TIB Weekly Newsletter “The stock market pulse”

June 16th 2008 Edition

Weekly review of the markets

Last week

Last week, we were under the impression the market was very vulnerable. Dow was the only one showing us signs of a rebound with the formation of a “bullish” chart figure. Dow, representing only 30 titles, had a tall order indeed in order to bring S& P500 upwards. This one, comprised of 500 titles, formed a “bearish” triangle which seemed ready to turn downwards. Nasdaq was still contained in its “bullish” channel but seemed ready to break the tendency.

Monday, following a strong bearish day on Friday, could have given us a rebound day, especially since we had a few positive developments the day. Firstly, the oil price dropped by 3% following the declaration of a leader of OPEC to the effect that the current price of oil was not supported by fundamental conditions. Then, the “pending”, sales of houses had caused a strong surprise. The economists predicted a fall of 0.4% but 6.3% was the official number. It was disappointing and of bad omen that the markets, although volatile during the day, closed practically unchanged.

Tuesday, investors had to digest Mr. Bernanke comments. He reaffirmed its determination to fight any resurgence of inflation making increasingly clear the cycle of interest rate cuts was over. This means we can expect the market to react more intensely to the fluctuations of oil prices and raw materials and to inflation figures. On “the future” market, contracts of “Fed Funds” established a 87% probability of an interest rate increase by September. Despite it all, the day finallyended practically unchanged.

Wednesday the market reacted with a strong fall to the fluctuations of the oil price and raw materials, those posting a rise of 4% and 2.7% respectively. The oil price was up 42% since the beginning of the year and 107% in the last 12 months. Then, just when the market seemed to have stabilized, the announcement of the “Beige Book” gave another push downwards. The “Beige Book” is a collection of anecdotes in economic matter coming from the 12 districts of the “FED”. The document reaffirmed the inflationary reality in a context of low growth. The closed way down; Dow losing more than 200 points to find support around 12,000. Nasdaq clearly broke its bullish trend and the formation of a double top was now obvious.

Thursday at the opening, a wind of optimism came up after a nice surprise from the “retail sales” report which posted a rise of 1.2% whereas a rise of 0.7% was expected. On top of that a slight fall of the oil price helped the mood. At midday, Lehman Brothers announced the dismissal of their CEO, a news which pummeled its PPS. What could hide such an event? Which bad news will they announce next which they tried to hide until now? It was a tough day to interpret. S&P500 had given us a candle which looked like a star but its position opposite the preceding one removed its value. Same concept applied to the Dow. Perhaps Nasdaq was going to give the key of the day to come. This index having been the engine preventing the two others from falling, but its impact seemed to suddenly be vulnerable.

Friday, before the open, the CPI results came out stronger then anticipated at +0.6% vs +0.5%. Nevertheless, the jump of 0.6% was strongest in 6 months and the figure year over year of 4.2% could have been disconcerting. The confidence index of Michigan, at 56.7, was weaker than was expected. We could have expected a negative day but we chose to ignore the economic figures and focus on another fall of 1.90$ of the oil price. A strong push in the last half an hour gave us a strong finish. Such a push following poor economic news was a good sign for the upcoming week.

This Week

Last weeks’ trading confirmed our concerns but the surprising positive turn of event on Friday, announces a bullish start to the week. It will be interesting to see what Rhe PPI has in store for us... Judging from the market’s reaction to the CPI Friday we could be in for a surprise even if we already know the total index will be inflated by the price of energy. The next set of numbers that could have a significant impact are due Thursday i.e. the leading indicators and the “Philly FED” confidence index.

Technically, the S&P500 seems to have completed a head and shoulder formation. Friday’s reversal was mostlydone on a support level. We could now expect, the activity will be contained between the two horizontal levels of 1320 and 1400. Dow is in a similar situation. These two horizontal levels are 12,000 and 12,800. Nasdaq, should be contained between 2400 and 2550.

You can expect a roller coaster trading week so be patient and use good money management.

