November Employment Report

The November employment brought with it several surprises. First, and foremost, payroll employment fell by far less than just about anyone (including me) had predicted. While the consensus number was a decline of around 120,000, the actual number was a decline of just 11,000. In addition to this, decreases from the prior two months were revised to show less job loss. So, with the addition of Census workers early next year, it is very likely that we will see the employment change go positive -- either next month when the November data are revised or when we get January or February data.  Second, there was a nostalgic element to Friday's action in that the stock market actually rose along with the US dollar. When was the last time that happened? You should read about the employment report from MarketWatch.com and the Wall Street Journal.

The stock market liked the employment report very much. The Dow-Jones Average started out showing a gain of around 150, but as is so typical of employment release days, gave most of that back (this apparently works in both directions). At the end of the day, the Dow was up 23 points (for 0.2%). Interestingly, the NASDAQ was up by a greater percentage than the Dow, as its 21 point gain was almost 1 percent. Typically, when observing markets it is a good sign when the NASDAQ outperforms the Dow-Jones average. As this stock market "rally" was occurring, the bond market obviously hated what it saw, so a selloff resulted. As bond prices fell, the 10-year bond rate rose by a full 10 bp, a rather significant change. The US Dollar index rose by just over one point (1.07) to close at 75.8. So, enjoy this combination while you can -- a bullish report triggered stock market gains, a bond market sell off, a stronger US Dollar, and a drop in Gold price. That is the way things normally go, but haven't gone this semester as the result of the dollar carry trade.

Along with this favorable economic report, of course, comes all the myopic garbage that has come to characterize coverage by the financial media. Will the Fed now begin to raise rates very soon based on the new-found economic strength? Give me a break! Is the carry trade dead, based on Friday? Gee, we have one full day of that result, so it must be inevitable! I'll probably reserve judgment, though, until I hear from Jon and Kate, and check in with Tiger Woods. Here is the URL for an article with an intelligent discussion of the likelihood of Fed actions based on Friday's report.

The interesting question is how long the pattern of the inverse relationship between the dollar and US stock market has existed. It must seem to all of you that this has been around for a very long time, that this is the "norm." For extra credit due at the beginning of class on Tuesday, produce a chart using weekly data going back three years with the Dow-Jones average and the US Dollar index in the same chart, both as solid lines. Adding annotations, eliminating other elements of the graph like MA's, pinpoint when the current pattern began based on this chart.

So the question now becomes whether the dollar carry trade is dead or possibly dormant for a while. If this is conjecture turns out to be true, the US Dollar should begin to rally without threatening the positive momentum of the US stock market. We can use technical analysis along with economic theory to ascertain whether any short-term bottoming of the dollar is in the cards. Based on the RSI(9) from weekly data, there was a bullish divergence for $USD -- the RSI had been rising while the weekly $USD was recently falling. So, in the very short-term at least, some dollar strength is likely, especially since the RSI is nowhere near an overbought level. In fact, the weekly RSI(9) is at 40.5, which if you look back several months to April, is a resistance level for the RSI. If that resistance is broken, the dollar index could go to either 77 (its next resistance point  determined the usual way) or all the way to 80 based on a Fibbonnacci Retracement from March of 2009 until the most recent low. Stay tuned!

How Overextended is Gold?

I have been going over the market for gold ($GOLD) in class since last week. We have looked at daily and weekly data, viewed the RSI, and we have gone back to consider where the US Dollar ($USD) is, as the dollar and commodities are inversely related (other things being equal). What I want to do in this post is to show you another way to show whether something is overbought or oversold.

First, chart  $GOLD using daily data. Find a moving average that fits the time period under consideration very well. After a number of different values (starting from 20-day to higher periods), I found that the 150-day simple moving average fits gold very well, as the chart shows (click to enlarge).

To find a way to view how far the closing price is from this moving average, under "Indicators" below the graph, use the following information with StockCharts.com: MACD with values 1,150,1 (select MACD then enter the values I indicated).

That produces the graph below the Gold chart. You can annotate any (or all) of this set of charts. Here, apply a horizontal line to the peaks of the gap measure (the MACD values) to find where resistance has been before. It should be clear from the chart that recently, Gold price moved above its 150-day moving average by the greatest amount since either June of 2008 or September of this year. Note, also, this has occurred as Gold is very overbought based on the RSI (which is also showing a bearish divergence).So, you can see from this chart that there is yet another basis to conclude that some short-term pullback in Gold price is likely. Note, though, that markets can remain overbought for some time, so any pullback might not occur for a while yet.

