Chapter 6
Understanding the Fundamentals of the Economy
In This Chapter
Understanding the U.S. economy
Getting to know the major economic reports
Staying awake for the leading economic indicators
Trading the big reports
To the beginner, the financial markets and reality seem to often be disconnected. That lack of connection, most often associated with stock trading, is not as often visible in the futures markets. This is especially so in the case of commodities, such as grains and the energy complex, because price changes in the markets often move through the system fairly rapidly and can be seen at the grocery store.
When I started trading, I was overwhelmed by the amount of data that was available, and I had a hard time correlating how that data was related to the movement of prices. To be honest, I thought that the whole thing was random.
My first reaction was to ignore the data and concentrate on the charts. And although chart-watching worked well for a while, it wasn’t good enough to get me in and out of trades fast enough or to prevent getting taken out of positions only to see them turn around and go in the direction that I expected them to go in the first place. I knew I needed something else, so I began watching how the market moved in response to economic data.
To be sure, this is not the only approach to trading, as there are purists on both sides of the aisle: those who propose charting as the best method, and those who swear by the fundamentals. But rather than confuse you with a bunch of jargon and useless justifications on either side, I can tell you that you’ll decide what works best for you, and that for me, the best method is to use charts as well as to keep my hands on the pulse of the economy.
It’s also fair to say that my problem in my early trading career was one of a lack of experience. This could have been remedied by a much finer use of different charting methods, as well as a better use of charts with different time frames. See Chapter 7 for more on technical analysis.
Just remember that the more experience you get, the more insight you’ll gain into what works best for you. Think of this book as a great place to get started.
Achieving a balance among what I want to know about the economy, what I need to know, and what I can use took time. So, after considerable trial and error, I’ve reached a comfortable middle ground: I am both an avid chartist, or someone who studies price charts and uses technical analysis of the financial markets to make trades, and also an avid follower of trends in the economy, although not in as much depth as you’d expect from a Nobel Prize–winning economist.
For me, the bottom line is this: Like many other successful traders, I understand how the markets and the monthly economic indicators can morph into a nice, reliable trading method. And so this chapter focuses on the effects of important economic indicators on the bond markets, stock indexes, and currency markets.
When I write, my goal is to make the examples not only as current as possible, but also universal, so that you can use them for an extended period of time. Most markets behave similarly, but certainly not identically, over time, so you have to be flexible in your interpretation of real-time trading. When I provide examples, my goal is to give you as classic a set of parameters as possible.
I purposely chose examples from April 2005 of how economic reports can affect the market for two major reasons. First, I wanted to show you that the concepts that I describe in the chapter are relevant to recent history, where the big event is the global economy during a controversial period in U.S. history — the post-September 11, 2001, era. And second, the period of time chosen had just about anything that a futures trader could ask for in the way of data that can move the markets, especially a significant amount of activity in the oil market, a booming housing market, and a Federal Reserve that was just hitting its stride in a major cycle of interest-rate hikes.
If you fast forward to 2007 or beyond, you will likely see different things happen, depending on the overall economy and how the market perceives the situation at the time. Yet, in the current world, the primary set of rules and circumstances that govern trading are no longer exclusive to the U.S. economy and its effect on the world. As a trader you also have to be keenly aware of the effect of China and other emerging markets on the macro-market, that linked beast that was unleashed in the stock market crash of 1987.
Understanding the U.S. Economy: A Balancing Act
Market experts and those well versed in economic theory, along with politicians and pundits, like to muddle things up when it comes to interpreting data and formulating working summaries of economic activity. That’s how they keep their jobs — by confusing the public when it comes to what’s really happening with the economy.
But understanding how the economy works and making it fit your trading approach doesn’t have to be that complicated. Simply stated, the U. S. economy, the largest in the world, is dependent upon a series of delicately intertwined relationships, so keep these factors in mind:
Consumers drive the U.S. economy.
Consumers need jobs to be able to buy things and keep the economy going.
