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This is the third in a six-part educational series for Trader Kingdom readers.
- Trading Bull Traps in E-minis
- 100 Year Review of the Dow Jones Stock Market Rescue Operations and Secular Bear Market Rallies: A Step Back in Time
- Assessing Market Expectations and Anticipating Market Behavior
- Key Reversal Signals to look for in E-mini's and Treasuries
- Trading Steidlmayer's False Auctions and Candlestick Tails
- Behavioral Finance Modeling in E-mini's and Treasuries
This is a precursor to part six, Behavioral Finance Modeling in E-minis and Treasuries. In my own experience, I have found it extremely helpful to be keenly aware of the monthly economic calendar. The economic calendar repeats itself every month, and as traders and investors managing risk, we are most interested in frequently recurring events that we can both assess and anticipate. The economic calendar is fairly well set in stone each month, so traders and investors can readily use the monthly economic calendar as a forward-looking tool useful for scenario planning and trade setups.
Frequently recurring events can be correlated or non-correlated. For risk management purposes, it is extremely important to note that frequently recurring events are often times not correlated, but they always shape market expectations. Market expectations are not static, they are dynamic and need to be assessed if we are to understand market sentiment and behavior. Specifically, because markets are primarily discounting mechanisms, we are most interested in assessing shifting market expectations surrounding the monthly economic calendar. As market expectations shift, so does market behavior and risk, and therein begins the long road to finding frequently recurring low risk trade setups that we .
Tools you will need for this study:
- At least one monthly economic calendar service
- An economic service that provides economists consensus expectations for the week ahead
I use two monthly economic calendar services, Bloomberg and Moody’s Economy.com. Both have monthly and weekly economic calendars. Bloomberg reports on treasury auctions, while Moody’s does not. Moody’s economic calendar also reports on economist expectations, whereas Bloomberg’s does not. In fact, Moody’s has a two week “Market Movers” calendar featuring economist expectations for the next two weeks. It is extremely beneficial to be as forward-looking as possible, and always looking into the following weeks economic events. Far too many traders and investors only focus on this week’s economic data. That is a mistake, because the market is a forward-looking mechanism. As such, a market buoyed by bullish economic data one week might be buffeted bearish economic data the next. Conversely, the market will sometimes look past bearish economic data one week to what it believes will be bullish data the next.
Another perk Moody’s Economy.com offers traders and investors is a wealth the data-mining. They provide a summary of every economic report going back ten years, providing traders and investors with powerful analytical tools (we will employ some of those tools in this report).
Both Bloomberg and Moody’s list key economic addresses from Fed and Treasury officials. Bloomberg tells you the audience the officials are addressing and what the topic is, whereas Moody’s does not. By using to economic calendar services, you are able to see and understand more using two calendars, sort of like two heads are better than one. This is why I recommend using two calendars.
Beyond publishing economic calendars, both Moody’s and Bloomberg publish articles that preview the market expectations of the week ahead for traders and investors. Here, I prefer to use Bloomberg’s preview as it is far more widely followed. Remember, if we want to assess market expectations, it is the more widely followed service which will shape market expectations and behavior the most.
Each Sunday, Bloomberg publishes an article that features a preview of the economic data for the week ahead largely based on economists’ consensus expectations. This preview is published on Sundays and this Bloomberg report generally sets the tone regarding market expectations in the coming week. What follows is a preview of the week ahead as reported by Bloomberg.
This particular upcoming week, economists expect all the economic data to come in above average. The headline says it all: Sales, Housing, Output in U.S. Probably Rose, Signaling Sustained Rebound. Whenever you see a rose-colored weekly preview like this, traders and investors need to intuitively recognize that the report may not be balanced, and that the report may contain downside risks with respect to market expectations. This particular report from Bloomberg, however, is well-balanced. While it is tempting to put on the contrarian hat, we don’t want to look for downside risks where there may be none. Remember, the trend is your friend, and a rose-colored preview may be just that, a tip that the economic reports that week will be friendly. And since we want to trade with the trend, our job is just to make sure the rose-colored preview has merit and is credible.
