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.

Fed Decision?

As expected, at 2:15 today the Federal Reserve made its decision not to raise rates (thank God!), and released its short statement summarizing its assessment of the economy now and in the future. Here is a copy of the actual Fed statement. And, as I indicated to you in class, the media provided an anal and microscopic evaluation of this statement compared to the previous one (click here).

How did the stock market react? Below is an image of the S&P 500 using 15-minute intervals (click to enlarge). Look this over, as a number of the key elements for reading market momentum show up. First, note when the announcement occurred at 2:15. The initial reaction was very positive (large up bar). But, that wasn't sustainable, as the RSI(9) showed an overbought reading (above 70). The next 15 minutes, we see a classic illustration of what happens when momentum diminishes -- a bar with a significant upper tail. This indicates that the bulls were able to push price fairly high, but the bears ultimately beat them back. For that bar, note the close (of the 15 minutes) was almost identical to the open. In the next bar, the open was above the prior bar's close, but things got bad for the bulls as the bears were clearly in control at this point. Take a look at the last bar of the trading day - a large range, the bears were clearly in control by then, and the close was almost at the low for that 15-minute period.


The day ended with an ugly price bar, but a glimmer of hope for tomorrow -- the RSI was giving an oversold reading (was below 30). If price should continue to fall, how low can we expect it to fall? Let me restate this: where is the next level of support? To find this, use the rule from class: look to the left. In other words, extend the time period of the chart. In the second graph (click to enlarge), I have extended to 5 days. From this, we are able to see the next level of support at around 1058.

Let's see what happens tomorrow.

Worst Week Ever?

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 Gone (for now at least) is their truly outdated advice to "buy and hold," "dollar cost average," and based on forward price-earnings ratios, conclude that the market is very "cheap."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

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

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

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

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

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

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

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

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