The forecast paper for ECN 327 that is due next Thursday MUST include correctly formatted footnotes and bibliographies. You should get into the habit of doing this for every paper you write. In order to make this process a bit less daunting for you, I have located an easy-to-use link that illustrates the appropriate footnote and corresponding bibliographic entries for various types of sources you might reference. I have chosen the Chicago style for this.
Finally, all of you need to avoid using incorrect words that unfortunately have the effect of making your writing and/or you appear to be "dumb" to persons who don't know you. I am referring to the confusion between "effect" and "affect," and "to" versus "too." I have a handout for you detailing this. If you confuse these words in your papers, you will be penalized a +/- on your paper grade.
Finally, those papers are due at the beginning of class next Thursday. I have no intention of negotiating dates I will receive these. As stated in the syllabus, you can still hand in a paper after class Thursday until the beginning of our exam, but with a grade reduced by one letter grade.
Monday, November 29, 2010
Third Quarter 2010 GDP Revision
The revision to third quarter 2010 GDP was released last week. The original estimate, 2.0%, was revised up to 2.5%, a more "respectable" number than the original. In the first release of each quarter's GDP number, inventories, exports, and imports are all approximated. Subsequent months will use available data to eliminate the "educated guesses" contained in the first estimate. That was the case for today's release. Here is a story discussing the GDP release.
As the official GDP releases represent somewhat "stale" data, we can approximate what they will entail using real-time data from asset markets, which has been a central theme of my classes. To do this, go to StockCharts.com and on the middle right select the PerfChart (this stands for Performance Chart) that deals with the sectors of the S&P 500. To save you time and effort, here is the link.
PROCEDURE:
First, choose a bar chart at the bottom left (second button from the left). Then, move the slider (bottom right) to cover the exact time period you desire. Here, I have used the third quarter of 2010.
ANALYSIS:
Observe which sectors have performed better than the S&P 500 index (i.e., outperformed the overall market). This occurs when the S&P 500 button at the top left of the chart is selected.
For the third quarter of 2010, clearly the most cyclically sensitive sectors outperformed the market, with the exception of Financials. Overall, this is a reflection of the growth that occurred during that quarter. Had the defensive sectors (i.e., Consumer Staples, Health Care, and Utilities) outperformed, this would have signaled a potentially weakening economy.
Can this analysis be used to help predict the GDP report before it is actually released? The answer is yes. Asset markets, one of which is the stock market, are leading indicators, which means they tend to move in advance of changes in other parts of the economy. So, current changes in leading economic indicators tend to signal future changes we can expect to observe in the overall economy.
What is the stock market (and its sectors) telling us about the fourth quarter rate of economic growth? The second chart (click to enlarge) shows market performance since October 1. Other than Energy and Consumer Discretionary stocks (which themselves are cyclical), the remainder of cyclical indicators are performing less well than they did in the third quarter. The apparent message is that economic growth in the fourth quarter will be slower than it was in Q3, or spotty at best in comparison.
There are two things that should be noted. First, there is no indication that economic growth will become negative in Q4. Second, the slowing of economic growth these sectors seem to be indicting also affects the defensive sectors, so they are more negative than they were in Q3. The greater under performance utilities may also reflect an expectation of somewhat higher interest rates in the near term (i.e., (public) utilities like electric companies tend to pay high dividends which become less attractive when interest rates are expected to rise). Part of this no doubt reflects ongoing worries about the US housing market and the economic stability and solvency of several European countries as well (Ireland, Portugal, Spain, Italy, and Greece, sometimes referred to as the PIIGS, using their first letters). Will economic weakness in Europe weaken the recent momentum the US has been experiencing? The market apparently believe that this is likely.
Let me suggest that you continue to follow the sectors as we move farther into the fourth quarter and see what the market is suggesting. We won't get the initial Q4 GDP data until late in January, so this should be informative in advance of the formal data in January (that will be stale at that point).
As the official GDP releases represent somewhat "stale" data, we can approximate what they will entail using real-time data from asset markets, which has been a central theme of my classes. To do this, go to StockCharts.com and on the middle right select the PerfChart (this stands for Performance Chart) that deals with the sectors of the S&P 500. To save you time and effort, here is the link.
PROCEDURE:
First, choose a bar chart at the bottom left (second button from the left). Then, move the slider (bottom right) to cover the exact time period you desire. Here, I have used the third quarter of 2010.
ANALYSIS:
Observe which sectors have performed better than the S&P 500 index (i.e., outperformed the overall market). This occurs when the S&P 500 button at the top left of the chart is selected.
For the third quarter of 2010, clearly the most cyclically sensitive sectors outperformed the market, with the exception of Financials. Overall, this is a reflection of the growth that occurred during that quarter. Had the defensive sectors (i.e., Consumer Staples, Health Care, and Utilities) outperformed, this would have signaled a potentially weakening economy.
Can this analysis be used to help predict the GDP report before it is actually released? The answer is yes. Asset markets, one of which is the stock market, are leading indicators, which means they tend to move in advance of changes in other parts of the economy. So, current changes in leading economic indicators tend to signal future changes we can expect to observe in the overall economy.
What is the stock market (and its sectors) telling us about the fourth quarter rate of economic growth? The second chart (click to enlarge) shows market performance since October 1. Other than Energy and Consumer Discretionary stocks (which themselves are cyclical), the remainder of cyclical indicators are performing less well than they did in the third quarter. The apparent message is that economic growth in the fourth quarter will be slower than it was in Q3, or spotty at best in comparison.There are two things that should be noted. First, there is no indication that economic growth will become negative in Q4. Second, the slowing of economic growth these sectors seem to be indicting also affects the defensive sectors, so they are more negative than they were in Q3. The greater under performance utilities may also reflect an expectation of somewhat higher interest rates in the near term (i.e., (public) utilities like electric companies tend to pay high dividends which become less attractive when interest rates are expected to rise). Part of this no doubt reflects ongoing worries about the US housing market and the economic stability and solvency of several European countries as well (Ireland, Portugal, Spain, Italy, and Greece, sometimes referred to as the PIIGS, using their first letters). Will economic weakness in Europe weaken the recent momentum the US has been experiencing? The market apparently believe that this is likely.
Let me suggest that you continue to follow the sectors as we move farther into the fourth quarter and see what the market is suggesting. We won't get the initial Q4 GDP data until late in January, so this should be informative in advance of the formal data in January (that will be stale at that point).
Friday, November 19, 2010
The 50-Day Moving Average as Support
In the last post, I addressed how the Dow-Jones Industrial Average (DJIA) failed at resistance. In cases where the DJIA is expected to fall from that level, how far can it be expected to decline? To translate this into technical analysis terms, where is the next support level? In the most recent situation, that support was at the 50-day moving average. The chart below shows this (click to enlarge).
Notice how the market moved all the way down to the 50-day moving average then "bounced" off this newly found support level. As of the time this post is being written the Dow is moving once again toward the prior resistance level.
Had the market fallen below its support at the 50-day moving average, where would it likely have fallen? Again, where are the next support levels? We should view the 50-day moving average as support level #1 (S1). Below that, the next support (S2) occurs around 10,900, then 10,700 is S3 (both of these are derived from horizontal support lines. After S3 comes the 200-day moving average at 10,600. Note, though, that the DJIA moved above support here when it was not yet overbought (the RSI never fell below 30). So, it is quite possible that we will be testing resistance once again. As I have stated in earlier posts, to determine whether resistance is likely to hold, it is necessary to evaluate what would drive profit expectations to higher levels so that resistance would be broken? Again, check the economic calendar for the upcoming week or two.
Let me finish this post by showing another way to determine likely levels of support should the market fall in coming days. This is illustrated using Fibonacci Analysis. In StockCharts.com, when you choose "Annotation," there is an icon to do this. Go from the most recent low to the recent high. The result is illustrated below (click to enlarge).
To add Fibonacci Analysis, click on the button highlighted in the upper portion of the above chart, then drag your mouse from the low value to the high (hold the mouse button until you reach the final level).
According to Fibonacci Analysis, the first likely level of support from an uptrend "retraces" 38.2% of that uptrend (this is called a Fibonacci Retracement). If that level of support fails, the next likely support occurs at 50% retracement. Finally, the last support level is at 61.8% retracement. If the market falls below 61.8% retracement, it is fairly likely that the prior low will be tested. Consult the RSI to assist you in deciding (in real time) if this is likely to occur.
Notice how the market moved all the way down to the 50-day moving average then "bounced" off this newly found support level. As of the time this post is being written the Dow is moving once again toward the prior resistance level.
