the large Tuesday sell off, but they were certainly part of it.

A recommendation when you buy stocks: USE STOP LOSSES, but leave room below support in case a false breakdown occurs. Remember, capital preservation should be a primary factor for you.

Big Drop in the Dow-Jones

This past week saw notable movements in the Dow-Jones Industrial Average ($INDU). We discussed much of this in class (thru Thursday anyway). Friday was not a good day. The DJIA closed down 120 additional points, ending at just over 12,100.

The DJIA has been in an uptrend for many months now (since August 2006), so some sort of correction was called for. Typically, these corrections range between 5 and 10 percent declines. The time frame is variable -- there is not a "typical" correction period. IF, however, a correction ultimately involves a 20% decline, the market is deemed to have changed to a "bear market."

After a week like the one we just went through, I recommend using weekly charts to view trends, etc. The chart shows $INDU weekly (click to enlarge it).

One thing to note: just as there is support for price in a main chart, you can use levels of the RSI to denote whether a trend remains in force. As you can see in the diagram, the uptrend remained in tact as long as the RSI (based on 9 periods) stayed at or above 50 (the demarcation point). Since July of 2006, until this past week, that condition was met.

Look at the large weekly bar, which closed near the low for the week. Not good!! Further note that this large drop occurred on large volume. Also not good!!

There is something that is visible on a weekly chart of $INDU that is not apparent from daily data: a bearish divergence. While $INDU was making higher highs since October of 2006, these were not confirmed by the RSI moving continually higher. Thus the bearish divergence.

Support appears to be around 12,000 (look at the chart). If we fall below this, things will get very interesting. How likely is it that we will move below 12,000? Fairly likely, since even after the horrible week, the RSI is not yet in oversold territory. Ugh! Stay tuned, let's see how this week plays out.

In situations like this, you should look to see if any major (i.e., potentially market moving) economic data will be released this week. The answer is yes -- the labor market numbers for January will be released this Friday. What kind of employment report would lead to further price declines? Increases? Also, don't forget about the bond market.