The ebb and flow between the degree of joblessness and full employment, how easy or difficult it is to get credit, and how much the supply of goods and services is in demand drive economic activity up or down.
As a rule, steady job growth, easy-enough credit, and a balance between supply and demand are what the Board of Governors of the Federal Reserve (the Fed) like to see in the economy. When one or more of these factors is out of kilter (teeters off balance), the Fed has to act by raising or lowering interest rates to
Tighten or loosen the consumer’s ability to obtain credit
Rein in a too-high level of joblessness
Increase or decrease the supply side to bring it in line with demand, or vice versa
Several government agencies and private companies monitor the economy and produce monthly or quarterly reports. These reports, in turn, are released on a regularly scheduled basis throughout the year. They provide futures traders with a major portion of the road map they need to decide which way the general direction of prices in their respective markets are headed.
Trading, in turn, is highly influenced by the government and private-agency reports and how the markets respond. Businesses are just the pawns of the Fed and the markets, and their reaction to changes in trend usually takes some time to be noticed.
The overall focus of the markets is on only one thing: What the Federal Reserve is going to do to interest rates in response to the report(s) of the day (see Chapter 1). Based on how traders (buyers and sellers) perceive their markets before the Fed makes its move and their reactions after the Fed’s response to economic conditions is announced, prices move in one direction or the other.
As a futures trader, 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 the individual components of the market and economic equation. Given these basic truths about the U.S. economy, I discuss the most important sets of data released by key reporting agencies and how to use the information to make trades.
Getting a General Handle on the Reports
Economic reports are important tools in all markets, but they’re a way of life for futures traders.
Each individual market has its own set of reports to which traders pay special attention. But some key reports are among the prime catalysts for fluctuations in the prices not only of all markets, but especially in the bond, stock, and currency markets, which form the centerpiece 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. Nevertheless, Gross Domestic Product, the consumer and producer price indexes, the monthly employment reports, and the Fed’s Beige Book, which summarizes the economic activity as surveyed by the Fed’s regional banks, are usually important and highly scrutinized.
The Institute for Supply Management (ISM) report (formerly the national purchasing manager’s report) also is important, and 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 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, with bond, stock, and currency traders paying special attention to them. These reports are especially important when the market is particularly keen on what the Federal Reserve is expected to change the trend of interest rates as the Fed looks at consumer spending, which is related to consumer confidence as a major influence on the economy.
Sometimes weekly employment claims data can move the market if they come in far above or below expectations. Retail sales numbers, especially from major retailers, such as Wal-Mart, can move the markets, and so can the budget deficit or surplus numbers. Consumer credit data can sometimes move the market as well.
Cable news outlets, major financial Web sites, and business radio networks — CNBC and Bloomberg are two that I follow — 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 covering the releases. The government agencies and companies that are responsible for the reports also post them on their respective Web sites immediately at the announced time.
Exploring how economic reports are used
From a public policy standpoint, 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.
From a trader’s point of view, you can best use them as
Sources of new information: No one should ever have access to the data in economic reports prior to their release — other than the press, which receives it expressly under embargoed conditions with instructions not to release the data prior to the proper time, and key members of the U.S. government, such as the Fed and the president. Anyone else who has the data before the release can be prosecuted if they leak it to anyone else.
Risk management tools: You can place your money at risk if you ignore any of the reports. Each has the potential for providing important information that can create key turning points in the market.
Harbingers of more important information: Individual headlines about economic reports are only part of the important data. The markets explore more data beyond what’s contained in the initial release. Sometimes data hidden deep within a report become more important than the initial knee-jerk reaction characterized within the headlines and cause the market to reverse its course. In other words, sometimes it’s best to wait a few minutes or even longer before making trading decisions based on trading reports.
Trend-setters: Current reports may not always be what matters. The trend of the data from reports during the last few months, quarters, or years, in addition to expectations for the future, also can be powerful information that moves the markets up or down. When looking through these reports, keep in mind what the prior reports have said, and pay attention to the revisions by the releasing agency that are included in the current report.