Had the market fallen below its support at the 50-day moving average, where would it likely have fallen? Again, where are the next support levels? We should view the 50-day moving average as support level #1 (S1). Below that, the next support (S2) occurs around 10,900, then 10,700 is S3 (both of these are derived from horizontal support lines. After S3 comes the 200-day moving average at 10,600. Note, though, that the DJIA moved above support here when it was not yet overbought (the RSI never fell below 30). So, it is quite possible that we will be testing resistance once again. As I have stated in earlier posts, to determine whether resistance is likely to hold, it is necessary to evaluate what would drive profit expectations to higher levels so that resistance would be broken? Again, check the economic calendar for the upcoming week or two.
Let me finish this post by showing another way to determine likely levels of support should the market fall in coming days. This is illustrated using Fibonacci Analysis. In StockCharts.com, when you choose "Annotation," there is an icon to do this. Go from the most recent low to the recent high. The result is illustrated below (click to enlarge).
To add Fibonacci Analysis, click on the button highlighted in the upper portion of the above chart, then drag your mouse from the low value to the high (hold the mouse button until you reach the final level).
According to Fibonacci Analysis, the first likely level of support from an uptrend "retraces" 38.2% of that uptrend (this is called a Fibonacci Retracement). If that level of support fails, the next likely support occurs at 50% retracement. Finally, the last support level is at 61.8% retracement. If the market falls below 61.8% retracement, it is fairly likely that the prior low will be tested. Consult the RSI to assist you in deciding (in real time) if this is likely to occur.
Friday, November 12, 2010
Dow Jones Fails at Resistance
The Dow Jones Industrial Average (DJIA) recently tested then failed at resistance (of 11,258). There were signs in advance that this might happen. First, the index was very overbought, as the RSI (for nine periods) was far above the typical overbought reading of 70. Second, there was an intermarket relationship at work -- the US dollar found support. For quite some time now, the stock market and the US dollar have moved in opposite directions (the result of the dollar carry trade). The chart below (click to enlarge) shows this recent price action in the DJIA. The line below the DJIA chart is that of the US Dollar Index. Note how it turned up at support just as the DJIA failed at resistance.
Where will the market go from here? Translating this to technical analysis, where is the next support level? From the chart, the next support occurs at 11,100. The second (next) support level after that is at 10,900.
There is another element in this situation that needs to be examined, however. While the overall market has recently pulled back, does this mean the uptrend has now ended? The definition of an uptrend is not, as might sometimes be thought, continual increases in price. Instead, an uptrend is a series of higher highs and higher lows in price. At present, the DJIA is still in an uptrend. There is another way to help determine this. Using the RSI, an uptrend exists as long as RSI(9) > 40. While typically, a bullish signal is an RSI at or above 50, many persons (including myself) use support for a trend at the RSI of 40. In other words, as long as the RSI(9) remains at or above 40, view the uptrend in the DJIA will still be in tact.
So, will the uptrend remain in tact? Remember that in general, stock prices depend on interest rates and profit expectations. The primary driver at present is profit expectations. So, the question shifts to how profit expectations will behave in the near term. To answer this, it is necessary to consider monetary policy and QE2, whether US fiscal policy will shift to being contractionary, what other central banks are doing and will do, and how much strength other economies will be able to sustain. A critical factor in this is the strength of the Chinese economy. This is obviously related to whether China will further tighten its credit. A possible slowing of Chinese growth was behind today's (Friday) pullback.
To end this post, look at profits, the difference between revenues and costs. As the US dollar has been weakening, which has pushed commodity prices higher, this will raise production costs, working against future profits. What about revenues? If the economy begins to grow more rapidly and consumer spending continues to strengthen, then revenues may well continue to move in the right direction. But will this be enough to offset the effects of commodity-based cost increases? This is the question that everyone will be attempting to answer in the coming weeks.
There is another element in this situation that needs to be examined, however. While the overall market has recently pulled back, does this mean the uptrend has now ended? The definition of an uptrend is not, as might sometimes be thought, continual increases in price. Instead, an uptrend is a series of higher highs and higher lows in price. At present, the DJIA is still in an uptrend. There is another way to help determine this. Using the RSI, an uptrend exists as long as RSI(9) > 40. While typically, a bullish signal is an RSI at or above 50, many persons (including myself) use support for a trend at the RSI of 40. In other words, as long as the RSI(9) remains at or above 40, view the uptrend in the DJIA will still be in tact.
So, will the uptrend remain in tact? Remember that in general, stock prices depend on interest rates and profit expectations. The primary driver at present is profit expectations. So, the question shifts to how profit expectations will behave in the near term. To answer this, it is necessary to consider monetary policy and QE2, whether US fiscal policy will shift to being contractionary, what other central banks are doing and will do, and how much strength other economies will be able to sustain. A critical factor in this is the strength of the Chinese economy. This is obviously related to whether China will further tighten its credit. A possible slowing of Chinese growth was behind today's (Friday) pullback.
To end this post, look at profits, the difference between revenues and costs. As the US dollar has been weakening, which has pushed commodity prices higher, this will raise production costs, working against future profits. What about revenues? If the economy begins to grow more rapidly and consumer spending continues to strengthen, then revenues may well continue to move in the right direction. But will this be enough to offset the effects of commodity-based cost increases? This is the question that everyone will be attempting to answer in the coming weeks.
Thursday, October 14, 2010
Macro Assignment
As I indicated in class today, I am posting the assignment that is due next Thursday (10/21). I prefer that you work in groups of two for this (I will consider groups of three with permission), but if you must work alone, please feel free to do so.
Over the weekend, try to use the material on flexible exchange rates we covered today to allow you to see the basis for several important trends, such as the recent decline in the US$ index.
Over the weekend, try to use the material on flexible exchange rates we covered today to allow you to see the basis for several important trends, such as the recent decline in the US$ index.
Wednesday, October 13, 2010
Golden Cross in the Dow-Jones Industrial Average
Something fairly rare has occurred in the Dow-Jones Industrial Average (DJIA) over the past few days: the 50-day moving average crossed above the 200-day moving average. This is referred to as a "Golden Cross." The chart below shows this (click to enlarge):
To many, this signifies a major buy signal for the stock market. Indeed, if you look at history, when this occurs, generally the market does fairly well for the next several months. Is that likely to be the case this time?
Over the past few years, the stock market has allowed patterns such as this to emerge. But, instead of potential investors being patient and waiting for further confirmation before entering the market or expanding their positions, they have all too often jumped in enthusiastically. What has the market done? It has caused the pattern to either reverse of be eliminated, stranding those poor (now literally) souls who impatiently dove into the market and committed their funds.
This happened about a year ago, when a head and shoulders pattern formed in the S&P 500. Before waiting for confirmation (price must fall below the "neckline"), it seems that just about everyone jumped in to short the market or obtain options that work the same way (puts). When the pattern failed to materialize, many were caught on the wrong side of the market (short the market). In a panic, there was an attempt at a mass reversal of direction, leading to a major rally for several months!
Let's get back to the chart. Yes, there has been a Golden Cross. BUT, note that the DJIA is in slightly overbought territory (i.e., the RSI > 70) AND at its current level, the market is not far from a resistance level. Put this all together and it is not clear that the Golden Cross will be sustained in the short-term. If resistance holds, those who have recently jumped into the market will not be happy.
Now let's shift gears and inject economics into this. In addition to the technical analysis I just covered to evaluate whether the DJIA is likely to go above resistance, use economic theory:
For the DJIA to break above resistance, it is necessary for profit expectations to be elevated above their current levels. QE2 (possible upcoming quantitative easing) has already been priced in. So, if that fails to materialize, stock prices will fall and much of this last leg up will likely be lost. Earnings results are beginning to be reported. If those are very good, better than expected, resistance may well be broken, as long as two things occur. First, top line (revenue) growth has to be emerging with greater regularity than it has in the past. Second, earnings guidance (what they expect to occur in future quarters) cannot be disappointing.
Then there is the election. The stock market will very likely react positively to the expected increase in the number of Republicans in the House and Senate. But I expect this to only be a short-term rally. Gridlock will occur, as governing will more closely resemble the WWE than what we studied in Civics class. Historically, gridlock favors bonds over stocks. Beyond this, the desire to move toward smaller budget deficits will hinder economic momentum over the short-term.
So, at this point, it will be interesting to see how all of this plays out. I do expect a short-term rally after the election, before the market returns to fundamentals as next year begins. While it is quite possible that the Golden Cross will hold for a few months, I expect this to be a shorter period of positive upward momentum that prior crosses have produced.
Over the past few years, the stock market has allowed patterns such as this to emerge. But, instead of potential investors being patient and waiting for further confirmation before entering the market or expanding their positions, they have all too often jumped in enthusiastically. What has the market done? It has caused the pattern to either reverse of be eliminated, stranding those poor (now literally) souls who impatiently dove into the market and committed their funds.
