Timing with the Reports That Move the Markets

Chapter 5: Timing with the Reports That Move the Markets

Homing in on an example

Figure 5-1 shows the reliable and important relationship between the growth rate of the economy (Gross Domestic Product, GDP), the unemployment rate, retail sales, and consumer spending. As the economy becomes sluggish — indicated by the highs and lows registered in GDP — the unemployment rate begins to rise. Eventually, retail sales slow, as consumer spending rolls over.

Figure 5-1:

Comparing economic indicators.

Note that as the unem-

ployment rate rose, sales and spending began to falter.

Figure 5-2 shows the unique relationship between rising demand for oil and commodities in the global economy. Meanwhile, the downturn in the U.S.

housing sector, resulting from the subprime mortgage crisis, eventually led to a collapse in U.S. consumer confidence.

The economic data highlighted in Figures 5-1 and 5-2 painted a difficult picture for the Federal Reserve, which had to pick a fight — beat back inflation, as shown by rising consumer and producer prices, or address an economy on the brink of recession, as highlighted by the collapse in consumer confidence.

Figure 5-2:

Rising demand for commodities in

emerging economies led to higher producer prices, which eventually led to higher consumer prices and the collapse in consumer confidence.

73 Chapter 5: Timing with the Reports That Move the Markets

The Federal Reserve had to fashion a unique response to the change in economic activity that developed in 2007 and 2008, as the U.S. subprime mortgage crisis led to simultaneous inflation and a major decrease in economic activity. Economic factors moved like a set of dominoes tumbling: The mortgage crisis led to job losses and a subsequent decline in the number of people who could spend money. At the same time, the global economy — partially powered by emerging economies — slowed, but not to the same degree as the U.S. economy, at least not by the time I wrote this book.

The Federal Reserve chose to aim its bullets at the U.S. economy and to worry about inflation later. The central bank began to lower interest rates aggressively and to implement several other significant methods aimed at keeping the economy from a significant contraction. Among the unusual steps taken by the Fed were to engineer a buyout of Wall Street investment bank Bear Stearns by J.P. Morgan, as well as to provide discount-rate lending to investment banks, a privilege previously reserved for consumer banks.

The discount rate is the interest rate charged by the Fed to banks. It is con- sidered a rate of last resort and is used by banks that have no other place to borrow.

On September 7, 2008, fearing a total global market collapse, the U.S.

Treasury stepped in and placed Freddie Mac and Fannie Mae under receiver- ship, essentially taking a controlling interest in both institutions, in hopes that this would provide a floor under the subprime mortgage crisis.

Keeping tabs on the data mill

Several government agencies and private companies monitor the economy and produce monthly or quarterly reports. These reports provide traders with a major portion of the road map they need for determining which way the general-direction prices in their respective markets are headed.

Trading, and specifically timing, is highly influenced by these government and private-agency reports and how the markets respond to them.

Businesses are just pawns of the Fed and the markets, and their reaction to these changes in trend usually takes some time be noticed.

The overall focus of the markets is one thing: what the Federal Reserve is going to do in response to the report(s) of the day — lower or raise interest rates or produce new methods for dealing with whatever is ongoing. That combination of factors — the market’s reaction to data and whatever the Fed does, or is expected to do at some point in the future — changes or maintains market trends. The essence of timing is trading along with the prevalent trend.

As a market timer you need to understand how each of these important reports can make your particular markets move and how to prepare yourself for the possibilities of making money based on the relationship between all of the individual components of the market and economic equation. I tell you more in the upcoming sections.

Getting a Handle on the Reports

Economic reports are important tools in all markets, but they’re a big influence on market timers, because they can affect the general trend of the markets. Each market has its own set of reports to which traders pay special attention. Some key reports are among the prime catalysts for fluctuations in the prices of all markets and especially the bond, stock, and currency markets, which form the center of the trading universe and are linked to one another. Traders wait patiently for their release and act with lightning speed as the data hit the wires.

Some reports are more important during certain market cycles than they are in others, and you have no way of predicting which of them will be the report of the month, the quarter, or the year, but you can usually count on the following being important and highly scrutinized:

✓ Gross domestic product

✓ Consumer price index

✓ Producer price index

✓ Monthly employment reports

✓ The Fed’s Beige Book, which summarizes the economic activity as surveyed by the Fed’s regional banks

The Institute for Supply Management (ISM) report, formerly the national purchasing manager’s report, is produced by the Institute for Supply Management and also is important. So is the Chicago purchasing manager’s report, which usually is released one or two days prior to the ISM report.

Many traders believe that the Chicago report is a good prelude to the national ISM report, and the day of its release can often lead to big market moves, both up and down.

Consumer confidence numbers from the University of Michigan and the Conference Board usually are market movers. Bond, stock, and currency traders pay special attention to them, because they can be very influential on the decisions made by the Federal Reserve with regard to interest rates.

