Happy Days are Here Again!?

There have been several pieces of good economic news lately. Today, durable goods (remember these are a leading economic indicator) rose unexpectedly, and sales of new homes also increased. You can read about these (homes, durable goods).

In following the economy, it is always advisable to track not only growth rates (rates of change) but levels as well. And, remember from the first few lectures, there are different ways of measuring growth rates (sequential, like month-to-month, or year-over-year). The media doesn't make this easy for you, all of the releases lately have focused on rates of growth and included only graphs of growth rates and not levels.

How can you go beyond this? Let me recommend a terrific web site for this: Economy.com's Freelunch. Its URL is: http://economy.com/freelunch. To access the data (for free) you need to first create an account, then disable pop-up blockers for that site so the graphs with data can appear.

Let's first look at new home sales. On the main page, this is under Real Estate and Sales. You are given a number of choices on the page that emerges. Choose View for New One-Family Housing Sold. A pop-up window with data and a graph emerges. Note that on the graph, you can change the data frequency (ex: go from monthly to quarterly), and/or you can change from the level of this variable to various rates of change (then click on the Refresh Data link).

Below is a table of what the markets are celebrating today: a rise in (sequential) new home sales of almost 5%, as sales went from 322,000 to 337,000 (seasonally adjusted). Look over these data and determine for yourself how well home sales are doing (always feel free to agree or disagree with the market for a longer-term perspective).

2009M2	337
2009M1	322
2008M9	434
2008M8	448
2008M7	505
2008M6	499
2008M5	515
2008M4	542
2008M3	513
2008M2	572
2008M12	371
2008M11	387
2008M10	404

Now let's look at the graph (click to enlarge) from Freelunch of the entire set of values (current levels). Isn't the cause for today's celebration by the stock market in response to this number obvious? It isn't for me!

What is the market really reacting to today? Is this one month change a blip or the actual bottom? It is impossible to know this. Will data revision next month remove February's increase? Will we return to more declines in March?

Let me state a few rules of data analysis rules I have always lived by:

RULE #1: NEVER MAKE TOO MUCH OUT OF ONE PERIOD'S VALUE.

RULE #2: ALWAYS ATTEMPT TO FIT A GIVEN PERIOD'S VALUE INTO THE BROADER CONTEXT OF A TREND.

RULE #3: ALWAYS INCORPORATE ECONOMIC ANALYSIS INTO ANY ANALYSIS OF DATA TO TRANSCEND THE SHORT-TERM AND TO BEGIN THE PROCESS OF VISUALIZING WHERE AND HOW THE DATA WILL ACTUALLY BE MOVING IN THE FUTURE.

If the graph above were a price chart, what do you think the RSI would be telling us? Remember: just as positive rates of growth can become unsustainable, the same is true for negative growth rates (thank God!). We are clearly due for the equivalent of "oversold bounces" in much economic data. These should be able to sustain the current bear market bounce for a while. But for how long?

To arrive at an answer to this, the final thing I recommend that you do is to identify the sectors that performed best and make intermarket sense out of the pattern that emerges. Personally, I will have to wait to see what Jim Cramer says before I can reach any meaningful conclusions!

Q4 GDP Surprise?

On Friday, the second round estimate of Q4 2008 GDP was released. Originally, the real growth rate for Q4 was -3.8%. But, as I noted in class, that release only approximated inventories, exports, and imports.

The value for Friday's release was fairly close to my expectation. My prediction was for a downward revision to -5.5%, but I didn't rule out a drop of around 6%. That's what we got: -6.2%. The media tried to play this as a huge surprise, but many economists saw this coming. Markets gyrated throughout the day. The Dow-Jones average started the day down over 100 points, eventually moved into positive territory, then closed down 119. ALWAYS PAY ATTENTION TO THE WEEKLY CLOSE. The ten-year bond rate closed above 3 percent, which will likely remain in force as budget deficit projections continue to rise.

The major revisions contained in the revised GDP data were a worse-than-expected fall in exports and a sharp downward reduction in inventories. Read this article about the report. Actually, the fact that inventories are much smaller than first estimated is a very positive sign. Inventories are a leading economic indicator - their behavior today signals likely changes in economic activity 3 to 6 months in the future. So, with the new inventory estimate, businesses have far less inventory to work off in future months, meaning they have already begun to work through this problem (review the Quantity Adjustment Mechanism from Supply and Demand notes). Unfortunately, working down inventories will continue for much of this year, as national and global weakness persists.

On Friday, the Dow-Jones average closed near the low of the day, which moved us very close to the 7,000 level. Next Friday the February employment data will be released. That could move us below 7,000, but only if there were very big surprises (a nightmare decline in employment, and a sharp rise in the unemployment rate). I'm not sure we'll see that as the markets have already priced in very bad employment data, especially in light of Thursday's initial claims level.