This happened about a year ago, when a head and shoulders pattern formed in the S&P 500. Before waiting for confirmation (price must fall below the "neckline"), it seems that just about everyone jumped in to short the market or obtain options that work the same way (puts). When the pattern failed to materialize, many were caught on the wrong side of the market (short the market). In a panic, there was an attempt at a mass reversal of direction, leading to a major rally for several months!
Let's get back to the chart. Yes, there has been a Golden Cross. BUT, note that the DJIA is in slightly overbought territory (i.e., the RSI > 70) AND at its current level, the market is not far from a resistance level. Put this all together and it is not clear that the Golden Cross will be sustained in the short-term. If resistance holds, those who have recently jumped into the market will not be happy.
Now let's shift gears and inject economics into this. In addition to the technical analysis I just covered to evaluate whether the DJIA is likely to go above resistance, use economic theory:
DJIA = f(short-term interest rates, profit expectations)
(this was covered in the most recent set of notes). Short-term rates, related to asset substitution, are likely to fall a bit more, but they are already very low. So, don't expect much change from this component. Focus instead on profit expectations.
For the DJIA to break above resistance, it is necessary for profit expectations to be elevated above their current levels. QE2 (possible upcoming quantitative easing) has already been priced in. So, if that fails to materialize, stock prices will fall and much of this last leg up will likely be lost. Earnings results are beginning to be reported. If those are very good, better than expected, resistance may well be broken, as long as two things occur. First, top line (revenue) growth has to be emerging with greater regularity than it has in the past. Second, earnings guidance (what they expect to occur in future quarters) cannot be disappointing.
Then there is the election. The stock market will very likely react positively to the expected increase in the number of Republicans in the House and Senate. But I expect this to only be a short-term rally. Gridlock will occur, as governing will more closely resemble the WWE than what we studied in Civics class. Historically, gridlock favors bonds over stocks. Beyond this, the desire to move toward smaller budget deficits will hinder economic momentum over the short-term.
So, at this point, it will be interesting to see how all of this plays out. I do expect a short-term rally after the election, before the market returns to fundamentals as next year begins. While it is quite possible that the Golden Cross will hold for a few months, I expect this to be a shorter period of positive upward momentum that prior crosses have produced.
Wednesday, October 6, 2010
Now that the Recession is Over, What's Next?
Now that the US recession has officially been declared as being over, the most obvious and pressing question is where we go from here?
As there are confusions about what a recession or recovery actually means (see the previous post), there are just as many confusions concerning whether we are actually in a recovery or a recession. I have provided a chart that will help to illustrate this point (click the chart to enlarge it).
I think it is safe to say that generally, most people refuse to believe the pronouncements of economists concerning when an economy is in the very early stages of either recession or recovery. Consider early recession in the chart. Note that the economy is not very far from its peak in economic activity. So, when economic data are released, the numbers are still very good in a historical context. In fact, unless you focus on what economists refer to as leading economic indicators, the numbers will show an economy that is still climbing the activity "hill" (i.e., to the left of the peak), making it even more difficult to assess what is actually taking place. Perhaps the best example of this is the one measure the general population focuses on most -- the unemployment rate. This is a lagging indicator, meaning its level at present reflects what happened in months past. Remember: a recession is NOT defined as a level of diminished economic activity. As the National Bureau of Economic Research (the "dating" body for economic cycles) points out, it is instead a period of diminishing activity. This highlights the distinction between levels and rates of change that I discussed in the previous post.
Right now, nationally at least, we find ourselves in the early stages of a recovery. Once again, look at the chart above. In the early stages of a recovery, an economy is close to the "bottom" of economic activity. The numbers that are released are therefore not going to be very good, and after a recession period, often discouraging. Of course, if you focus on lagging indicators, you will almost certainly conclude that we are still in a recession.
At this point, I need to reiterate that contrary to popular "wisdom," being in a recovery does not necessarily require a return to "normal" times and historical averages (or above) of economic variables. It might. But generally it takes some time to get back to "typical" levels. The next chart will help to explain this.
As this chart should illustrate, not all recoveries are alike. Each path reflects how rapidly economic activity will be rising in the future. Historically, when there is a very deep national recession like the one we just had, the economy rebounds quickly. This leads to a "V" shaped recovery (the green line). It doesn't take all that long to return to "normal" levels of economic activity. In that situation, a recovery feels like a recovery.
But recovery paths are different since not all recessions are the same. Global recessions occur over longer periods and are generally more damaging than more "typical" recessions. When there is a global recession with major financial problems, as the one we just had, the pace of recovery tends to be slow and it takes a longer time to return to "normal" levels of economic activity (the red line). Consider that at present, individuals are spending less, saving, and paying down debt. Banks have lowered leverage. All of this is very positive in the medium to longer term, but it extracts a cost on the rate of economic growth in the short term. Add to this the fact that banks aren't lending as much as they might have in previous recoveries, and you get what Mohammed El-Erian of Pimco refers to as "The New Normal" (click here for a video of El-Erian explaining this concept). He and I are somewhat concerned with the possibility of deflation in the near-term as well.
So, where does all of this leave us? What are you to think? Hopefully you are now more aware of the basics of what is really going on, what an early recovery means, and the possible paths the US economy might take. THE question is which path will be the one our economy follows. Let me be very honest about this: economists, including me, don't really know the answer to this, in spite of all our forecasts and predictions. In this context, let me state one of my favorite sayings: CERTAINTY IS AN ILLUSION. Any forecast, no matter who makes it, is essentially a scenario. It assumes what the areas are that will be the most important over the forecast period, how each of those areas will actually change, and the interactions between and among them. Obviously, there are numerous sources of potential error.
In a period of such uncertainty, where things seldom appear to be what they actually are, many persons are all too willing to step forward with their "solutions." While these might sound good, or appeal to the increasingly subjective notion of "common sense," they too are based on scenarios. So, they might be right. Or, they might be wrong. Let me recommend that you critique any or all of these within the context of one of my favorite sayings: "Complex problems have simple, easy to understand, wrong answers."
Let me finish by acknowledging that at this point you are no doubt wondering where I stand on the future path of economic growth. I will outline this in the coming days (it's time for me to get to class). Before doing that, I need to apply the information in these last two posts to what is occurring in Rhode Island. Stay tuned!
As there are confusions about what a recession or recovery actually means (see the previous post), there are just as many confusions concerning whether we are actually in a recovery or a recession. I have provided a chart that will help to illustrate this point (click the chart to enlarge it).
Right now, nationally at least, we find ourselves in the early stages of a recovery. Once again, look at the chart above. In the early stages of a recovery, an economy is close to the "bottom" of economic activity. The numbers that are released are therefore not going to be very good, and after a recession period, often discouraging. Of course, if you focus on lagging indicators, you will almost certainly conclude that we are still in a recession.
At this point, I need to reiterate that contrary to popular "wisdom," being in a recovery does not necessarily require a return to "normal" times and historical averages (or above) of economic variables. It might. But generally it takes some time to get back to "typical" levels. The next chart will help to explain this.
As this chart should illustrate, not all recoveries are alike. Each path reflects how rapidly economic activity will be rising in the future. Historically, when there is a very deep national recession like the one we just had, the economy rebounds quickly. This leads to a "V" shaped recovery (the green line). It doesn't take all that long to return to "normal" levels of economic activity. In that situation, a recovery feels like a recovery.
But recovery paths are different since not all recessions are the same. Global recessions occur over longer periods and are generally more damaging than more "typical" recessions. When there is a global recession with major financial problems, as the one we just had, the pace of recovery tends to be slow and it takes a longer time to return to "normal" levels of economic activity (the red line). Consider that at present, individuals are spending less, saving, and paying down debt. Banks have lowered leverage. All of this is very positive in the medium to longer term, but it extracts a cost on the rate of economic growth in the short term. Add to this the fact that banks aren't lending as much as they might have in previous recoveries, and you get what Mohammed El-Erian of Pimco refers to as "The New Normal" (click here for a video of El-Erian explaining this concept). He and I are somewhat concerned with the possibility of deflation in the near-term as well.
So, where does all of this leave us? What are you to think? Hopefully you are now more aware of the basics of what is really going on, what an early recovery means, and the possible paths the US economy might take. THE question is which path will be the one our economy follows. Let me be very honest about this: economists, including me, don't really know the answer to this, in spite of all our forecasts and predictions. In this context, let me state one of my favorite sayings: CERTAINTY IS AN ILLUSION. Any forecast, no matter who makes it, is essentially a scenario. It assumes what the areas are that will be the most important over the forecast period, how each of those areas will actually change, and the interactions between and among them. Obviously, there are numerous sources of potential error.
