broad market analysis (session 5)
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Broad Market Analysis
“Beware of geeks bearing formulas”Warren Buffett
IndexIntroduction
Inflation, interest rates and the FED
Flow of capital
Economic turning points and government reports
Seasonal factors
Strategic market assessment using indexes
Industry sector as forecasting tools
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Introduction
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• Analysis techniques that identify market trends by reviewing flow of money, analyzing index performance, keeping tap on industry leadership, changes in the advance/decline line (A/D line)
• Three out of four stocks move in tandem with the general trend of the market
• Take into account that the market will change course when it suspects the economy is heating up or slowing down.
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Introduction
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• There are a variety of reports, indicators indicators and general tools that enable investors to keep their fingers in the pulse of the stock market
• These tools include: monetary policy: (interest rates, value of the dollar) Government report index analysis sector comparisons market indicators seasonal factors changes in political climate
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Inflation, Interest Rates and the FED• Preservation of capital is at the heart of the investment
battle• Rate of inflation is an ever-changing
rate runs at 3% to 4%, said to be on check inflation means less profits > lower stock valuations high inflation > increase in interest rates > slows the economy down (reins on lending and business expansion, increases mortgage rates and scales back consumer spending) low inflation and low interest rates keep money flowing into the
stock market
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Inflation, Interest Rates and the FED• FED is a conglomerate of 12 separate banks governed by a
seven member Board of Governors• Federal Reserve System is charged with fostering growth
without generating inflation
Federal Open Market Committee (FOMC) > balance the amount of money in circulation
economy needs a boost > members tell the Federal Reserve Bank of New York to speed up the creation of dollars
inflation is on the rise > they use their secret weapon: interest rates
money supply is the key to keeping the economy expanding or contracting
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Inflation, Interest Rates and the FED
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Inflation, Interest Rates and the FED
• Money supply is the key to keeping the economy expanding or contracting M1: money that can be spent immediately,
includes cash, checking accounts M2: M1 + assets invested in short term, includes
money markets and money market mutual funds M3: M2 + big deposits include institutional
money market funds
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Inflation, Interest Rates and the FED
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• Federal fund rate interest rate at which
banks lend and borrow federal funds among themselves
most sensitive indicator of the direction of the market
set daily by the market these loans take place in a
private financial market
Federal Reserve Bank of New York (gold reserve vault)
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Inflation, Interest Rates and the FED
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• Federal fund rate– interest rate at which banks lend and borrow federal funds
among – most sensitive indicator of the direction of the market– set daily by the market– these loans take place in a private financial market
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Inflation, Interest Rates and the FED
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Inflation, Interest Rates and the FED
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• Discount rate interest rate charged by the 12 Federal Reserve Banks for
short term loans made to member banks Federal Reserve Board controls interest rates by moving the
discount rate up or down – Ben Bernanke (chairman)
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Inflation, Interest Rates and the FED
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• Natural law of financial physics that money always flows to the highest return on capital
• Stocks and bonds have an inverse relationship to interest rates does not always hold these divergences are usually
short lived• Bond prices and stock market move
in tandem
INTEREST RATES
DOLLAR BONDS STOCKS
Up Up Down Down
Down Down Up Up
Sideways Sideways Sideways Up
• Increase in rates has a negative effect on stocks prices
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Flow of Capital
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• Money controls the economy of nations and the quality of life for people
• Success of a company stock depends on money• Flow of money sometimes becomes flight of money
interest rates in once country are lower than risk-adjusted rates in other countries
the fact that money has moved between countries and between investment categories such as bonds, equities and commodities and between individual stocks, commodities and bonds results in a shift of the risk/reward ratio
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Flow of Capital
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• General tendency of all stocks to follow the market• Various studies attribute as much as 70% of a stock’s
performance to the movement of the market as a whole• Many investors fight the trend by taking a contrarian stance• Stock market is a mini-version of the flow of global capital• So too does money flow into the stock market as a whole,
always searching for the best risk/reward ratio• Money tends to seek out the hottest sectors or stocks• Regardless of market direction, not all sectors go up or down at
the same time
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Economic Turning Points and Government Reports
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• Fed collects data from a number of resources, uses this data to judge whether the economy is expanding or contracting, more importantly at the pace it is doing so employment report Unemployment rate (%)
followed by investors picture of the nation’s health several important components:
unemployment rate non-farm job growth weekly hours hourly earnings
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Economic Turning Points and Government Reports
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• Employment Cost Index (ECI) quarterly data based on a survey on employer payrolls measures changes in labor costs on wages and salaries non farm private sector and state and local government analyst specifically look at acceleration or declaration
• Consumer Price Index (CPI) measures the value of a basket of goods in the current year to the