Is the Bottom Here?

Yesterday (Thursday, 11/13) after class the markets tested their October lows. The response by the market was substantial -- SUPPORT HELD!! When the Dow-Jones Industrial Average (DJIA) broke below the 8,000 mark, a great deal of buying occurred (amazing how many persons are now technical analysts!!!), pushing the price up over 500 points for the day.

What we witnessed yesterday, was a technical formation -- a key reversal day, which technically speaking, is a reversal pattern. In the context of a downtrend (it's safe to call our situation that), here's what a key reversal day entails:
(1) the market opens below the prior day's close;
(2) prices that day go below the low for the previous day;
(3) that day's high is above the prior day's high; and
(4) the close for that day is higher than the high of the prior day.

The daily chart below shows this (click to enlarge). Importantly, the key reversal day occurred with very high volume (conviction by buyers).

The media took this as the bottom being here, attributing the turn to President Bush's speech. Sadly, both hypotheses are wrong. Although the turnaround occurred as President Bush was speaking, the substance of his speech had been known for several hours, so his speech was a correlation but not causation. Actually, what we saw was a "major league" oversold bounce which then brought about a great deal of short covering.

How can we try to decide if yesterday was "the" bottom? Look at the weekly chart, which is given below (click to enlarge). Note the triangle formation from late September to now. On a weekly basis, the rally yesterday (and all of this week's price action) has failed to challenge the upper resistance line. While the low of yesterday (also the low for the week) did entail a breakdown from the lower support line, as of the time I am writing this, the value of the DJIA snuck back above support. Also, volume is not particularly large this week.

How will the week close? ALWAYS pay attention to Friday's close (and the weekly bar). It is highly likely that this week will not be a key reversal week. That would require a weekly high above last week's high of around 9,500, etc. As a rule: WEEKLY SIGNALS ARE MORE SIGNIFICANT THAN DAILY SIGNALS. Obviously, monthly signals trump both weekly and daily signals as well. So, we need further data to confirm whether (and when) a weekly key reversal will occur.

How might we try to answer that question? Economic theory -- specifically intermediate macroeconomics. What a coincidence, that's the subject of our course! The reversal will require better-than-expected news on different parts of the global economy that imply the worst of the global recession is now able to be visualized. As stock markets are leading economic indicators, remember the stock market will turn up before the economy does. How much before the economy turns cannot be known in advance. Don't pay attention to specific values such as 6 months. Start with the key drivers of stock prices: interest rates and profit expectations, and forecast what they will likely do in the next 3-12 months. Here's a video that attempts to address the question. Remember to critique this and anything else in the media.

An Economic Indicator is Born

This past Friday, there was a great deal made of the fact that for the first time ever, the number of customers visiting Starbucks declined. This had a very negative effect on Starbucks' stock (SBUX) and, more interestingly, the entire stock market reacted negatively to this news. Why would Starbucks' stock drag down the entire stock market?

The answer to this lies in assessing the overall strength of the US economy. Starbucks coffee is more expensive than its primary competitors nationally, Dunkin Donuts and McDonalds (it recently made a dramatic upgrade in the quality of its coffee). And, coffee at Starbucks is more expensive than both of these competitors. Furthermore, an important input for retailers selling prepared coffee is milk (and cream), the price of which has risen sharply of late, hurting its profitability.

So, the interpretation of the Starbucks situation Friday was that: (1) it is yet another company being hurt by rising costs; and (2) the deterioration in discretionary income resulting from higher food and energy prices has now spread to Starbucks, signalling the broadening of overall demand weakness. Thus, a new economic indicator was born on Friday: STARBUCKS AS AN INDICATOR OF DISCRETIONARY SPENDING.

How accurate is Starbucks as an indicator of discretionary spending and hence as a leading economic indicator? Has it been a very good indicator for quite a while and we didn't realize this until last Friday? For extra credit (due at the beginning of class tomorrow, 11/19), graph Starbucks stock price (SBUX) as a line graph in the same graph as consumer discretionary stocks (XLY). To do this, below the main graph under Indicators select Price. Enter the symbol XLY . Under POSITION, select BEHIND PRICE. Then make this a line as well. Add any annotations you think will illustrate your beliefs about the relationship between these two variables. Those annotations will serve as your discussion. Copy this graph and paste it into a Word document and bring it to class Monday.

Here is the link for an article written about Friday's events. Read it and critique it (you should begin doing this routinely).

RSI as leading indicator

While macro courses always refer to a traditional set of variables as being the only leading economic indicators considered, one of which is the stock market, we recently saw a leading indicator of the stock market. The $INDU chart shows the recent daily behavior of the Dow-Jones Industrial Average. Notice that a declining RSI that was occurring as the DJIA attained a higher peak. This BEARISH DIVERGENCE is a leading indicator of future stock price declines.