Remember, most economists are employed by sell-side houses. They have a vested interest in creating positive spin and outputting sanguine forecasts. Economists’ forecasts generally lag the downturns in the economy and so oftentimes disappoint the market. Conversely, because of their optimistic bias, they sometimes lead the economic data in recoveries. That is, their optimism gets ahead of the economic recovery and this too disappoints market expectations. Disappointments lead to weakness in the equity markets. While equity markets can generally recovery quickly from disappointments in bull markets, this is not always the case in bear markets.
Collectively, economists often get their forecasts right, but all too often wind up getting it wrong. Our job as mkt participants is always to figure out when the actual economic data will likely disappoint or upside surprise consensus expectations. With a little effort, sometimes anecdotal nuances can be vetted that will indicate economist expectations may be a bit suspect.
This coming week Bloomberg’s weekly preview focuses on Monday’s retail sales and NY Empire Survey, Tuesday’s Industrial Production on Tuesday, Wednesday’s Housing Starts, and Thursday’s Philly Fed report. They do not consider Bernanke speaking on Monday, Lacker on Tuesday. Nor does Bloomberg’s weekly preview consider Producer Prices on Tuesday or jobless claims and Philly Fed on Thursday. Still, the Bloomberg article does focus on the most salient reports that will effect behavior in the equity markets and correctly filters out reports of less import.
Economists expect headline retail sales to be up 0.9% due to a month over month increase in vehicle sales and core retail sales to be up 0.4%. Yes, vehicle sales were up month over month in October, so the headline might be right, but will the core have improved to 0.4% if consumers became more pessimistic than ever? Anecdotally, I wonder about consumers’ ability to spend more in October in core sales if they felt worse than ever. From Moody’s Economy.com on October’s decline in consumer confidence:
The Conference Board index of consumer confidence dropped more than expected in October, showing that consumers remain deeply pessimistic about the economy. The expectations component led the decline, [and] present conditions component hit a new cyclical low in the month [which] suggests consumers remain unconvinced the recession has ended. Consumer expectations for stock prices deteriorated while nearly half of consumers expect interest rates to rise over the next year…Confidence is pretty clearly not rising.
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Still, the Bloomberg preview did do some nice channel checking with retailers this week. They note that October y-o-y sales climbed at TJ Maxx, Marshalls, Saks, and Nordstrom. But then, I will remind you October 2008 was the height of the financial and auto crisis, which caused month over month retail sales to be the worst on record.
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So, what Bloomberg leaves unanswered is whether sales increased month over month in Oct 2009, which is what the retail sales index is gauging and not y-o-y. The other report on Monday comes from the Nov NY Empire mfg survey. Consensus expectations estimate the NY Empire mfg survey will clock in at 32 vs 34.6 in the Oct survey.
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The Oct NY mfg survey was a big upside surprise. The employment index jumped in October as “25% of respondents reported hiring in October, [and] manufacturers grew more optimistic about the [six month outlook] than any time since Oct 2004. Moody’s concurred, and sees the mfg sector as able to sustain its recovery into early next year. Even though this survey can be volatile, this did manage to sustain and accelerate the gains it kicked out during the manufacturing recovery of 2003 until peaking in Feb 2004. This leads me to believe this survey will be on an upward trajectory into Q1 10 as well.
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Industrial Production enjoyed three consecutive month over month gains in Q3 2009. It’s 1.2% gain in August 2009 set the peak production rate for all of 2009. Peak production occurred during the cash-for-clunkers program. Month over month production gains in September was 0.7% for IP. But as we move further away from peak production spurred on by the gov’t CFC program, will the Oct IP be able to gain another 0.4% in October?
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During the mfg recovery of 2003, we find that the month over month change in IP was fairly volatile, but did remain in positive territory until March and June 2004. This anecdotally suggests that Industrial Production should be able to sustain month over month growth rates into Q1 2010.
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On Wednesday, economists expect housing starts to inch up from 590,000 in September to 600,000 in October. Moody’s notes that both permitting and completions were weakening in September, and housing starts have never been above 600,000 all year, peaking at 593,000 starts in July. So, why would housing starts accelerate in October when it has been flatlining around 590,000 since June? And Moody’s cautioned against any optimism with respect to last months housing starts data, noting that “a large pipeline of foreclosures will come on the market towards the end of this year.” This could weaken demand yet again for new homes. Other reason’s to caution against an acceleration of housing starts in October was that in October the index for expected six months' sales of single-family homes came in at 27, down from 29 in September. And, the index for prospective buyers' traffic came in at 14, down from 17 in September.