75 Chapter 5: Timing with the Reports That Move the Markets

Weekly employment claims data that come in far above or below expectations can move the market. Retail sales numbers also can move the markets, especially when they come from major retailers, such as Wal-Mart, or when several retailers report good or bad numbers on the same day. So can the budget deficit or surplus numbers. Consumer credit data can sometimes move the market as well, but that is fairly rare.

Cable news outlets, major financial Web sites, and business radio networks broadcast every major report as it is released, and the wire services send out alerts regarding the reports to all major financial publishers not already cov- ering the releases. The government agencies and companies that are respon- sible for the reports also post them on their respective Web sites immediately at the announced time.

Economic reports find their way into political speeches in the House of Representatives and on the Senate floor. The president and his advisors, other politicians, bureaucrats, and spin-doctors quote data from these reports widely and often, using them to suit their current purposes.

As a timer you can best use economic reports as

✓ Sources of new information: When you combine the data in the reports with the market’s reaction to that data, you end up with your best guide as to whether you open new positions, keep your current ones, or make changes in your portfolio.

✓ Risk-management tools: You can make costly mistakes if you ignore the market’s reaction to the data. Each report has the potential to move the market — in your favor or against.

✓ Further influences on the markets: The headlines are only part of the story, mere clues about the meat of the report. Data hidden deep within a report can often become more important than the initial knee-jerk reaction to the headlines and cause the market to change direction.

✓ Trendsetters: Current reports may not always be what matters. The trend of the data from reports during the past few months, quarters, or years — in addition to expectations for the future — also can be power- ful information that moves the markets up or down.

Trading solely on economic reports can be very risky and requires experience and thorough planning on your part. Make the reports part of your strategy, not the center of your strategy. It’s still all about how the market responds to the reports and how the reports affect the overall trend of the market.

Exploring Specific Economic Reports

Some reports are more important than others, but at some point, they all have the potential to influence the market. In this section, I give you the tools to interpret the reports and to use them in your timing.

Using the employment report

By far, the most important report over the past several years has been the employment report. It is the first piece of major economic data released in the cycle — on the first Friday of every month — and is formally known as the Employment Situation Report. Bond, stock index, and currency futures traders are often on the edge of their seats as they wait for the release of the number at 8:30 a.m. eastern time.

The release of the employment data usually is followed by very active, often frenzied trading that can last from a few minutes to an entire day. Much of the action that follows this important number depends on what the data shows and what the markets were expecting. The report has become so important that it can set the overall trading trend for the financial markets for several days or even weeks after the release — especially if other reports confirm the status of the economy the employment report shows.

When consecutive employment reports show that a trend is in motion, the markets tend to follow that trend and act accordingly with regard to price action. When the trends in the employment report change, the markets also tend to change. Figure 5-3 shows that the stock market, as measured by the S&P 500, can take a good deal of bad news and keep moving higher. But, by 2007, too many negatives were in the mix, and when the unemployment rate began to consistently trend higher, the index began to falter.

The employment report is most important when the economy is shifting gears, similar to the way it did after the events of September 11, 2001, during the 2004 presidential election, and as the effects of the subprime mortgage crisis began to spread through the economy.

For timing purposes, the major components of the employment report are ✓ The number of new jobs created: This figure tends to predict the trend

of the economy. Large numbers of people working and rising numbers of new jobs usually are positive for the economy. A declining number of new jobs usually indicates that the economy is slowing.

77 Chapter 5: Timing with the Reports That Move the Markets

Generally, weakness in the employment report is a prelude to lower interest rates from the Federal Reserve, while a very rapid rate of growth in employment can be a signal that growth in the economy is overheating. The Federal Reserve sees too-rapid growth in employment as a potential prelude to rising wage pressures, inflation, and the need for higher interest rates.

✓ The unemployment rate: The month-to-month rate of unemployment is not always as important as the trend in the rate. The Federal Reserve gets concerned when the rate climbs or falls for several months and is accompanied by other signs of the economy rising or falling. For example, in September 2008, the unemployment rate rose above 6 percent, the highest level in many years, and it had risen above 5 percent in the previous month.

Two back-to-back months of rising unemployment is a signal that the economy is increasingly weak and that the Federal Reserve may have to consider lowering interest rates.

If the employment report delivers a number that would generally be seen as bullish (good job creation, stable unemployment rate) and the market sells off, look to your open positions and see whether they hold above their support levels, such as your 20- and 50-day moving averages.

Figure 5-3:

The S&P 500 from 2006–

2008. As the unemploy-

ment rate began to climb in late 2007, the S&P 500 began to falter.

Chart courtesy of AskResearch.com.

Taking in the Consumer Price Index (CPI)

The CPI is the most important inflation report for the financial markets. Rising consumer prices usually lead to falling bond prices, rising interest rates, and increased market volatility, as fear of rising interest rates from the Federal Reserve take hold. This report is important because consumer buying drives the U.S. economy. Price changes at the consumer level change consumer behavior, and thus eventually affect the economy, as well as corporate earnings.

