Friday's Tumble

The stock market tumbled on Friday. The ultimate decline, 312 points, was a blessing. How? Before trading began here, markets in Asia and Europe had fallen sharply. Stock index futures for the Dow-Jones, S&P, and NASDAQ all had trading halted, as they reached limit down. Those futures were signaling an open in the US with the Dow-Jones falling as much as 1,000 points! Prior to opening, the word "crash" was being used by many (almost all, actually) market observers. I also viewed the potential for labeling the entire bear market as a crash had expectations occurred.

While the markets did drop sharply at the open, they began to recover. At times during the day, the market had moved to only "small" declines in the context of what has been happening routinely now for weeks.


The chart (click to enlarge) shows technical information about Friday, using 10-minute bars. The first thing to note is where support and resistance were. Resistance from late Thursday held all through Friday, not a very bullish sign, even though the market didn't end up at its daily low (there was a failed breakout at the end of Thursday). Look at the last bar of the day: a large bar (big range in last 10 minutes), but the close was far below the open for that time interval, also bearish going into Monday.

It is also important to consider that support held on Friday, making the overall news mixed. There was a double bottom, a reversal pattern, which signaled the rally that started around 2:00. During that time, the RSI remained above 50, signaling that an uptrend was occurring. That only changed at the close.

What were the economic factors surrounding Friday? First, there were large sell-offs in Asia and Europe. GDP for England was negative for the first time in about 15 years. That became a confirmation signal to markets that a global recession was either already in progress, or very likely. In the US, home sales actually improved. Of course, whether this is the beginning of a sustainable uptrend is a different matter. That accounted for part of the upward momentum at mid-day. Finally, one of the more important factors was the collapse of the yen carry trade. Review this on the online notes and don't be surprised if it pops up on the exam this Tuesday. For an excellent video clip concerning this, click here. As investors cashed in their overseas investments, they paid their yen loans, since the primary risk from the carry trade is the yen appreciating relative to the US $. Clearly, that had been happening all week. As I write this, the dollar-yen exchange rate is below 95 yen/$.

To determine how markets will do this week, check out the week's economic schedule. On Thursday, we get the first read on third quarter GDP in the US. IF, as many of us suspect, this will come in negative or very small, the global recession scenario will be reinforced, causing heightened market weakness, in spite of whatever market momentum might occur on Monday through Wednesday. Stay tuned!

Worst Week Ever?

This past week was a very trying one for the stock market, as all of you know. To see how bad things have become, notice that even the financial "experts," whose ridiculous recommendations have led so many to live in mortal fear of their 401(k) statements, are suddenly humbled. Gone (for now at least) is their truly outdated advice to "buy and hold," "dollar cost average," and based on forward price-earnings ratios, conclude that the market is very "cheap." Their only refuge is the assertion that when the market does bottom, it will probably rise by as much as 30 percent. Given the inherent conflict of interest these persons bring to the media, they make money from stock transactions, they are still trying to drum up business, but doing it in a more subtle way. Here is a video clip summarizing the past week.

This is where the power of technical analysis comes in. Asset prices are leading indicators of fundamental information. And, in times like this, where future earnings, etc. are incredibly uncertain, you can use the real-time information provided by markets to guide you.

How should we view Friday's market activity? Support at 8,000 (going back several years) for the Dow-Jones ($INDU) held. More importantly, while the market fell sharply at the open it then recovered quickly for a wild ride. The following chart from StockCharts.com will help you see this (click on it to enlarge). This shows the last two weeks of market data for the Dow-Jones.

First, look at the bar from eight days ago. It looks like a cross. In candlestick analysis, this is referred to as a "doji," which signifies indecisiveness - the bulls and bears fought a battle that nobody won. Note how short the bar is -- the gap between high and low was very small. Both features point to the possibility of a momentum reversal. Now go to the next day. Still a short bar, but the market closed near the low of the day, and close was below open. Not good for the bulls! The next day is even worse for the bulls: close at the day's low (near very short-term support) and an upward tail (undefended territory).

Now let's focus on the last two days, after apparent support (around 10,300) began to become a distant memory. The bars got much higher, so the daily battle of bulls and bears was intensifying. For Thursday, close was at the day's low. Ugh! For Friday, there was a large sell-off at open that probably produced much "panic" selling, so the day's low was within the first hour of trading. Then the market pulled up noticeably -- even though it was still down from the previous day. It went positive at several points, so the high was above the open, and by 3:30, the market was up by around 330. There was selling toward the close, so there was undefended high territory and the day's close was down 128 points.