Good trading!
Eric LeRiche
www.trading-and-investing-for-beginners.com

Economic calendar
(Reports I consider will impact the market the most with definitions and expectations)

Tuesday

Producer Price Index
8:30 ET
Consensus 1.0%
Core 0.2%

Definition
The Producer Price Index (PPI) is a measure of the average price level for a fixed basket of capital and consumer goods received by producers.

Why Do Investors Care?

The PPI measures prices at the producer level before they are passed along to consumers. Since the producer price index measures prices of consumer goods and capital equipment, a portion of the inflation at the producer level gets passed through to the consumer price index (CPI). By tracking price pressures in the pipeline, investors can anticipate inflationary consequences in coming months.

While the CPI is the price index with the most impact in setting interest rates, the PPI provides significant information earlier in the production process. As a starting point, interest rates have an "inflation premium" and components for risk factors. A lender will want the money paid back from a loan to at least have the same purchasing power as when loaned. The interest rate at a minimum equals the inflation rate to maintain purchasing power and this generally is based on the CPI. Changes in inflation lead to changes in interest rates and, in turn, in equity prices.

The PPI comes in three versions: finished goods; intermediate supplies, materials & components; and crude materials that need further processing. The finished goods PPI is most often cited in the media. This index covers final products bought from producers by businesses to sell to consumers or to use for capital equipment.

The PPI is considered a precursor of both consumer price inflation and profits. If the prices paid to manufacturers increase, businesses are faced with either charging higher prices or they taking a cut in profits. The ability to pass along price increases depends on the strength and competitiveness of the marketplace.

Producer prices are more volatile than consumer prices. The CPI includes services components - which are more stable than goods - and the PPI does not. Wages are a bigger share of the costs at the retail level than at the producer level. Commodity prices react more quickly to supply and demand. Volatility is higher earlier in the production chain. Food and energy prices are major sources of volatility, hence, the greater focus on the "core PPI" which excludes these two components.

The bond market rallies when the PPI decreases or posts only small increases, but bond prices fall when the PPI posts larger-than-expected gains. The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.

Thursday

Leading Indicators
10:00 ET
Consensus 0.0%

Definition

A composite index of ten economic indicators that should lead overall economic activity. This indicator was initially compiled by the Commerce Department but is now compiled and produced by The Conference Board. It has been revised many times in the past 30 years - particularly when it has not done a good job of predicting turning points.

Why Do Investors Care?

Investors need to keep their fingers on the pulse of the economy because it dictates how various types of investments will perform. By tracking economic data such as the index of leading indicators, investors will know what the economic backdrop is for the various markets. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market prefers less rapid growth and is extremely sensitive to whether the economy is growing too quickly-and causing potential inflationary pressures.

The index of leading indicators is designed to predict turning points in the economy -- such as recessions and recoveries. More specifically, it was designed to lead the index of coincident indicators, also now published by The Conference Board. Investors like to see composite indexes because they tell an easy story, although they are not always as useful as they promise.

The majority of the components of the leading indicators have been reported earlier in the month so that the composite index doesn't necessarily reveal new information about the economy. Bond investors tend to be less interested in this index than equity investors. Also, the non-financial media tends to give this index more press than it deserves.

 

Philadelphia Fed Survey
10:00 ET
Consensus -10%

Definition

The general conditions index from this business outlook survey is a diffusion index of manufacturing conditions within the Philadelphia Federal Reserve district. This survey, widely followed as an indicator of manufacturing sector trends, is correlated with the ISM manufacturing index and the index of industrial production.

Why Do Investors Care?

Investors need to monitor the economy closely because it usually dictates how various types of investments will perform. By tracking economic data such as the Philly Fed survey, investors will know what the economic backdrop is for the various markets. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market prefers more moderate growth which won't lead to inflation.
The Philly Fed survey gives a detailed look at the manufacturing sector, how busy it is and where things are headed. Since manufacturing is a major sector of the economy, this report has a big influence on market behavior. Some of the Philly Fed sub-indexes also provide insight on commodity prices and other clues on inflation. The bond market is highly sensitive to this report because it is released early in the month and is available before other important indicators.

 

That’s it for the economic calendar this week.

Have a great week!

Yours truly,

Eric LeRiche

www.trading-and-investing-for-beginners.com

 

 

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