Planning tools: 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. How the market responds to the reports is what really matters.
Gaming the calendar
As a trader, your world is highly dependent on the economic calendar, the listing of when reports will be released for the current month.
Each month a steady flow of economic data is generated and released by the U.S. government and the private sector. These reports are
A major influence on how the futures and the financial markets move in general
A source of the cyclicality, or repetitive nature, of market movements
You can get access to the calendar in many places. Most futures brokers post the calendar on their Web sites and can mail you a copy along with key information on their margin and commission rates — pretty convenient, eh? Customer service in the futures market actually is quite awesome if you can handle the greasy guys that you sometimes have to talk to.
The Wall Street Journal, Marketwatch.com, and other major news outlets also publish the calendar, either fully posted for the month or for that particular day or week.
The reports follow a familiar pattern, usually following each other in similar sequence from one month to the next.
Exploring Specific Economic Reports
Some reports are more important than others, but at some point, they all have the potential to influence the market. The reports that consistently carry the most weight and result in the biggest shifts in the markets tend to be the employment report, the Producer Price Index (PPI), the Consumer Price Index (CPI), and two reports on consumer confidence. Other economic data that have an important bearing on the markets include the Purchasing Manager’s report from the Institute for Supply Management (ISM), Beige Book reports produced eight times a year by the Federal Reserve, housing starts compiled by the U.S. Department of Commerce, and of course, the granddaddy of all, the Index of Leading Economic Indicators, which the Fed also produces.
Working the employment report
The U.S. Department of Labor’s employment report is the first piece of major economic data released each month. It’s released on the first Friday of every month and is formally known as the Employment Situation Report. Bond, stock index, and currency futures are keyed upon the release of the new jobs and the unemployment rate numbers at 8:30 a.m. eastern time. See the Remember icon directly ahead for more.
The release of the employment data usually is followed by frenzied trading that can last from a few minutes to an entire day, depending on what the data shows and what the market was expecting. The report is so important that it can set the trend for overall trading in the entire arena of the financial markets for several weeks after its release.
When consecutive reports show that a dominant trend is in place, the trend of the overall market tends to remain in the same direction for extended periods of time. The reversal of such a dominant trend can often be interpreted as a signal that bonds, stock indexes, and currencies are going to change course.
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, and during the 2004 presidential election. During the election, the markets not only bet on the economic consequences of the report, but they also bet on how the number of new jobs would affect the outcome of the election.
The number of new jobs created: This number tends to predict which way the strength of the economy is headed. Large numbers of new jobs usually mean that the economy is growing. When the number of new jobs begins to fall, it’s usually a sign that the economy is slowing. More important, weakness in the employment report often leads the Federal Reserve to lower interest rates, while rising strength may lead the Fed to stop lowering rates, and even raise them if the report is seen as potentially creating inflation.
The unemployment rate: The rate of unemployment is more difficult to interpret, but the trend in the rate is more important than the actual monthly number. A workforce that is considered to be fully employed usually is a sign that interest rates are going to rise, so the markets begin to factor that into the equation.
Other subsections of the employment report have their moments in the sun. For example, the household survey, which uses interviews from people that work at home, was heavily scrutinized during the 2004 election season. The numbers of self-employed people became more important as the election neared, because the market began to price in an economic recovery based on adding together the data from both the traditional establishment survey, which measures the people who work for companies, with the household survey.
Probing the Producer Price Index (PPI)
The PPI is an important report, but it doesn’t usually cause market moves as big as those effected by the CPI and the employment report.
The PPI measures prices at the producer level. In other words, it’s a measurement of the cost of raw materials to companies that produce goods. The market is interested in two things contained in this report:
How fast these prices are rising: If a rise in PPI is significantly large in comparison to previous months, the market checks to see where it’s coming from.