Gold Breaks $1,000

Friday was a roller coaster day for the stock market. The Dow-Jones, down by over 200 points in the early afternoon, finished "only" down 100 points, as the Obama administration assured a nervous market that nationalization of banks was not imminent (apparently, many thought this weekend could have ended with a surprise not unlike we saw at the end of last year -- this time nationalization of both Citigroup and Bank of America). You can read about this.

While the stock market was gyrating, gold rose to over $1,000/ounce (click here for story). While that is not far from the record in nominal terms, it was very far from the all-time record in real terms (around $2,200 in 2008 dollars). The move to gold was a flight to safety, not unlike what we often see for bonds (review Supply and Demand notes). Globally, markets are unsure about how long and severe this recession will be. So, rotate from stocks to bonds (interest rates fell Friday) and gold. Part of what underlies this uncertainty can be seen all too vividly with the following graph:

Gains that accumulated over five years have been wiped out over the last year and a half! We have now broken below support from 2002. Look closely at the most recent two price bars and the information they contain.

Where do we go from here? The only good news in the chart is that the RSI is giving an extremely oversold reading (of around 10). So, based on the way markets usually work, we are due for an oversold bounce. But other things are not equal. So, when might the bounce occur?

This is where you need to add economics to model the Dow-Jones average. Recall, the two primary factors moving it are interest rates and profit expectations. Interest rates for now are not a concern, so focus primarily on profit expectations. Predicting them necessarily requires a forecast of credit availability and financial system workings (read this intriguing article). Because this is so uncertain at present, opinions change every day. As market participants continue to change their minds often, they move in and out of different assets and stock sectors, causing volatile stock prices (referred to as the repricing of risk).

Expect this to continue until markets see a predictable (not necessarily effective) direction for financial markets, housing prices, and overall economic activity. ALL THREE ARE ENDOGENOUS AND SIMULTANEOUSLY DETERMINED.

Sector Rotations and the 200-day Moving Average

Bloomberg's had an excellent interview with John Murphy, the author of this course's Intermarket Analysis text. Here is a link to the You Tube interview. You will probably need to play it a few times, but take notes and try to understand the role of gold (here's an article to help), how the 200-day moving average has significance in reading the market, especially for selecting stocks, and how to use sector performance data as a leading indicator for when the overall stock market will bottom.

Today's market behavior moved us closer to testing the Dow-Jones and S&P 500 average bottoms from November. Note that the media refers to closes as bottoms, while technically lows should be used. If reaction tomorrow to the President's plan to control foreclosures is tepid or just plain hostile, we should test the November lows. Study today's OHLC bar and where the RSI(9) is relative to giving an oversold reading. Then strap your seatbelts for tomorrow's market action.

Gold Rally?

I have heard an increasing number of "talking heads" in the media recommend investing in gold. You can track gold using $GOLD (it is end of day values, though) or invest in it through an Exchange Traded Fund, GLD. How can such recommendations in general be evaluated?

Many persons watching or listening to the "talking heads" of course just rush into recommended investments. After all, these people have been analyzing markets for years! But, as we have discussed in class, experience is a sufficient but not necessary condition for competency in a given field. Then there is consideration of the short term versus longer term. Technical analysis and economics can help with both of these. Although there are never any guarantees, just a higher probability of success based on systematic analysis, the benefit of this combination is that you can check to see where mistakes occurred after the fact and improve your economic analysis.

A further edge into this is provided by intermarket analysis. As we have already discussed in class, gold and the US Dollar tend to move in opposite directions, as gold and other commodities have prices stated in US Dollars. For extra credit, due at the beginning of class tomorrow (2/17), prepare a Word document were you paste a graph of $GOLD and the US Dollar Index in the same graph, converting each to line charts (from OHLC). Is the relationship between this pair that expected from intermatket analysis at present? Explain why or why not (write a few sentences to explain this), after reading about the recent behavior of each from sources on the Internet, etc. Then, in a separate graph (you can go back to OHLC), have both gold and the RSI(9) in the same chart and paste this into your document. What does the relationship betwen gold price and the RSI indiacate about any "legs" the short-term gold rally can be expected to have? Write a bried explanaton of your answer.

Finally, today Japan reported a quarterly (sequential) change in real GDP of over 3%! This translates into an annualized decline of around 13%. OUCH!! You can read about this. What did the Japanese Yen do in reaction to this? It actually rose, believe it or not! Clearly, this is yet another instance where "other things" are not equal.

As the semester progresses, think about how weakness in Japan will likely affect the global recovery (they are the #2 economy in the world), and how this might play into your forecast.