Most people will focus on the fact that the market was down again, this time by 128 points. YOU should focus on the facts that: (1) the close and open were fairly close; and (2) a large lower tail emerged on Friday. Lower tails suggest the possibility of a bottom, or weakening of downward momentum. Consistent with this, the RSI(9) is also in very oversold territory.

So, my interpretation is that we are possibly very close to a temporary bottom, as support at 8,000 held, the RSI indicates oversold conditions, and a large lower tail emerged on the most recent daily bar. A few negative notes from the credit market: the 1-month t-bill rate remains below 0.10%; and while the overnight LIBOR rate fell sharply on Friday, the one and three-month rates remain elevated. NEVER OVERLOOK THE CREDIT MARKET!

How can we further decide whether this bottom will hold? How about economic theory? What a coincidence, that's what ECN 327 is all about! What determines stock prices? Interest rates (asset substitution, etc. that we covered in class) and most importantly expected future profits. So, looking forward, you need a forecast of the overall economic picture -- both national and international. But, for extra credit (due at the beginning of class on Tuesday), bring in two graphs, one with daily data, with annotations, showing support and resistance, the other repeating this for weekly data going back as far as possible.

This week should be a very important one for the future of this stock market downturn. Will the G-7 meetings produce tangible results? If not, will the market sell-off further? Will credit markets start to loosen and begin more normal lending again? Follow the bars each day and interpret them for what they convey. Practice like this will help you further understand charting and the information it provides.

Friday, October 3: Employment and Vote

This morning, the US Bureau of Labor Statistics released its September employment report. True to expectations, payroll employment fell by 159,000 relative to August. There were some revisions to earlier months, but these were very small (actually positive). The unemployment rate remained unchanged at 6.1% (I had expected this to rise), and average hourly earnings rose by 0.2%. Read this article about the report.

What reaction did markets have to such a disappointing report? The opposite of that expected. Stock market futures improved substantially. And, with this "bad news," interest rates rose, as did the US dollar. Perhaps the only expected result was the movement out of industrials, which are cyclically sensitive. What happened?

"Other things" were not even close to being equal. The weak employment report was perceived as increasing the likelihood of the passage of the rescue plan later today. Furthermore, credit crisis effects weren't even reflected in this report, so employment reports in future months should be even more disappointing. Thus, markets are also building in the presumption of Fed rate cuts, possibly today if the legislation fails to pass.

What about industrials? These are pro-cyclical, so with a slowing economy, you should expect these to decline. But, industrial companies also tend to rely substantially on externally generated funds. So, in light of the current and ongoing financial difficulties, even if the rescue legislation passes, there are questions about how far down industrials might fall in coming months. Where did the money exiting industrials go (rotate) to? Large banks, who have the money, even if they don't necessarily want to lend it. Graph XLI on Stockcharts.com and observe its behavior over the last few days and contrast that with today.

Let me reiterate that I continue to believe the Fed must lower interest rates. Remember, the Fed has a target of 2%, but the fed funds rate is a market rate that isn't always at its target. So, go back to the graph we did in class with real money demand falling due to a slowing economy and the Fed having a target of 2%. Were they to have kept the fed funds rate at 2%, the money supply would have been falling. But, all the injections of liquidity over the past few weeks have made the actual fed funds rate much lower than the 2% target. So, if the Fed decides to keep its existing 2% target and enforce it, they would have to undertake major withdrawals of liquidity, which would further exacerbate the current national recession (I continue to believe the US has been in a recession since January) and global weakness.

Finally, even if the rescue legislation plan passes (and I expect it will), DO NOT expect equity markets to go straight up from here. There is still a national recession, Europe and Asia are weakening, and global weakness will continue moving forward. And, last Monday when it was presumed the legislation would pass the first time around, the market was down about 3% even before the vote. There is an old saying in the stock market: Buy on the rumor, sell on the news. So, "the news" will be passage of the legislation. And, lots of money is waiting to sell any rally. So, don't be surprised if the market is down, maybe by several hundred points, for the day. And, if the legislation is passed, the anti-shorting ban will have a time table for expiration of a few days. What will happen when this is removed?

As I write this post (10am on Friday), the Dow Jones is up 136, NASDAQ is up 44, and the S&P 500 is 23 points higher. The 10-year bond is up 3 bp to 3.67%.