In a period of such uncertainty, where things seldom appear to be what they actually are, many persons are all too willing to step forward with their "solutions." While these might sound good, or appeal to the increasingly subjective notion of "common sense," they too are based on scenarios. So, they might be right. Or, they might be wrong. Let me recommend that you critique any or all of these within the context of one of my favorite sayings: "Complex problems have simple, easy to understand, wrong answers."
Let me finish by acknowledging that at this point you are no doubt wondering where I stand on the future path of economic growth. I will outline this in the coming days (it's time for me to get to class). Before doing that, I need to apply the information in these last two posts to what is occurring in Rhode Island. Stay tuned!
Tuesday, September 21, 2010
ECN 327 Syllabus
I have posted the online lecture notes on the bond market. Please download them and bring them to our next class.
Monday, September 20, 2010
The US Recession is Officially Over
Today, the group officially responsible for applying dates to national business cycle turning points (i.e., recessions and recoveries), the National Bureau of Economic Research (NBER), declared that the most recent recession ended in June of 2009. Read their full statement.
Just as most people didn't realize we were in recession for quite some time after the most recent recession began, many didn't realize that we have now been in an economic recovery for over a year. There are several reasons for this.
First, a (national) recession is not defined the way most people think it is. Apparently almost everyone believes that a recession occurs when the US economy experiences at least two consecutive quarters where real (inflation-adjusted) GDP declines. This definition is predicated entirely on the behavior of a single variable -- national output, which would be declining for at least six consecutive months. Were this the definition, it would be very easy to "date" recessions: count to two after checking GDP releases, looking for negative growth rates. Second, the NBER does not do things this way, nor do they restrict their analysis exclusively to quarterly data. Read the Q&A about the way they define recessions and recoveries. In this, the NBER states a very important point: a recession isn't defined as being a period of low activity, but a time period of continually declining economic activity. Extending this to recoveries, these don't necessarily indicate a return to "normal" times. Instead, they reflect continually improving economic activity in a number of areas.
What is the actual definition the NBER uses to define a recession? According to the NBER, a recession is defined in the following way:
"The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."
So, from this, what we can infer is that as we are now about a year into a national economic recovery, economic activity in a number of areas is improving (on average). THIS DOES NOT MEAN WE HAVE RETURNED TO "TRADITIONAL" LEVELS OF THESE VARIABLES. That could take months or even years, especially as our economy is in a period where persons are saving and paying down debt, and bank lending is not as great as we would like to see it.
Confusion surrounding the dates of recessions and recoveries is the manifestation of a very basic observation I will make: persons instinctively focus on the levels of economic variables; economists extend this focus on levels to rates of change as well. So, the rate of economic growth is just that -- a rate of growth and thus a measure of rate of change. Actually, economists often go farther, as we are now concerned about whether the rate of economic growth will be slowing. This means economists are now focusing on rates of change (are we slowing?) in the rate of change (the rate of economic growth). You will often hear this referred to as the "second derivative" of economic activity. Clearly, economists think and speak a different language than do most people, often defying "intuition."
Just as most people didn't realize we were in recession for quite some time after the most recent recession began, many didn't realize that we have now been in an economic recovery for over a year. There are several reasons for this.
First, a (national) recession is not defined the way most people think it is. Apparently almost everyone believes that a recession occurs when the US economy experiences at least two consecutive quarters where real (inflation-adjusted) GDP declines. This definition is predicated entirely on the behavior of a single variable -- national output, which would be declining for at least six consecutive months. Were this the definition, it would be very easy to "date" recessions: count to two after checking GDP releases, looking for negative growth rates. Second, the NBER does not do things this way, nor do they restrict their analysis exclusively to quarterly data. Read the Q&A about the way they define recessions and recoveries. In this, the NBER states a very important point: a recession isn't defined as being a period of low activity, but a time period of continually declining economic activity. Extending this to recoveries, these don't necessarily indicate a return to "normal" times. Instead, they reflect continually improving economic activity in a number of areas.
What is the actual definition the NBER uses to define a recession? According to the NBER, a recession is defined in the following way:
"The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."
So, from this, what we can infer is that as we are now about a year into a national economic recovery, economic activity in a number of areas is improving (on average). THIS DOES NOT MEAN WE HAVE RETURNED TO "TRADITIONAL" LEVELS OF THESE VARIABLES. That could take months or even years, especially as our economy is in a period where persons are saving and paying down debt, and bank lending is not as great as we would like to see it.
Confusion surrounding the dates of recessions and recoveries is the manifestation of a very basic observation I will make: persons instinctively focus on the levels of economic variables; economists extend this focus on levels to rates of change as well. So, the rate of economic growth is just that -- a rate of growth and thus a measure of rate of change. Actually, economists often go farther, as we are now concerned about whether the rate of economic growth will be slowing. This means economists are now focusing on rates of change (are we slowing?) in the rate of change (the rate of economic growth). You will often hear this referred to as the "second derivative" of economic activity. Clearly, economists think and speak a different language than do most people, often defying "intuition."
Tuesday, September 7, 2010
Welcome Back!
Welcome to the Fall 2010 semester.
This blog will have postings throughout the semester -- my way of communicating important information to you when we are not meeting as a class. Check in on the days after class meets, especially on weekends.
The past few years have been dominated by a severe financial crisis and a global recession. The recession was so severe (believed to be the worst since the Depression) that it took on a name: "The Great Recession." This semester, growth remains a major concern, as there is considerable debate about whether or not the national economic recovery will falter, moving us to a "double dip recession." Whether or not this occurs, credit market weakness (ongoing credit problems and further after-effects of sub-prime mortgages) continues too be important, as is the behavior of future price change (are we closer to inflation or deflation?). The Fed can no longer lower the fed funds rate, as it is currently at (or near) 0. What do they do if things weaken? We will discuss this.
By semester's end, you will come to understand that all of the factors we will be discussing throughout this semester are interrelated. And, as the semester unfolds, you will observe the collective actions of the world's central banks, and whether their prior assessments prove to be correct.
For now, read all of Stikki Stock Charts for next Thursday and visit the web site: StockCharts.com. On the online syllabus I have added introductory material that will assist you in using that web site (we will be referring to it all semester).
If you have any questions throughout the semester, don't hesitate to e-mail me (llardaro@uri.edu) and/or stop by my office, Chafee 804. DO NOT LEAVE PHONE MESSAGES!!
Finally, if during the semester, you want to research the entire set of blog posts on a specific topic, click on its label beyond a particular post. The result will be a view of all of the posts that include that word as a label.
This blog will have postings throughout the semester -- my way of communicating important information to you when we are not meeting as a class. Check in on the days after class meets, especially on weekends.
The past few years have been dominated by a severe financial crisis and a global recession. The recession was so severe (believed to be the worst since the Depression) that it took on a name: "The Great Recession." This semester, growth remains a major concern, as there is considerable debate about whether or not the national economic recovery will falter, moving us to a "double dip recession." Whether or not this occurs, credit market weakness (ongoing credit problems and further after-effects of sub-prime mortgages) continues too be important, as is the behavior of future price change (are we closer to inflation or deflation?). The Fed can no longer lower the fed funds rate, as it is currently at (or near) 0. What do they do if things weaken? We will discuss this.
By semester's end, you will come to understand that all of the factors we will be discussing throughout this semester are interrelated. And, as the semester unfolds, you will observe the collective actions of the world's central banks, and whether their prior assessments prove to be correct.
For now, read all of Stikki Stock Charts for next Thursday and visit the web site: StockCharts.com. On the online syllabus I have added introductory material that will assist you in using that web site (we will be referring to it all semester).
If you have any questions throughout the semester, don't hesitate to e-mail me (llardaro@uri.edu) and/or stop by my office, Chafee 804. DO NOT LEAVE PHONE MESSAGES!!
Finally, if during the semester, you want to research the entire set of blog posts on a specific topic, click on its label beyond a particular post. The result will be a view of all of the posts that include that word as a label.
Wednesday, May 5, 2010
Potential Exam Questions for ECN 334
I have gone through the questions submitted for potential inclusion on the final exam. Here are the questions I will choose from (there will be at least one and possibly two selected).
1. Outline the impact of tougher financial regulation on the stock market.
2. Last year, the Fed decided not to pursue inflation as its primary target. Outline the actions the Fed would have taken had its target been inflation and the consequences of those actions at the present time.
3. How will the stock and bond markets react to the debt crisis in Europe, specifically in Greece?
4. Discuss the effect of bond prices on interest rates based on Yield to Maturity. In doing so, indicate in detail other factors that determine how bond prices or the bond market would react if one of these factors were to suddenly change.
5. Using the material from this course, outline why the US will have a slow and long recovery from the financial crisis of 2007, focusing on businesses and consumers.
6. What are some of the risks of unregulated derivative trading by investment banks? Be sure to explain what a derivative is and teh specific dangers they pose to the economy if unregulated.