value of that same basket a year earlier widely regarded as the most important inflation report a year to year CPI report can give a clear picture of the rate of
inflation increase in inflation has a negative effect on stocks and vice-versa http://www.minneapolisfed.org/
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Economic Turning Points and Government Reports
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• Producer Price Index (PPI) strong influence on the Fed’s reaction to pricing inflation index gauges the prices of commodities:
raw materials intermediate goods finished goods
investors look for an annualized PPI to stay below 3%
• National Association of Purchasing Management Index (NAPM) another indicator of economic growth wide ranging view of the manufacturing sector’s ups and downs broken down into specific components of supplier deliveries, order
backlog, new orders, production, employment, inventories, import orders, new export order and prices paid
example: statistics for order backlogs > vendor performance index web site: www.napm.org
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Economic Turning Points and Government Reports
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• Retail Sales consumer spending makes up for approximately two thirds of the
national economy most closely watched economic indicator reviews monthly sales for auto manufacture, major retailers, and
chain store sales
• Gross Domestic Product (GDP) is the total production and consumption of good and services in
the US > excellent gauge of economic growth single most comprehensive picture of the economy
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Economic Turning Points and Government Reports1 2 3 4 5 6 7
Economic Turning Points and Government Reports
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• Housing Starts and Sales of New and Existing Homes housing stats show the first signs of any new direction changes are usually set off by changes in home mortgage rates high stars indicate a healthy economy sales of new and existing homes gives analyst an idea how future
sale of things look, such as appliances, furniture and other good
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Economic Turning Points and Government Reports
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• Construction Spending nonresidential and public housing projects a strong number here > high degree of confidence in
economy Lagging indicator > numbers are not re[ported until
structures are completed analysts do the reading every three months>very volatile
• Industrial Production Index aggregate output of all country’s utilities, factories, mines directly affects the stock market lagging indicator > numbers are not re[ported until
structures are completed
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Economic Turning Points and Government Reports
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• Capacity Utilization measures at what rate the manufacturing capacity of the
nation is being utilized 80% or lower can cause concerns of underutilization high (not too high) capacity utilization brings stock up and
bonds down capacity rate of 85% can indicate the point at which
inflationary pressures begin• Factory Orders – Durable Goods and Nondurable Goods
looks at factory shipments that are measures of current demands, new factory orders, inventories and unfulfilled orders
tracking orders for big ticket items such as cars refrigerators that are expected to last more than three years
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Economic Turning Points and Government Reports
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• Personal Income and Consumption Expenditures help gauge the prospect of future consumer spending as income rises, so does the stock market important way to measure overall economic activity
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Seasonal Factors• Have an impact on the markets year round• Are much broader than climate issues• During election years > historically high performing years• History tends to repeat itself
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Seasonal Factors• January Effect
describes a pattern in which smaller cap-stocks outperform their blue chip brethren in January
statistically the pattern has been evident there has been years (1996-1999) in which this effect failed to
materialize
• October Jinx• great crash of 1929, repetition in 1987, as well as the minus 554
point day in 1992• history of the DOW, 6 of the 12 largest daily drops have occurred in
October > many good runs have began in November• Government shut-down in 2013 also occurred in the October month
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Seasonal Factors• Quarter End Fluctuations
end of quarter is of special significance to portfolio managers SEC requires mutual funds to post performance and holdings clunkers are replaced in favor of stocks that are current favorite window dressing creates some wild times on the last trading days of
March, June, September and December
• Monthly Options Expirations third Friday of every month > final hours of trading can bring some wild price gyrations money managers and traders will often create sophisticated hedge positions that will need to be unwound
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Seasonal Factors• Supply and Demand
the number of total number of shares (supply) is fixed demand for the fixed number of shares will vary continuously depending
on the data available: company, sector and the economy Stock exchange is like an auction:
more buyers than sellers > stock prices will more sellers than buyers > stock prices will
• International and Political Factors politics does not always reinforce business interests worldwide economic dependency has moved to the front > digitally linked with fewer trade barriers than ever before
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Strategic Market Assessment Using Indexes• There are evens that have an impact on entire industries,
sectors at times the market as a whole• Comovement or covariance – the degree to which stocks move
together• Indexes serve the purpose to think of the aggregate or
composite performance of stocks• Index represents a cross section of the economy or market
sector• Understanding indexes is an effective way of subdividing the
stock market into groups or sectors• Price weighted (DOW) vs. capitalization or market weighted
(S&P 500)
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Strategic Market Assessment Using Indexes• DOW
back in 1884 Charles Dow published the average closing prices of 11 U.S. companies in 1896 two new averages were published daily:
average prices of 20 railroad stocks (Dow Jones Railroad Average) average prices of 12 industrial stocks (Dow Jones Industrial Average)
in effect, Dow simplified the monitoring of a large number of stocks individually by compiling and publishing the average performance of a list of like popular stocks.
