Bearing that in mind, a time lag of at least six months is typically required before the NBER even considers declaring a recession or a recovery, which effectively renders the official announcement useless for traders. The peak of a business cycle occurs during the last month before some key economic indicators begin to fall. These indicators include employment, output, and new housing starts. However, because neither a recession nor a recovery can be declared until enough data is accumulated, finding a way around the time lag in official information is impossible.
Looking at an earlier business cycle, you can see the whole process. Just as in October , clear signs that the economy was headed toward a recession were seen as early as the spring of , which is when the NASDAQ index hit its peak and began its downward spiral. The effects of the recession took a bit longer to hit the other major exchanges, but they started a downward trend by the summer of Just like in , job losses had started mounting by mid- , and many economists already were sending alarms that the economy was headed into a recession.
Even though the NBER announced the official beginning of that recession as March 21, , and the official end of the trough and beginning of the recovery as November , no significant recovery was seen in the markets until October Job growth remained anemic as of early The first sign of job growth was seen during the fourth quarter of , after nearly three years of job losses.
That economic expansion finally picked up steam, and ultimately lasted through Most economists attribute changing business cycles to disturbances in the economy. Growth spurts, for example, result from surges in private or public spending. One way public spending can surge is during a war, when government spending increases and companies in industries related to the war effort prosper.
They often need to increase hiring to fulfill government orders. Employees at these companies usually receive increases in their take-home pay and start spending that extra money. When these same factors work in reverse, the start of a recession is sure to follow. For example, a cut in government spending will likely result in layoffs at related industrial plants, reduced take-home pay, and finally declines in output and production to cope with reduced spending. In addition to government spending, a decision by the Fed to either raise or lower interest rates is another major disturbance to the economy.
When interest rates rise, spending slows, and that can lead to a recession. When interest rates are cut, spending usually goes up, and that can aid in spurring an economic recovery. Chapter 5: Fundamentals Observing Market Behavior 71 Another school of economic thought disagrees with the notion that government policy or spending is responsible for changes in the business cycle. This second group of theorists believes that differences in productivity levels and consumer tastes are the primary forces driving the business cycle.
From this point of view, only businesses and consumers can drive changes in the economic cycle. Peaks and troughs are flat periods periods where the high or low stays primarily even before moving in the opposite direction and are impossible to identify until months after they end. As a trader, you can identify shifts in buying and spending behavior by watching various economic indicators.grattilrawen.tk
To find out what they mean, you first need to understand how economic cycles affect the stock market. Bulls are people who believe that all is right with the world and the stock market is heading for an increase. They definitely think the economy is expanding. Bears are people who believe the economy is heading for a downturn, and stocks will either stagnate or go down. A bull market is a market in which a majority of stocks are increasing in value, and a bear market is a market in which a majority of stocks are decreasing.
Bears definitely believe the economy is either in a recession or headed that way. Regardless of whether the bulls or the bears are right, you can make money as a trader. The key: Identify the way the market is headed and then buy or sell into that trend.
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During a bear market, traders make their money by selling short, or taking advantage of falling prices more about that in Chapter Traders sell short by borrowing stock from their broker and then selling it with the hope of making a profit when the price falls. Even during a bear market, some stocks offer opportunities for traders to make money, including oil and gas stocks and real estate investment trusts REITs. Petroleum stocks and REITs pay higher dividends and, therefore, are most attractive when the rest of the market is falling or showing no growth potential.
During a bull market, riding a stock through recovery but getting out before a fall is key. We talk more about trends and what they mean in Chapter Some traders are adept at rotating their investments from one sector to another that is more likely to benefit from the part of the business cycle that is driving the economy. This basic trading strategy is called sector rotation. Although the book is out of print, you can still follow his advice about sectors on the BusinessWeek Web site at www.
Stovall developed the Sector Rotation Model shown in Figure As you can see, he found that market cycles tend to lead business cycles. Markets tend to bottom out just before the rest of the economy is in a full recession. The start of a bull market, on the other hand, can be seen just before the rest of the economy starts its climb toward recovery. Markets reach their tops first and enter a bear market before the general economic indicators show a peak.
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You need to buy into the sectors with stock prices that are likely to rise, or you can sell short the sectors in which prices are expected to fall. We discuss short selling in Chapter Chapter 5: Fundamentals Observing Market Behavior 73 Early recovery You can spot an early recovery when consumer expectations and industrial production are beginning to rise while interest rates are bottoming out. That scenario was evident during a recent economic cycle discovered during the fall and early winter months of During the early stages of recovery, Stovall found that industrial, basic industry, and energy sectors tend to take the lead.
Full recovery When the economy has fully recovered, you start seeing signs that consumer expectations are falling and productivity levels and interest rates are flattening out. During that period, companies in the consumer staples and services sectors exhibited a tendency to take the lead, and interest rates had actually started to fall. Investors know that the staples of life are needed even in times of recession, so the stocks of those companies tend to benefit.
Early recession When the economy reaches the earliest part of a recession, consumer expectations fall more sharply and productivity levels start to drop. Interest rates also begin to drop. Most of the 2.