7. Explain how the federal funds rate is an important indicator for the stock market.
When you take the final exam on Friday, MAKE SURE THAT EACH OF YOUR RESPONSES ANSWERS THE SPECIFIC QUESTION IT IS ADDRESSED TO. I strongly suggest that before you hand in your exam, read each question again then make sure that your response is to the specific question posed and not just a series of statements that might be correct overall but that don't really answer the question.
1. Outline the impact of tougher financial regulation on the stock market.
2. Last year, the Fed decided not to pursue inflation as its primary target. Outline the actions the Fed would have taken had its target been inflation and the consequences of those actions at the present time.
3. How will the stock and bond markets react to the debt crisis in Europe, specifically in Greece?
4. Discuss the effect of bond prices on interest rates based on Yield to Maturity. In doing so, indicate in detail other factors that determine how bond prices or the bond market would react if one of these factors were to suddenly change.
5. Using the material from this course, outline why the US will have a slow and long recovery from the financial crisis of 2007, focusing on businesses and consumers.
6. What are some of the risks of unregulated derivative trading by investment banks? Be sure to explain what a derivative is and teh specific dangers they pose to the economy if unregulated.
7. Explain how the federal funds rate is an important indicator for the stock market.
When you take the final exam on Friday, MAKE SURE THAT EACH OF YOUR RESPONSES ANSWERS THE SPECIFIC QUESTION IT IS ADDRESSED TO. I strongly suggest that before you hand in your exam, read each question again then make sure that your response is to the specific question posed and not just a series of statements that might be correct overall but that don't really answer the question.
Potential Exam Questions for ECN 335X
I have gone through the questions submitted for potential inclusion on the final exam. Here are the questions I will choose from (there will be at least one and possibly two selected).
1. Outline the underlying basis of the relationship between bond and commodity prices. Give an example of how this relationship can change based on occurrences in the other two intermarkets that would contradict this "traditional" relationship.
2. Explain the effects of a weakening US Dollar in an intermarket context.
3. Can the stock market and commodities move in opposite directions? Explain the basis of your answer.
When you take the final exam tomorrow, MAKE SURE THAT EACH OF YOUR RESPONSES ANSWERS THE SPECIFIC QUESTION IT IS ADDRESSED TO. I strongly suggest that before you hand in your exam, read each question again then make sure that your response is to the specific question posed and not just a series of statements that might be correct overall but that don't really answer the question.
1. Outline the underlying basis of the relationship between bond and commodity prices. Give an example of how this relationship can change based on occurrences in the other two intermarkets that would contradict this "traditional" relationship.
2. Explain the effects of a weakening US Dollar in an intermarket context.
3. Can the stock market and commodities move in opposite directions? Explain the basis of your answer.
When you take the final exam tomorrow, MAKE SURE THAT EACH OF YOUR RESPONSES ANSWERS THE SPECIFIC QUESTION IT IS ADDRESSED TO. I strongly suggest that before you hand in your exam, read each question again then make sure that your response is to the specific question posed and not just a series of statements that might be correct overall but that don't really answer the question.
Wednesday, April 28, 2010
Final Paper Citations
The forecast paper for ECN 335 that is due Friday MUST include correctly formatted footnotes and bibliographies. You should get into the habit of doing this for every paper you write. In order to make this process a bit less daunting for you, I have located an easy-to-use link that illustrates the appropriate footnote and corresponding bibliographic entries for various types of sources you might reference. I have chosen the Chicago style for this.
Finally, all of you need to avoid using incorrect words that unfortunately have the effect of making your writing and/or you appear to be "dumb" to persons who don't know you. I am referring to the confusion between "effect" and "affect," and "to" versus "too." I have a handout for you detailing this. If you confuse these words in your papers, you will be penalized a +/- on your paper grade.
Finally, all of you need to avoid using incorrect words that unfortunately have the effect of making your writing and/or you appear to be "dumb" to persons who don't know you. I am referring to the confusion between "effect" and "affect," and "to" versus "too." I have a handout for you detailing this. If you confuse these words in your papers, you will be penalized a +/- on your paper grade.
Wednesday, April 21, 2010
What are Interest Rates Telling Us?
As we outlined in class yesterday, interest rates and the bond market have a great deal of predictive ability concerning future levels of economic activity. The simple yet very powerful model of interest rates you should use is:
As I noted, inflation expectations and growth expectations are not necessarily independent of each other, so the time frame you are considering becomes relevant to seeing which matters more. You can use the TIP:TLT ratio in StockCharts.com as one proxy for expected inflation, while a preferable way is to calculate (and track through time) the TIPS spread (= nominal interest rate - TIP rate with same maturity). This is available daily (in real time) from Bloomberg.com. Here is a link to the web page to use for this. As of today (4/21/10), the 10-year US Treasury bond has a rate of 3.79%, while the 10-year Inflation Indexed Security (TIP) has a rate of 1.43%. So:
Historical data on this is available from the Federal Reserve Economic Data (FRED).
If you want to find a proxy for the level of economic activity and income, you can use consumer cyclicals ($CYC) in Stockcharts.com. Where is support for this? Resistance? Are there any leading indicators from technical analysis that can be of help in the short-term (ex: bullish or bearish divergences based on the RSI)?
So, you should use the interest rate model above whenever you need to explain interest rate changes or to make interest rate forecasts. To do this, you will need to generate a forecast for each explanatory factor. Possibly, over the time period of your forecast, a factor that usually matters will not matter much. Or possibly, a factor that normally doesn't matter much will be influential. Remember: NOBODY KNOWS THE FUTURE (except CNBC, of course).
For those of you who have taken ECN 327 with me, you can expand the basic interest rate model substantially. Using general macroeconomic models such as the IS-LM and AD-AS, you can identify a fairly large set of factors that determine either economic growth (Ye in those models) or inflation (changes in Pe in the AD-AS model). Basically, those factors are the "other things" of the relevant curves.
Looking at a chart (click to enlarge) of the 10-year rate ($TNX), resistance at 4% becomes readily apparent (note: you must divide the number on the right axis by 10 to get the interest rate). Short-term support is at roughly 3.5%. Why has resistance held over the one-year period covered by this graph? Rates fell twice from 4% (a double top, by the way). What causes interest rates to decline? To answer this question, use the interest rate model.
Rates decline for some combination of declining expected inflation, less expected future growth, or monetary easing. Obviously, we can rule out monetary easing. That leaves us with declines in expected growth and inflation.
Will the 10-year re-test resistance or support? Again, use the interest rate model to answer this question. Anyone doing their forecast on interest rates will have to do this.
Read the relevant chapters in John Murphy's Intermarket Analysis to further help you with an understanding of this topic.
interest rate = f(expected inflation, economic growth, monetary policy)
As I noted, inflation expectations and growth expectations are not necessarily independent of each other, so the time frame you are considering becomes relevant to seeing which matters more. You can use the TIP:TLT ratio in StockCharts.com as one proxy for expected inflation, while a preferable way is to calculate (and track through time) the TIPS spread (= nominal interest rate - TIP rate with same maturity). This is available daily (in real time) from Bloomberg.com. Here is a link to the web page to use for this. As of today (4/21/10), the 10-year US Treasury bond has a rate of 3.79%, while the 10-year Inflation Indexed Security (TIP) has a rate of 1.43%. So:
TIPS SPREAD = 3.79% - 1.43% = 2.36%
Historical data on this is available from the Federal Reserve Economic Data (FRED).
If you want to find a proxy for the level of economic activity and income, you can use consumer cyclicals ($CYC) in Stockcharts.com. Where is support for this? Resistance? Are there any leading indicators from technical analysis that can be of help in the short-term (ex: bullish or bearish divergences based on the RSI)?
So, you should use the interest rate model above whenever you need to explain interest rate changes or to make interest rate forecasts. To do this, you will need to generate a forecast for each explanatory factor. Possibly, over the time period of your forecast, a factor that usually matters will not matter much. Or possibly, a factor that normally doesn't matter much will be influential. Remember: NOBODY KNOWS THE FUTURE (except CNBC, of course).
For those of you who have taken ECN 327 with me, you can expand the basic interest rate model substantially. Using general macroeconomic models such as the IS-LM and AD-AS, you can identify a fairly large set of factors that determine either economic growth (Ye in those models) or inflation (changes in Pe in the AD-AS model). Basically, those factors are the "other things" of the relevant curves.
Looking at a chart (click to enlarge) of the 10-year rate ($TNX), resistance at 4% becomes readily apparent (note: you must divide the number on the right axis by 10 to get the interest rate). Short-term support is at roughly 3.5%. Why has resistance held over the one-year period covered by this graph? Rates fell twice from 4% (a double top, by the way). What causes interest rates to decline? To answer this question, use the interest rate model.Rates decline for some combination of declining expected inflation, less expected future growth, or monetary easing. Obviously, we can rule out monetary easing. That leaves us with declines in expected growth and inflation.