Charles Dow is known as the father of stock market indexes original editor of the Wall street Journal
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Strategic Market Assessment Using Indexes used stock market indexes as a way of gauging trends in the economy Charles Dow also put forth the idea of market trends
trend has three parts: he likened them to tides, waves and ripples» primary trend (tides)
long period of rising or falling stock prices» secondary trend (waves)
lasts three weeks to three months moves against the primary trend Retrace or correct anywhere from 1/3 to 2/3 of the prior
trend’s movement, with the most frequent correction of 50%» third trend (ripples)
lasts around three weeks represented fluctuations on the secondary trend generally considered unimportant
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Strategic Market Assessment Using Indexes• William P. Hamilton
Dow successor at the WSJ refined Dow’s early ideas and developed the Dow Theory
the averages discount everything» market is the world’s most efficient processor of information» anything that happens, including an act of God is already priced in
the market has three trends major trends have three phases
» accumulation phase (informed buying by those close to the co.)» public participation» distribution phase
the averages must confirm each other» Dow was speaking of the railroads and the industrials » both needed to be in the same primary trend, did not have to begin
at same time
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Strategic Market Assessment Using Indexes volume must confirm the trend
» Mr. Dow was a big believer in volume» it should increase in the direction of the primary trend
a trend is assumed to be in effect until it gives a definite signal it has reversed» one of the basic tools of modern day technical analysis
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Strategic Market Assessment Using Indexes• INDEXES
late 1800’s bonds were highly regarded stock market was an unknown territory index is made up of a select group of stocks can measure and report value changes to the whole group by tracking
its highs and lows, today’s performance vs. yesterday’s, volume and volatility
many indexes tailored to reflect performance of different sectors The Dow Jones Industrial Average ($INDU)
» Dow 30 » oldest market average in the world
The Standard & Poor’s 500 ($SPX)» capitalization weighed» 500 stocks (industrials, utilities, financials and transportation)
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Strategic Market Assessment Using Indexes The New York Stock Index ($NYA)
» measures aggregate performance of all stocks in the NYSE The Nasdaq Composite Index ($COMP)
» capitalization weighed index» measures the performance of all stocks trading in the Nasdaq
The Wilshire 5000 ($TMW» one of the broadest measures of U.S. stocks» created in 1974 it had 5.000 stocks, now it is closer to 7.000» requirements:
firm’s headquarter has to be in the U.S. stock is actively traded on a U.S. exchange stock has widely available information
U.S. Total Market Index» Dow Jones Co. launched this index, designed to represent 95% of all
U.S. stocks
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Strategic Market Assessment Using Indexes another popular way of categorizing stocks is by market capitalization
The Russell 2000 Small Cap Index ($RUT)» measure of the 3.000 most actively traded stocks in the NYSE,
Nasdaq and the American Stock Exchange» 1.000 largest companies are removed» most widely follow gauge of small-cap stock performance
The S&P Midcap 400 Index ($MID)» consists of 400 mostly industrial companies» selection is made by market size and popularity (trading volume)
The Wilshire 4500 Index» all of the companies of the Wilshire 500» S&P 500 removed» provides a measure of both small and mid-cap stocks
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Strategic Market Assessment Using Indexes indexes can track performance in terms of specific economic sectors
The NASDAQ 100 ($NDX)» measure of the 100 largest nonfinancial companies» accurate gauge of the technology sector
The Dow Jones Utility Average ($DJU)» developed in 1929 when all utility stocks were removed form the
Dow Jones Industrial Average» index of only utility stocks
The Dow Jones Transportation Average ($DJT)» originally known as the Dow Jones Railroad Average» reliable way to study the railroad sector
The AMEX Oil Index ($XOI)» tracks the performance of the energy sector
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Strategic Market Assessment Using Indexes other indexes are designed to track the performance of economic
sectors and industry groups The PHLX Semiconductor Index ($SOX)
» price weighted index of 16 companies» companies engaged in the manufacture and distribution of
semiconductors The PHLX Box-Maker Index ($BMX)
» price weighted index» 9 companies involved in the manufacture, distribution and sales of