For example, the May 2005 PPI report pegged prices at the producer level as rising 0.6 percent in April, following a 0.7 percent increase in March and a 0.4 percent hike in February. At first glance, the market viewed the April increase (compared to the previous two months) as a negative number. However, market makers discovered a note deeper in the report, indicating that if you didn’t measure food and energy — in this case (especially) oil prices — producer prices at the so-called core level rose only 0.3 percent.
The market looked at the core level, and bonds rallied. You and I know that food and energy are important expenses, and that if they are more expensive, we pay more. But futures traders live in a different world when they’re in the trading pits and in front of their trading screens, meaning that they trade on their perceptions of the data and not what you and I find intuitive.
Whether producers are passing along any price hikes to their consumers: If prices at the core level are tame, as they seemed to be in the April 2005 report, traders will conduct business based on the information they have in hand, at least until the CPI is released — usually one or two days after the PPI is released. In this case, based only on the PPI, inflation at the core producer level was tame, so traders wagered that producers were not passing any added costs on to the consumer.
Browsing in the Consumer Price Index (CPI)
The CPI is the main inflation report for the futures and financial markets. Unexpected rises in this indicator usually lead to falling bond prices, rising interest rates, and increased market volatility.
Consumer prices are important because consumer buying drives the U.S. economy. No consumer demand at the retail level means no demand for products along the other steps in the chain of manufacturers, wholesalers, and retailers.
Here are some key factors that govern consumer prices and the inflation that they measure:
Prices at the consumer level are not as sensitive to supply and demand as they are to the ability of retailers to pass their own costs on to consumers. For example, clothing retailers can’t always or immediately pass their wholesale costs for fabric components or labor to consumers, because they’ll start buying discount clothing if premium apparel is too expensive. Much of this volatility has to do with the fact that a large amount of retail merchandise is made in Asia, where labor is cheap and competition is stiff.
Supply tends to be more important in many cases than demand. When enough of something is available, prices tend to stay down. Scarcities, however, don’t necessarily mean inflation (but they certainly can accompany it).
Inflation is not a price phenomenon but rather a monetary phe-nomenon. When too much money is chasing too few goods, inflation appears.
Inflationary expectations and consumer prices are related. This factor is true because inflationary expectations are built into the cost of borrowing money.
By the time prices begin to rise at the consumer level, the supply-and-demand equation, price discovery, and pressure on the system have been ongoing at other levels of the price chain for some time.
Understanding the relationship between prices and interest rates is key to developing an intuitive feeling for futures trading.
Managing the ISM and purchasing manager’s reports
The Institute for Supply Management’s (ISM’s) Report on Business usually moves the markets, or is a market mover, however you want to say it. It measures the health of the manufacturing sector in the United States. This report is based on the input of purchasing managers surveyed across the United States and is compiled by the ISM.
The Report on Business is different from the regional purchasing manager’s reports, although some regional reports, such as the Chicago-area report, often serve as good predictors of the national data. You also need to know, however, that the regional reports are not used as a basis for the national report.
The report addresses 11 categories, including the widely watched headline, the PMI index. Here is how to look at the ISM report:
A number above 50 on the PMI means that the economy is growing.
You want to find out whether the main index and the subsectors are above or below 50.
Just as important is whether the pace of growth is slowing or picking up speed. The report, which is available at the ISM Web site at www.ism.ws, clearly states whether each individual sector is growing or not growing, and whether it is doing so because its pace is slowing or picking up speed.
The data for the entire report is included with a summary of the economy’s current state and pace near the headline of the report.
The April 2005 report concluded that the economy had been growing for 42 straight months and that the manufacturing sector had been growing for 23 straight months. The report concluded that although prices paid by manufacturers were on the rise and inventories were low, both the economy and the manufacturing sector were still growing, but the growth rate was slowing.
The bond market rallied. The dollar strengthened. And stocks had a moderate gain.