Will the 10-year re-test resistance or support? Again, use the interest rate model to answer this question. Anyone doing their forecast on interest rates will have to do this.
Read the relevant chapters in John Murphy's Intermarket Analysis to further help you with an understanding of this topic.
Saturday, April 17, 2010
Financial Sector Plunges on Goldman News
On Friday, news about the SEC bringing charges against Goldman Sachs and one of its VP's for fraud charges shook the markets. According to the SEC, Goldman created Collateralized Debt Obligations (CDOs), a collection of parts of mortgage backed bonds, which were destined to fail, then sold them to entities without fully disclosing the facts concerning how these were constructed (toxic) and that a major hedge fund (of Paulson) was betting against them. Here is a link to a story about this. And, in an amazing intermarket application of all of this, there is a potential basis to associate the difficulties with Goldman Sachs with future gold prices. Here is a story about this.
Technical analysis of the ETF for financials (XLF) shows how significant Friday's events were. The chart (click to enlarge) shows how the sharp decline in price on Friday broke a very steep trendline, while still preserving (for now at least) the overall uptrend (based on RSI >= 40). This decline did not lack conviction (sorry for the pun), as it was based on extremely high volume.
Based on Fibonacci Analysis, the next potential support for XLF occurs at the 38.2% retracement level with a price of $15.77 (Friday's close was $16.36). On the chart, note that the 50% retracement occurs at a prior high (from early January of this year) of $15.35. At this point, a 50% retracement can not be ruled out, as more news will no doubt emerge next week, much of which will involve negatives for Goldman Sachs and (potentially) other similar firms as well. Also, markets tend to overreact in the short-term to such momentous news events.
The question now becomes how financials react and whether this trend for XLF is broken convincingly. For extra credit due at the beginning of class next Tuesday, create a PerfChart of the S&P sectors (as I did in class on Thursday) with a time period that starts at the beginning of April this year. Based on this, which sector has led this "leg" of the rally? What does the chart above signify about any potential changes in what the PerfChart shows? Should the defensive sectors see money flowing in as the result of Friday's news? Paste the PerfChart and brief answers to these questions in a Word document.
One way to assess how financials will do in the near term is to perform technical analysis on the overall stock market. Prior to Friday, the S&P 500 was very overbought, as the RSI(9) was well above 70. After Friday, the RSI fell to below 70, so it is no longer overbought. I also recommend that you look at the economic "numbers" that will be coming out this week. Other than the Leading Economic Indicators on Monday, the only major number with market moving potential is Durable Goods, which is released next Friday morning. So, for much of this week, the market overall and financials in particular will be driven by further news concerning the SEC's case against Goldman Sachs.
Technical analysis of the ETF for financials (XLF) shows how significant Friday's events were. The chart (click to enlarge) shows how the sharp decline in price on Friday broke a very steep trendline, while still preserving (for now at least) the overall uptrend (based on RSI >= 40). This decline did not lack conviction (sorry for the pun), as it was based on extremely high volume.
Based on Fibonacci Analysis, the next potential support for XLF occurs at the 38.2% retracement level with a price of $15.77 (Friday's close was $16.36). On the chart, note that the 50% retracement occurs at a prior high (from early January of this year) of $15.35. At this point, a 50% retracement can not be ruled out, as more news will no doubt emerge next week, much of which will involve negatives for Goldman Sachs and (potentially) other similar firms as well. Also, markets tend to overreact in the short-term to such momentous news events.The question now becomes how financials react and whether this trend for XLF is broken convincingly. For extra credit due at the beginning of class next Tuesday, create a PerfChart of the S&P sectors (as I did in class on Thursday) with a time period that starts at the beginning of April this year. Based on this, which sector has led this "leg" of the rally? What does the chart above signify about any potential changes in what the PerfChart shows? Should the defensive sectors see money flowing in as the result of Friday's news? Paste the PerfChart and brief answers to these questions in a Word document.
One way to assess how financials will do in the near term is to perform technical analysis on the overall stock market. Prior to Friday, the S&P 500 was very overbought, as the RSI(9) was well above 70. After Friday, the RSI fell to below 70, so it is no longer overbought. I also recommend that you look at the economic "numbers" that will be coming out this week. Other than the Leading Economic Indicators on Monday, the only major number with market moving potential is Durable Goods, which is released next Friday morning. So, for much of this week, the market overall and financials in particular will be driven by further news concerning the SEC's case against Goldman Sachs.
Tuesday, March 16, 2010
Picking Stocks to Invest In
As you probably know, there are different sized firms (small, medium, and large capitalization), and there are different emphases among them in ETF's. In this post I focus on growth and value orientations.
To get the symbols for these, I went to the ishares.com web site, which has an easy navigation method. On the left, select the US Market Cap/Style tab. Sub-tabs appear giving the different market cap possibilities, and when you click on one of these, you get the symbols for the market cap and emphasis of that ETF.
You can use these symbols to determine the size/orientations that are outperforming (hopefully) the market using PerfCharts in StockCharts.com. I have done this for you. Click on the following link to get the PerfChart for this.
You will need to convert this to a bar chart, so click on the bar designation below the graph on the bottom left.
- To compare performance to the S&P click on the S&P tab above the bar chart.
- On the bottom right below the graph, drag the bar to select the time period you will investigate. NOTE that the dates you end up with are given in the top left of the graph.
Once this is done, you will be able to see which sizes are performing best, or which orientation is doing better than others. I used the most recent low for the S&P 500 which occurred on February 5. Using this as the starting date (through the most recent date), small cap growth is the most rapidly growing ETF.
As an investor, how can you use this procedure for selecting potential ETF's or stocks to invest in? Obviously, any ETF's that outperform the S&P are obvious choices for you to consider. BUT, make sure you check the technicals of each of these ETF's before you decide whether to purchase shares (using the regular SharpCharts in StockCharts.com).
If you want to purchase individual stocks, what can you do? The answer to this is simpler than it might appear: Get the symbol of the ETF that is outperforming (here JKK), return to ishares.com, and investigate it there. Enter the symbol on the ishares home page or go to the tab to get to that ETF's page. There you will find the primary holdings in that ETF. You can click to find all holdings if desired), and its sector breakdown. If you click on View All Holdings in ishares.com, symbols for each holding are given. Get the symbols for the 10 largest holdings (PerfCharts can only deal with 10 things at a time). Return to PerfCharts, enter those symbols, then determine which individual stocks have outperformed the other ETF holdings.
Once you identify those, the final step consists of charting these and performing a technical analysis of each (or CandleGlance for the entire group). Based on your results, decide which if any you want to purchase (you should also have a sense of where the overall market is going).
To get the symbols for these, I went to the ishares.com web site, which has an easy navigation method. On the left, select the US Market Cap/Style tab. Sub-tabs appear giving the different market cap possibilities, and when you click on one of these, you get the symbols for the market cap and emphasis of that ETF.
You can use these symbols to determine the size/orientations that are outperforming (hopefully) the market using PerfCharts in StockCharts.com. I have done this for you. Click on the following link to get the PerfChart for this.
You will need to convert this to a bar chart, so click on the bar designation below the graph on the bottom left.
- To compare performance to the S&P click on the S&P tab above the bar chart.
- On the bottom right below the graph, drag the bar to select the time period you will investigate. NOTE that the dates you end up with are given in the top left of the graph.
Once this is done, you will be able to see which sizes are performing best, or which orientation is doing better than others. I used the most recent low for the S&P 500 which occurred on February 5. Using this as the starting date (through the most recent date), small cap growth is the most rapidly growing ETF.
As an investor, how can you use this procedure for selecting potential ETF's or stocks to invest in? Obviously, any ETF's that outperform the S&P are obvious choices for you to consider. BUT, make sure you check the technicals of each of these ETF's before you decide whether to purchase shares (using the regular SharpCharts in StockCharts.com).
If you want to purchase individual stocks, what can you do? The answer to this is simpler than it might appear: Get the symbol of the ETF that is outperforming (here JKK), return to ishares.com, and investigate it there. Enter the symbol on the ishares home page or go to the tab to get to that ETF's page. There you will find the primary holdings in that ETF. You can click to find all holdings if desired), and its sector breakdown. If you click on View All Holdings in ishares.com, symbols for each holding are given. Get the symbols for the 10 largest holdings (PerfCharts can only deal with 10 things at a time). Return to PerfCharts, enter those symbols, then determine which individual stocks have outperformed the other ETF holdings.
Once you identify those, the final step consists of charting these and performing a technical analysis of each (or CandleGlance for the entire group). Based on your results, decide which if any you want to purchase (you should also have a sense of where the overall market is going).
