February 2011 Employment Report

The much anticipated employment report for February was released this morning. The expectation was for an increase of about 200,000 jobs, while anticipated changes in the unemployment rate varied over a wide range. Here is a summary of the report, and a link to the CNBC video discussing it.

Today's market action illustrated an important concept  -- the whisper number. While there are official expectations (the market consensus), often the market has already priced this expectation in prior to the data release. The result: the market rises in anticipation of the number, but sells off when the expected number occurs. This is the basis of the old saying: "Buy on the rumor, sell on the news." Markets often do this. I prefer a re-wording of this: "Buy on the mystery, sell on the history." The whisper number is an unofficial number, representing what market participants actually want to occur for the market to move higher. Going into today, the expectation was +200,000 jobs, but the whisper number was much higher: +280,000 - +300,000. Since today's number was well below the whisper, hitting the consensus value was anticlimactic, so the market sold off. Note, however, that prior month values were revised higher as well, so this month's number was actually better than the 192,000 reported.

An hourly chart of the Dow-Jones Average helps to show this (click to enlarge). Note how the first four hourly candlesticks were bearish -- solid real bodies, indicating that the close for each hour was below the open. The fifth hour candle was a doji, touching the prior low. Recall that a doji indicates a "toss up" in terms of momentum. That candle actually marked a turning point, as the final two candles were bullish, with the first of these constituting a bullish engulfing pattern of the doji. The final candle of the day has a wider range and a large real body.

Throughout all of this, the Dow Jones remained in the uptrend that began late February (see dashed line). While today's price action erased much of yesterday's large gains, some of those gains remained.

Not all of today's Dow Jones action was related to the employment report, of course. There was a vary favorable factory orders number (+3.1%), the most rapid rise in years. Adding a seemingly more rapid trend in employment and the improving factory orders, oil prices rose sharply. The price per barrel of oil (West Texas Crude) closed the day at $104.91, an increase of almost 3 percent compared to yesterday.

So, while the talking heads appear all too willing to believe that the market won't be able to rise with oil above $100/barrel, the fact that the uptrend in the Dow Jones remains in tact, would appear to contradict them. What will it take for oil prices to rise dramatically? As I stated in class a while ago, dramatic reductions in either oil production or shipping in the middle east. This could happen. For now, the markets have not priced that risk in yet.

NASDAQ Support at the 50-Day Moving Average

The market has now been in correction mode for a few days now. Focusing on the NASDAQ, as of last Friday, the RSI was in overbought territory and a Doji appeared. Since then, the NASDAQ has been lower. But it is important to see that sometimes a "psychological level" can provide either support or resistance. In the present case, the 50-day moving average has become support for this NASDAQ's pullback, as the chart shows (click to enlarge).

Note how changes occurred right at the (rising) 50-day moving average. While the RSI remains below 50, the traditional value above which a bullish trend is viewed to be in place, it does still remain above 40 -- a level that can be viewed as support during an uptrend.

Does the uptrend remain in tact? Remember that an uptrend means higher highs and higher lows. At the present time, the recent lows remain above the low from the end of January, so the uptrend is still in force. Also, note the increase in the RSI over the past few days. This too provides some reason for optimism.

The fate of oil production and shipping in the Middle East will ultimately determine whether the present support level holds. However, the February employment number will be released on Friday morning (8:30am). This will be pivotal. A very bad number then absent weather influences, will very likely cause support to be broken -- for now.

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.

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.

Big Drop in the Dow-Jones

This past week saw notable movements in the Dow-Jones Industrial Average ($INDU). We discussed much of this in class (thru Thursday anyway). Friday was not a good day. The DJIA closed down 120 additional points, ending at just over 12,100.

The DJIA has been in an uptrend for many months now (since August 2006), so some sort of correction was called for. Typically, these corrections range between 5 and 10 percent declines. The time frame is variable -- there is not a "typical" correction period. IF, however, a correction ultimately involves a 20% decline, the market is deemed to have changed to a "bear market."

After a week like the one we just went through, I recommend using weekly charts to view trends, etc. The chart shows $INDU weekly (click to enlarge it).

One thing to note: just as there is support for price in a main chart, you can use levels of the RSI to denote whether a trend remains in force. As you can see in the diagram, the uptrend remained in tact as long as the RSI (based on 9 periods) stayed at or above 50 (the demarcation point). Since July of 2006, until this past week, that condition was met.

Look at the large weekly bar, which closed near the low for the week. Not good!! Further note that this large drop occurred on large volume. Also not good!!

There is something that is visible on a weekly chart of $INDU that is not apparent from daily data: a bearish divergence. While $INDU was making higher highs since October of 2006, these were not confirmed by the RSI moving continually higher. Thus the bearish divergence.

Support appears to be around 12,000 (look at the chart). If we fall below this, things will get very interesting. How likely is it that we will move below 12,000? Fairly likely, since even after the horrible week, the RSI is not yet in oversold territory. Ugh! Stay tuned, let's see how this week plays out.

In situations like this, you should look to see if any major (i.e., potentially market moving) economic data will be released this week. The answer is yes -- the labor market numbers for January will be released this Friday. What kind of employment report would lead to further price declines? Increases? Also, don't forget about the bond market.