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The final consideration for this week is going to come from the Philly Fed index on Thursday. That mfg survey peaked at 14.1 in Sept, and fell to 11.5 in October. Bloomberg reports that economists expect this survey accelerated in November. Moody’s consensus expectations believe the survey will accelerate to 12.3. Perhaps, accelerate is the wrong choice of words here, but capex plans did improve in October, which is a “positive for investment heading into 2010.”
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Even with the positive capex in the Oct Philly Fed survey, Moody’s suggested there is an “interesting disconnect” between the Philly Fed and NY Empire surveys. While not uncommon, the first two regional manufacturing surveys for October are sending mixed messages about the strength of the recovery. The modest decline in the Philadelphia Fed survey is in sharp contrast to its New York counterpart. The New York Fed manufacturing survey soared in October to a five-year high. Even though the regions' industrial composition is similar, the gap between the Philadelphia and New York surveys is its widest since August 2007. Its important to remember that these surveys are not derived from the components; therefore, they reflect changes in business sentiment. Overall, the true health of manufacturing likely lies somewhere between the Philadelphia and New York Fed surveys.
I would also point out that the Philly Fed index recovery during the mfg recovery of 2003 peaking above 35 in Jan 2004 was much more robust than it is today. Note too, the contraction in the Philly Fed survey troughed just below -5 in 2003, whereas the trough in 2009 was below 40.
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What are the takeaways for this week? Well, I think it is this. Headline Retail sales could provide a warm fuzzy based on the rebound in vehicle sales. However, core retail may be entirely at risk of disappointing. More than likely the market will be looking to put a happy face on the retail sales report regardless of what core retail sales generates.
The rest of the week will largely focus on manufacturing (we are skipping over the inflation/deflation reports, believing as probably does the Bloomberg preview that they have little bearing on equities even though the CPI report on Wednesday could have negative bearing on Treasuries). Most market participants probably know the manufacturing numbers are going to be favorable into Q1 2010. Because of this fact, any strength in equities on mfg reports may not see the firepower that we saw in September. This means even though mfg reports will be supportive of the primary bull trend off the March 2009 low, the short squeezes will not be as impressive, the bull market will have to work harder for what gains they get.
The biggest stumbling blocks to equities come from Wednesday’s housing starts and possibly from Thursday’s Philly Fed survey. Whatever gains the e-minis see, should be seen early in the week. After that, downside risks may begin to outweigh the upside risks at least until investors get past the November 24 consumer report the following Tuesday.
We saw the acceleration in the 2003 mfg recovery peaking in Q1 2004, presumably the acceleration in the mfg recovery will peak in Q1 2010. Another question that arises from this report is what happens to the stock market after the acceleration in manufacturing likely peaks in Q1 2010. The consumer was far healthier in 2004 than he will be in 2010. Job growth began in April 2002, the economy is likely to still be shedding jobs in Q1 2010 as the mfg acceleration phase plateaus. The stock market will have to rely increasingly on economic data that reflects on the health of the consumer throughout the balance of 2010. If the consumer remains strapped, the stock market will oftentimes be held hostage by millions of consumers that just are cutting it.
A resumption of job growth will most certainly have to surface in early 2010 when the acceleration in mfg flattens out. I suspect, as does Goldman, that we will see a just in time jobs stimulus package in early 2010 from the Obama administration to prop up the consumer, and by extension the economy and stock market. Without it, we should expect to see an increase in stock market turbulence as 2010 unfolds.
As for the stock market early this week, a breach of 1099, targets 1106-1108 on Monday (remember the bear close gap at 1108), and possibly 1114 or higher by mid-week. The 21 point scare we had last week is beginning to look like a garden variety pullback and will have lost all of its menace if 1099 is breached overnight.
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The risk for traders and investors is that some of the gains garnered from economic reports this week will be offset by a bearish consumer confidence report in the following week. But as noted, the stock market can quickly recover from a bearish report in a bull market discounting an economic recovery.
For more from John Bougearel, visit Structural Logic |