Sunday, March 7, 2010
February's Employment Report
February's employment report was better than expected. Even though there was a loss of 36,000 jobs, weather factors had been fully expected to exacerbate the final number. More importantly, when weather-distorted values of employment such as February occur, the jobs number in the following month almost always shows a significant rise, as some of the weather-related loss is "made up." This is clearly the expectation going forward, that March will show a rise in employment (not just because of the addition of Census workers). The unemployment rate remained at 9.7 percent, also better than anticipated, leading some to conjecture that we have already. Gseen the peak unemployment rate (I am not convinced of this yet). Here is an article about the report, and two videos from CNBC about the employment report. The first is pre-report, the second occurred after the data were released. The bond market hated the employment news, selling off, as the 10-year bond rose 8 basis points (remember: when bond prices fall, interest rates rise).
Most of the time, when an employment number is released, the stock market tends to bounce around, as bulls and bears battle throughout the day. Generally, this leads to a small daily change for the market that day. This was not the case on Friday, as the market shot higher and sustained its momentum throughout the trading day. The result was a large candle, a large real body, and almost no shadow (tails). Here is the chart for Friday (click to enlarge). Note that resistance in terms of the RSI(9) remains above 60, but it is now slightly overbought. So, will we make it to the next resistance at 1150 without a short-term pullback? Check next week's economic releases and see if there are any major releases that can materially affect the stock market.
I believe that the stock market sustained its earlier momentum as the day wore on because in addition to the jobs report, there was a report that consumer credit had risen, painting a potential picture of how a recovery will gain traction. Of course, time will tell if that perception turns out to be correct, but I believe the market is pricing this in.
There was a good video on CNBC that discusses sectors (a bit) and the interest rate to look at (2-year US Treasury) as a signal that the market will break out from its recent sideways action.
Finally, I didn't mention it in class Thursday, since I want to see who reads the blog postings, but our exam will be on Tuesday, March 16. So, dig in, do the assignment, and study for the upcoming exam.
Most of the time, when an employment number is released, the stock market tends to bounce around, as bulls and bears battle throughout the day. Generally, this leads to a small daily change for the market that day. This was not the case on Friday, as the market shot higher and sustained its momentum throughout the trading day. The result was a large candle, a large real body, and almost no shadow (tails). Here is the chart for Friday (click to enlarge). Note that resistance in terms of the RSI(9) remains above 60, but it is now slightly overbought. So, will we make it to the next resistance at 1150 without a short-term pullback? Check next week's economic releases and see if there are any major releases that can materially affect the stock market.
I believe that the stock market sustained its earlier momentum as the day wore on because in addition to the jobs report, there was a report that consumer credit had risen, painting a potential picture of how a recovery will gain traction. Of course, time will tell if that perception turns out to be correct, but I believe the market is pricing this in.
There was a good video on CNBC that discusses sectors (a bit) and the interest rate to look at (2-year US Treasury) as a signal that the market will break out from its recent sideways action.
Finally, I didn't mention it in class Thursday, since I want to see who reads the blog postings, but our exam will be on Tuesday, March 16. So, dig in, do the assignment, and study for the upcoming exam.
Wednesday, February 24, 2010
Three Different Resistance Measures
The S&P 500 has stalled around its 50-day moving average, as was true the other day (see the previous post). Now that a few more days have passed since then, we saw a couple of spinning tops, which indicate indecision, then a large down day (yesterday) followed by a significant up day (today). Today's bullish candlestick was not as large as yesterday's bearish candle, and today the market opened from a higher level than yesterday's close. In OHLC charting, this is referred to as an inside day. Overall, I think it is safe to say that there is no definitive direction for future price change at this time. As I stated in class, at times like this, it is advisable to consult the economic calendar for the remainder of this week and next week, identify the "biggie" releases that will occur, then attempt to determine what each of these will do and how the market will react. Nobody can know this with certainty, so don't be intimidated. Actually, if you listen to the "talking heads" on the financial stations and keep track of what they predict, you'll probably be surprised by how inaccurate these persons are. So, don't be afraid to venture out and try this, you probably won't do any worse than the "talking heads."
Look at the following charts and analyze the most recent candlesticks and think about what they indicate about the battle between bulls and bears. Using these, I will now present three different ways to measure resistance.
#1: Fibonacci Retracement: If we apply a Fibonacci Retracement to the most recent high and low of the daily S&P 500 (see chart, click to enlarge), we see something quite interesting: the recent rally stalled at the 61.8% retracement point. The use of Fibonacci Retracement suggests that after a decline, the first possible point of resistance in a rally is when 38.2% of that rally has been erased (retraced). The next possible resistance point is at 50%, while the last occurs at 61.8% retracement.
#2: 50-day Moving Average: The next charts (click to enlarge) shows that the 50-day moving average acted as support for the S&P 500 since last fall, then became resistance in late January of this year. It is fairly common for prior support to become resistance (and vice versa). Note how the most recent rally failed just at the 50-day moving average. At this point, based on the most recent candlesticks, the direction of future price is still a toss up. A definitive move above the 50-day moving average, especially for a major market index, would be very bullish, and we might have a shot at returning to the previous high. If that were to occur, then the market falls below that level, what technical formation do we have? A double top, which is a reversal pattern. More about establishing a down target later this semester if this possibility occurs.
#3: RSI(9) < 60. In this same chart, look at the RSI in the upper portion. Note how the most recent high coincided with the RSI falling below 60 and remaining there. Just as the S&P is now testing its 50-day moving average, so too is it testing the RSI at 60.Often, an RSI value of 60 is used as resistance for a downtrend, while 40 is used to designate support for an uptrend.
So, what will happen from here? As I stated above, look at the economic calendar, identify the "biggie" numbers that can potentially move the market, and attempt to predict what each of these will do. In doing this, you are actually using economic theory, which states (for our purposes at this point):
Stock Prices = f(interest rates, expected future profit)
In analyzing the future releases, focus primarily on the macroeconomic implications for profit expectations, since Fed Chair Bernanke indicated again today that the fed funds rate will remain low "for the foreseeable future." That reassurance was a fundamental driver of today's rally which erased most of yesterday's losses.
Look at the following charts and analyze the most recent candlesticks and think about what they indicate about the battle between bulls and bears. Using these, I will now present three different ways to measure resistance.
#1: Fibonacci Retracement: If we apply a Fibonacci Retracement to the most recent high and low of the daily S&P 500 (see chart, click to enlarge), we see something quite interesting: the recent rally stalled at the 61.8% retracement point. The use of Fibonacci Retracement suggests that after a decline, the first possible point of resistance in a rally is when 38.2% of that rally has been erased (retraced). The next possible resistance point is at 50%, while the last occurs at 61.8% retracement. #2: 50-day Moving Average: The next charts (click to enlarge) shows that the 50-day moving average acted as support for the S&P 500 since last fall, then became resistance in late January of this year. It is fairly common for prior support to become resistance (and vice versa). Note how the most recent rally failed just at the 50-day moving average. At this point, based on the most recent candlesticks, the direction of future price is still a toss up. A definitive move above the 50-day moving average, especially for a major market index, would be very bullish, and we might have a shot at returning to the previous high. If that were to occur, then the market falls below that level, what technical formation do we have? A double top, which is a reversal pattern. More about establishing a down target later this semester if this possibility occurs.
So, what will happen from here? As I stated above, look at the economic calendar, identify the "biggie" numbers that can potentially move the market, and attempt to predict what each of these will do. In doing this, you are actually using economic theory, which states (for our purposes at this point):
Stock Prices = f(interest rates, expected future profit)
In analyzing the future releases, focus primarily on the macroeconomic implications for profit expectations, since Fed Chair Bernanke indicated again today that the fed funds rate will remain low "for the foreseeable future." That reassurance was a fundamental driver of today's rally which erased most of yesterday's losses.
Friday, February 19, 2010
Surprise Discount Rate Announcment
Yesterday, after the markets closed, the Fed announced that it was raising the discount rate by 25 bp. Here is a story about this. The initial reaction after hours was as expected -- the announcement took everyone by surprise. Before this morning's market open, futures pointed to a down day, although the amount kept shrinking. What all of this points to is uncertainty and indecision as market participants digested all of this and formulated their views of the likely consequences.
Which types of candlestick bars depict this? Forget a candle with a long real body and little in terms of shadows (i.e., tails). Look over the candlesticks I covered the other day in class. One would expect either a doji or a spinning top. What actually occurred for the S&P 500 was a spinning top. Here is a chart of the current data (click to enlarge) as of the Friday close.