desktops and notebooks The Street.com Internet Index ($DOT)
» 20 companies engaged in the Internet commerce, software and services
useful index links: www.cboe.com www.amex.com
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Strategic Market Assessment Using Indexes• HOLDRS
sector specific depositary receipt trade like stocks, but actually are made up of a group of stocks easily and conveniently buy a basket of stocks within a sector
biotechnology, semiconductor, pharmaceutical
unlike index funds or index shares, they do not track a specific index > represent ownership of stocks in a particular industry
• studies prove that being in the right sector outperformed being in the market at the right time by a margin of 4:1
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Strategic Market Assessment Using Indexes Index Shares (iShares)
exchange traded funds (ETF’s) or index shares are funds designed to match the performance on an index
funds buy the same stocks that are in the index shares of the funds are traded on an exchange like a stock
S&P Depositary Receipt (SPDR – Spiders) – (AMEX), tracks the S&P 500)
Dow Jones Industrial Average (Diamonds) Nasdaq (QQQ)
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Industry Sectors As Forecasting Tools• Economy has an array of sectors that can be doing well as
another is doing poorly• Many investors believe that half of a stock’s price performance
can be attributed to its respective industrial sector • Money flows in and out of various sectors – sector rotation• BusinessWeek has divided the market into approx. 197 sectors
– http://investing.businessweek.com/research/sectorandindustry/overview/sectorlanding.asp
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Industry Sectors As Forecasting ToolsMarket Indicators• Number of tools called indicators that provide insight to broad market
analysis advance/decline line up and down volume TRIN new highs/new lows Market Breath / Advance-Decline line (A/D line)
simply a measure of the number of stocks advancing versus the number of stocks that are declining
2.400 stocks advance vs. 1.200 decline – market breath is said to be positive 2 to 1 and viceversa
graphic representation of the advance/decline line over a period of time it is cumulative – each day the new total is added to the previous total
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Industry Sectors As Forecasting Tools advance/decline line is best used in conjunction with senior averages the advance decline line is considered the best indicator of market movement
considered a good sign when the Dow jones Industrial Average and the New York Stock Exchange A/D line are rising together
unhealthy when the Dow is setting new highs and he NYSE A/D line is moving lower – breath is said to be lagging or poor
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Industry Sectors As Forecasting Tools• Volume
is the level of activity associated with a specific market or security up and down volume are helpful indicators NYSE reports the level of activity each day market strategist will look beyond total volume and and look at the
advancing volume versus the declining volume
more declining than advancing – interpreted as a negative bearish sign more advancing than declining – interpreted as a positive bullish sign http://wsj.com/mdc/public/page/2_3021-tradingdiary2.html
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Industry Sectors As Forecasting Tools• TRIN
also known as the closing Arms Index is a volume indicator derived by using the advance/decline ratio and up and down volume formula is pretty straightforward
if a drop in the senior averages is accompanied by heavier trading volume ratio > 1 = market negative (falling stocks have greater average volume than
advancing volume) ratio < 1 = market positive (advancing stocks have greater average volume than
falling volume)
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Industry Sectors As Forecasting Tools• New highs and lows
market analysts focus on the ratio of new highs to new lows new highs refer to stocks that are setting one year new highs new lows are stocks that are setting new one year lows the new highs/new lows indicator is simply the new highs minus (-) the new
lows most insight if used in conjunction with senior averages
Dow is rising to new highs and the primary trend is bullish, NYSE’s new highs/new lows ratio is also moving higher > interpreted as a bullish sign > strength in the overall market
on the other hand, senior averages are recording new highs, but the new highs/new lows ratio is moving lower > it is considered bearish because more stocks are moving lower than higher
insightful to compare data between Nasdaq and the New York Stock Exchange >sometimes market data on one exchange will differ substantially from another
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