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During , the Federal Reserve cut interest rates 11 times to try to ease the concerns about the upcoming recession. The Fed started to raise rates in , but then lowered them again in during the mortgage crisis. Another key recession sign was the mounting loss of jobs in and early Utilities and finance sector stocks are the most likely to see rising prices during the first part of a recession, because under those circumstances, investors seek stocks that provide some safety because owning them involves less risk and pay higher dividends. Gold and other valuable mineral stocks also look good to investors seeking safety.
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Though the financial sector did not follow this pattern in the recession, it is still typical to see banks, insurance companies, and investment firms perform well during the early parts of a recession. And fade. For a sector to outperform, the stocks beside the point. Economic indicators can help within it must also outperform.
You need to be you understand the big picture, which, in turn, monitoring those stocks before they begin their can help you make better trading decisions. Of all the economic tools available, sector Plenty of data is available to help you separate rotation analysis is probably the most valuable. You can also monitor sectors by in the strongest sectors, which is why we following exchange-traded funds ETFs , monitor sector performance carefully.
Full recession Although it may not make much sense intuitively, during a full recession is when you first start seeing indications that consumer expectations are improving, which is seen by increased spending. Additionally, interest rates continue to drop, because both business and consumer spending are slow, so demand for the money weakens while competition for new credit customers grows between banks and other financial institutions.
During a full recession, cyclical and technology stocks tend to lead the way. Investors look to safety during a recession, so companies that satisfy that need tend to do best. Understanding Economic Indicators The key to knowing where, as a trader, you are during the business cycle is watching the economic indicators. Popular indicators track employment, money supply, interest rates, housing starts, housing sales, production levels, purchasing statistics, consumer confidence, and many other factors that indicate how the economy is doing. Economic indicators are useful to your trading.
Some are definitely more useful than others. Fed watch: Understanding how interest rates affect markets Watching the Federal Open Market Committee FOMC of the Federal Reserve which includes the seven members of the Board of Governors, the president of the New York Federal Reserve Bank, and presidents of 4 of the other 11 Federal Reserve Banks and tracking what it may or may not do to interest rates is almost a daily spectator sport in the business press.
Although members of the FOMC meet only eight times per year, discussions about whether the Federal Reserve will raise or lower interest rates serves as fodder for stories published on at least a weekly, if not daily, basis. Every time Fed Chairman Ben Bernanke speaks, people look for indications of what the Fed may be thinking. Most press coverage will shortcut all this by saying the Fed may raise or lower interest rates. The key reason for you to be concerned: A change in interest rates can have a major impact on the economy and thus on how you make trades.
An increase in rates is likely to slow down spending, which can lead to an overall economic slowdown. An increase in interest rates can reduce spending and thus ease overheating. If, on the other hand, the Fed fears an economic downturn or is trying to fuel growth during a recession, the board frequently decides to cut interest rates to spur spending and growth. In addition to following press reports covering speeches and Congressional testimony by members of the Fed, you can also get a good hint about what the Fed is thinking by reading the Beige Book, which is a report compiled by the 12 Federal Reserve Banks.
Summaries about current economic conditions in each of the 12 districts are circulated to Federal Reserve Board members two weeks prior to the FOMC meeting, at which monetary policy, including interest rates, is set. The summaries are developed through interviews with key business leaders, economists, market experts, and others familiar with each individual district. You can read the Beige Book online at www. These links give you access not only to current issues of the Beige Book and FOMC statements but also to information from those two sources dating back as far as They can provide an excellent overview of economic trends and possible shifts in Federal Reserve monetary policy.
Money supply The money supply is a key number to watch, because growth in money supply can be a leading indicator of inflation in situations when the money supply is greater than the supply of goods. When more money than goods is around, prices are likely to rise. Commodities and money traders will want to keep close watch over these three aggregates — money supply, inflation, and goods and services. The Fed tracks two monetary aggregates: M1 and M2. M1 includes money used for payments, such as currency in circulation plus checking accounts in banks and thrifts.
Currency sitting in bank vaults and bank deposits at the Fed are not part of M1, but instead are part of the monetary base. M2 includes M1 money plus retail nontransaction deposits, which is money sitting in retail savings accounts and money market accounts. You can follow the money stock measures for M1 and M2 at www. The Fed decided in July that it no longer would set target ranges for growth rates of the monetary aggregates.
As money supply grew to what was considered out of hand, the Fed kept raising interest rates until they were so high that many believe the Fed moves actually caused the recession in the early s.
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After that time, managing interest rates became a higher priority than managing money aggregates. Now that the Fed has proved interest-rate management works, it decided it no longer needed to set a target for monetary aggregates. Inflation rate Several key economic indicators point you toward ways of identifying the risk of inflation. You can also follow monthly trends by keeping your eye out for the Consumer Price Index, the Producer Price Index, and Retail Sales Data, as described in the list that follows.
GDP is released quarterly in three different versions.
Related Volume Spike Analysis: Includes 3 free Volume Spike Analysis indicators for Esignal inside this book
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