The RSI is not yet overbought, so potentially there is room for further upward price movement. Note that the RSI is approximately 60, which is the value that some use to indicate resistance for a time of weak price movement. The most striking thing in this chart is the fact that the $SPX closed above its 50-day MA for the first time since January of this year. If the market were worried about the impact of the Fed raising the discount rate, would the S&P have closed above its 50-day MA today? No, it would not have. So, today's price action, in spite of signaling indecision in terms of a spinning top, does allow for the possibility that it the S&P will remain above its 50-day MA at least for the very near term. The real question is whether former resistance, in terms of the 50-day MA, will now become support.
How can we arrive at a way to answer this question? Using economic theory, we model stock prices. According to economic theory:
Stock Price = f(interest rates, expected profits)
Interest rates pertain to asset substitution possibilities in the short-term (review the stock and bond info in the Supply and Demand notes) and product demand in the medium term. Were yesterday's surprise discount rate announcement taken to indicate that Fed tightening was about to begin, not only would the market have failed to clear the 50-day MA today, there would likely have been a noticeable upper shadow (tail) as well. Also, there was a CPI data report today that signaled benign inflation, which signals that interest rates should not rise much. So, the primary factor to focus on is profit expectations. For extra credit, due at the beginning of class on Tuesday, plot the relative strength of the S&P 500 (a measure of stocks) compared to TLT, a measure of longer-term bond prices using as a chart type a solid line with weekly data. In a short word document, include the chart with annotations from StockCharts.com (not hand written) and a very short discussion of what the relative strength of stocks vs bonds is showing us about expectations for future economic activity (and therefore profits). Feel free to consult John Murphy's text about this.
When you get a chance, you should read two excellent columns on technical analysis by Michael Kahn in Barron's Online. I strongly suggest that you save these and others throughout this semester (and beyond). The first of these, written in early February, talks about the market correction. Follow his reading of candlestick charts and overall analysis. The second, from this past week, analyzes the question of whether the market will be fighting back and trend up.
Which types of candlestick bars depict this? Forget a candle with a long real body and little in terms of shadows (i.e., tails). Look over the candlesticks I covered the other day in class. One would expect either a doji or a spinning top. What actually occurred for the S&P 500 was a spinning top. Here is a chart of the current data (click to enlarge) as of the Friday close.
The RSI is not yet overbought, so potentially there is room for further upward price movement. Note that the RSI is approximately 60, which is the value that some use to indicate resistance for a time of weak price movement. The most striking thing in this chart is the fact that the $SPX closed above its 50-day MA for the first time since January of this year. If the market were worried about the impact of the Fed raising the discount rate, would the S&P have closed above its 50-day MA today? No, it would not have. So, today's price action, in spite of signaling indecision in terms of a spinning top, does allow for the possibility that it the S&P will remain above its 50-day MA at least for the very near term. The real question is whether former resistance, in terms of the 50-day MA, will now become support.How can we arrive at a way to answer this question? Using economic theory, we model stock prices. According to economic theory:
Stock Price = f(interest rates, expected profits)
Interest rates pertain to asset substitution possibilities in the short-term (review the stock and bond info in the Supply and Demand notes) and product demand in the medium term. Were yesterday's surprise discount rate announcement taken to indicate that Fed tightening was about to begin, not only would the market have failed to clear the 50-day MA today, there would likely have been a noticeable upper shadow (tail) as well. Also, there was a CPI data report today that signaled benign inflation, which signals that interest rates should not rise much. So, the primary factor to focus on is profit expectations. For extra credit, due at the beginning of class on Tuesday, plot the relative strength of the S&P 500 (a measure of stocks) compared to TLT, a measure of longer-term bond prices using as a chart type a solid line with weekly data. In a short word document, include the chart with annotations from StockCharts.com (not hand written) and a very short discussion of what the relative strength of stocks vs bonds is showing us about expectations for future economic activity (and therefore profits). Feel free to consult John Murphy's text about this.
When you get a chance, you should read two excellent columns on technical analysis by Michael Kahn in Barron's Online. I strongly suggest that you save these and others throughout this semester (and beyond). The first of these, written in early February, talks about the market correction. Follow his reading of candlestick charts and overall analysis. The second, from this past week, analyzes the question of whether the market will be fighting back and trend up.
Monday, February 8, 2010
January Employment Report
Friday's employment report was multifaceted, to say the least. First, there were the employment change results: -20,000 (a very small amount for the entire country, and not statistically significant). Then there were the employment revisions for 2009 -- very large, making the job loss during "The Great Recession" equal to 8.4 million. Finally, there was the unemployment rate, which fell from 10 percent to 9.7 percent. Recommendation: ALWAYS LOOK AT REVISIONS TO PRIOR PERIOD(S) BEFORE EXAMINING THE NEW DATA (as this establishes a proper context for you).
Much was written about these results. Here's what the WSJ said. Here is the link for a video from CNBC after the results were announced, and another link for the same group discussing things before the release. After reviewing all of these,make sure you understand: (1) that there are two separate surveys used for these results; (2) how can the unemployment rate actually fall if employment falls; and (3) what are the implications of the set of results for the stock market, bond market (interest rates), and the US dollar. As I have said numerous times already this semester, "other things" are seldom "equal." So, as a backdrop to all of this information from Europe, is the ongoing concern about the Sovereign debt of Spain, Ireland, and Portugal (these countries have now come to be referred to as the "PIG" countries). So, the final outcome of the day was the joint effect of the Sovereign debt problems and the US employment/unemployment rate data.
Much was written about these results. Here's what the WSJ said. Here is the link for a video from CNBC after the results were announced, and another link for the same group discussing things before the release. After reviewing all of these,make sure you understand: (1) that there are two separate surveys used for these results; (2) how can the unemployment rate actually fall if employment falls; and (3) what are the implications of the set of results for the stock market, bond market (interest rates), and the US dollar. As I have said numerous times already this semester, "other things" are seldom "equal." So, as a backdrop to all of this information from Europe, is the ongoing concern about the Sovereign debt of Spain, Ireland, and Portugal (these countries have now come to be referred to as the "PIG" countries). So, the final outcome of the day was the joint effect of the Sovereign debt problems and the US employment/unemployment rate data.
Monday, February 1, 2010
GDP Surprise
Friday's GDP report, the preliminary look at Q4 economic performance, was surprising. The consensus was for about a 4 percent gain, but the number came in at 5.7 percent. This was an excellent example of how "good news" impacts interest rates: good news tends to cause higher interest rates, as we discussed in class the other day. Here is the link for an article discussing this.
Initially the stock market and interest rates rose as the results were released. By the end of the day, however, things had changed. The chart (click to enlarge), which uses 60-minute OHLC bars, shows how the ten-year US Government bond reacted throughout Friday's trading. First thing to note, the actual interest rate is 1/10 of the value listed on the right scale. So, for example, 36 corresponds to 3.6, etc. Second, note how closing values exceeded opening values for the first two bars (hours). How could we figure that momentum might begin to shift? Look for upper tails, where the bulls were unable to support high levels, and by the end of the time period, bears had pushed values lower. After the second bar (hour), things turned around for the rest of the day, as close was below open each hour. By the last hour, there was essentially a "toss up," as open and close were almost identical.
Why did rates reverse on the "good news." Much of the overall GDP growth was the result of inventory effects (3.7% of the 5.7%), which will not persist in coming quarters.So, while this GDP number was a surprise and good news, interest rates, like asset markets in general, are forward looking. So the news in coming quarters might not necessarily be all that much better than what the markets had been anticipating prior to the GDP release. More data, primarily for this actual quarter, will be needed to move the direction of interest rates from where they were that day. Support, though, appears to be at 3.6 percent. Will this level hold? As the course progresses , I will show you how to use economic models to make an educated guess at questions like this.
Initially the stock market and interest rates rose as the results were released. By the end of the day, however, things had changed. The chart (click to enlarge), which uses 60-minute OHLC bars, shows how the ten-year US Government bond reacted throughout Friday's trading. First thing to note, the actual interest rate is 1/10 of the value listed on the right scale. So, for example, 36 corresponds to 3.6, etc. Second, note how closing values exceeded opening values for the first two bars (hours). How could we figure that momentum might begin to shift? Look for upper tails, where the bulls were unable to support high levels, and by the end of the time period, bears had pushed values lower. After the second bar (hour), things turned around for the rest of the day, as close was below open each hour. By the last hour, there was essentially a "toss up," as open and close were almost identical.
Why did rates reverse on the "good news." Much of the overall GDP growth was the result of inventory effects (3.7% of the 5.7%), which will not persist in coming quarters.So, while this GDP number was a surprise and good news, interest rates, like asset markets in general, are forward looking. So the news in coming quarters might not necessarily be all that much better than what the markets had been anticipating prior to the GDP release. More data, primarily for this actual quarter, will be needed to move the direction of interest rates from where they were that day. Support, though, appears to be at 3.6 percent. Will this level hold? As the course progresses , I will show you how to use economic models to make an educated guess at questions like this.
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