Friday's Tumble

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

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


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

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

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

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

Inflationary Expectations are Rising

Recently the Fed affirmed its worries about rising inflation. If you want to read a good article about this, click here. And today the Producer Price Index (PPI) report for March was released (click for article). How can we examine inflationary expectations without waiting until a CPI, PPI, or GDP deflator report is released? The answer is to examine the ratio of TIP prices (Treasury Inflation-Protected Securities) to nominal bond prices. I have found it useful to use the ratio of 20+ year bonds. In StockCharts.com, the symbols for these are TIP and TLT. So, to examine the ratio, use TIP:TLT. Also, switch to viewing this as a line graph and remove moving averages, etc. but keep the RSI (use 9 periods). The resulting chart is given below (click on the image to enlarge it).

A critical technical formation has appeared with this ratio: a double bottom. Recall from Stikki Stock Charts that a double bottom is a reversal pattern. This price ratio has failed to break below a support level twice, which often (BUT NOT ALWAYS) signals an upward move is forthcoming. According to technical analysis, it is possible to determine a likely upside price target assuming a reversal does occur. To do this, form a neckline connecting prior recent peaks (i.e., resistance). In the present example this is at 1.148. Subtract from this the value of the bottom, which is 1.121, which I will round to 1.12. Then add this difference to the neckline value to arrive at the price target:

TARGET Change = Neckline - Bottom
= 1.148 - 1.12 = 0.028
TARGET VALUE = Neckline + Target Change
= 1.148 + 0.028 = 1.176

So, should this double bottom play out as a reversal, we would expect to see the ration TIP:TLT rise to around 1.176. The graph contains this information with a horizontal line drawn at this value. Notice anything interesting? The price target move us almost exactly to a prior level of support from June of 2006!

How likely is it that we will actually reach 1.176? Note from the RSI that it is not yet overbought, so there is room to move up. It is not far from the overbought reading of 70, however, so there will likely be a short-term downward move before that target would actually be reached. I suggest that you consider a support for the upside rally of a value of 50 for the RSI. As long as the RSI(9) remains at or above 50, don't rule out the possibility of reaching the upside target.