Here is some important information about the consumer price index and inflation:

✓ Consumer price inflation is most dependent on the ability of retailers to pass on rising prices. Increasing competition from discounters makes it much more difficult for traditional retailers to pass on their rising costs.

✓ Supply is often more important than demand, especially with trendy items like clothing or electronic equipment. A lot depends on what’s hot at the moment. For example, if a retailer orders bellbottom pants in hopes that bellbottoms will be the back-to-school trend and the kids don’t buy them, the discounting begins. Supply rises and prices fall.

✓ Inflation doesn’t result from higher prices. Inflationary trends develop when too much money chases too few goods.

✓ Inflationary expectations and consumer prices go hand in hand with one another because inflationary expectations are built into the cost of bor- rowing money.

✓ Rising consumer prices develop late in the inflationary cycle and can be a sign of rapidly rising inflation in the financial system.

The real return on any investment is the percentage of the profit that you gain after subtracting inflation. If you make 10 percent but inflation is running at a 5 percent clip, your real gain is 5 percent.

Watch for reaction to CPI numbers in more than one market as interest rate, currency, and stock traders react and you can see moves in the bond, stock, and currency markets. If the report shows a significant amount of inflation, it could also move gold prices higher.

Perusing the Producer Price Index (PPI)

The PPI is not a critically important piece of data and usually doesn’t cause market moves as big as those wrought by the CPI and the employment report.

79 Chapter 5: Timing with the Reports That Move the Markets

The PPI measures prices at the producer level; it measures the cost of raw materials to companies that produce goods. The market looks for two things in this report:

✓ The speed with which prices are moving up or down: If PPI registers a sudden rise in prices, the market wants to know where it’s coming from.

For example, the February 2008 PPI report stated

The Producer Price Index for Finished Goods rose 0.3 percent in February, seasonally adjusted. . . . This increase followed a 1.0 per- cent advance in January and a 0.3 percent decline in December. At the earlier stages of processing, prices received by manufacturers of intermediate goods moved up 0.8 percent in February subsequent to a 1.4 percent advance in January, and the crude goods index rose 3.7 percent after climbing 2.5 percent in the prior month.

This report clearly suggested that inflation was well entrenched in the system, and that it had been so for several months. Refer to Figure 5-3 to note the overall poor performance of the stock market during the month of March when the report was released.

✓ Whether inflation is being passed on to consumers: The same report noted that the indexes for finished goods were mixed, with energy finished goods rising, but food finished goods falling, while other finished goods were on the rise. The overall tone, though, was that producers were starting to pass on costs to consumers, another sign that inflation was working its way into the economy at a steady pace.

Making sense of the ISM and purchasing managers’ reports

The Institute for Supply Management’s (ISM) Report on Business is quite important and is usually a market mover. The report is an excellent measure of how well the manufacturing sector in the United States is functioning. The data is compiled from surveys of purchasing managers across the United States and is summarized by the ISM. Find it at www.ism.ws.

The national report, known as the Report on Business, is different from the regional purchasing manager’s reports, although the market pays attention to a few of the regional reports, such as the Chicago-area report, because they can serve as good predictors of the national data. However, the regional reports aren’t used as a basis for the national report.

The ISM report has 11 categories. The most important market moving number, though, is the PMI index. Here’s how to look at the ISM report:

✓ A number above 50 on the PMI means that the economy is growing. You want to know whether the main index and the subsectors are above or below 50.

✓ Watch the rate of movement of the index and the subindexes, up or down. The faster the ongoing trend is moving, the more likely that it will have an effect on the markets.

The March 2008 report noted a Purchasing Manager’s Index of 48.6 percent, a sign of mild economic slowing, noting:

This completes the weakest quarterly performance for the U.S. economy since Q2 of 2003. Manufacturers’ order backlogs continue to erode as the New Orders Index failed to grow for the fourth consecutive month.

Additionally, manufacturers continue to experience heavy cost pressures, as the prices they pay are still rising even with slower overall demand. Some manufacturers are still benefiting from strong export demand and continue to see growth in export orders.

The bond market remained stable. The dollar weakened. And stocks

remained range bound, after suffering heavy losses in the preceding months.

(Refer to Figure 5-3.)

Considering consumer confidence

Consumers play a central role in the U.S. economy, and so consumer confidence data is a good metric to keep your eye on. It comes from two credible sources that publish separate reports, the Conference Board, a private research group, and the University of Michigan.

The Conference Board Survey

The Conference Board, Inc., interviews 5,000 consumers per month in order to produce its monthly survey.

The three most widely watched components of The Conference Board survey are:

✓ The monthly index

✓ Current conditions

✓ Consumers’ outlook for the next six months

In March 2008, The Conference Board’s survey fell 12 points, a collapse that led to some market volatility. The report noted the following:

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