Considering consumer confidence
The report that measures consumer confidence is a big report that comes from two 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., publishes a monthly report based on survey interviews of 5,000 consumers. Key components of the Conference Board Survey are
The monthly index
Current conditions
Consumers’ outlook for the next six months
In April 2005, the monthly index fell, and so did the current condition and outlook portions of the survey. The result: Bonds rallied, stocks rallied, and the dollar remained steady. The report became another piece of the economic puzzle at a key time in the U.S. economy. The way the market looked at the data, following eight straight Federal Reserve interest-rate increases, showed that the economy was starting to slow. To a layman, a slowing economy would be bad news, but to a futures trader, the data meant that the Fed was nearing the end of its rate hikes (or that interest rates were leveling off).
The University of Michigan Survey
The University of Michigan conducts its own survey of consumer confidence, and it publishes several preliminary reports and one final report per month. Key components of the University of Michigan Survey are
The Index of Consumer Confidence
The Index of Consumer Expectations
The Index of Current Economic conditions
In April 2005, the University of Michigan reported that “Consumer confidence sank in April, marking the fourth consecutive monthly decline, with the Sentiment Index falling to its lowest level since September 2003.” The report cited rising gas prices and a poor job outlook as reasons for the sag in consumer confidence and the increasingly negative data for consumer expectations. The impact on the markets was predictable. Bonds rallied and so eventually did stocks — after an initial dip.
Again, the key to the report was that consumer confidence was falling. When consumers are less confident, the Fed is less likely to continue to raise interest rates.
Perusing the Beige Book
The Beige Book, one of my favorite reports, is a key report from the Federal Reserve that is released eight times per year. In each tome, the Fed produces a summary of current economic activity in each of its districts, based on anecdotal information from Fed bank presidents, key businesses, economists, and market experts, among other sources.
The 12 Federal Reserve District Banks are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
The Federal Reserve produces the Summary of Commentary on Current Economic Conditions, otherwise known as the Beige Book. In it, the Fed summarizes anecdotal reports on the economy by district and sector and packages it into a comprehensive summary of the 12 district reports. Each Beige Book is prepared by a designated Federal Reserve Bank on a rotating basis.
The Beige Book is released to the members of the Federal Open Market Committee (FOMC) before each of its meetings on interest rates, so it’s an important source of information for the committee members when they’re deciding in what direction they’ll vote to take interest rates.
On April 20, 2005, the Federal Reserve district in Dallas had its turn to publish the Beige Book and summarized its findings as follows:
“Eleventh District economic activity expanded moderately in March and early April. The manufacturing sector continued to rebound, while activity in financial and business services continued to expand at the same pace reported in the last Beige Book (the one released March 9, 2005). Retailers said they were disappointed with recent sales growth. Residential construction continued to cool from last year’s strong pace, amid signs that commercial real estate markets were slowly improving. The energy industry strengthened further, and contacts said exploration activity was expanding on the belief that energy prices would remain high. Agricultural conditions remained generally positive. While activity was strong in some industries, in many sectors contacts reported slightly less optimism about the strength of activity for the rest of the year, largely because demand has not been picking up as quickly as they had hoped.”
What I look for when I scan the full text on the Web is what the Beige Book says about individual sectors of the economy. Under manufacturing in April 2005, the Beige Book said that although little pickup was reported in the growth for electronics, slightly rising demand was noted for networking switches and other related products in telecommunications.
If you see something like that, you can start looking at the action of key stocks in that sector. Interestingly, the stock of Cisco Systems, the leader in switches and related products, made a good bottom in the month of April, and on April 21, a day after the Beige Book was released, it began to rally. By May 20, the stock was up over 10 percent.
For example, the Federal Reserve’s Beige Book released on October 17, 2007, summarized the U.S. economy as one that was expanding “in all Districts in September and early October.” Yet, in the next sentence, the Fed noted “but the pace of growth decelerated since August.”
That was enough to end a nice rally in the stock market. The Beige Book was released at 2 p.m. eastern time, and by the close the market was already not acting too well. Over the next couple of days, the market started to drift lower. And on October 19, the 20th anniversary of the Crash of 1987, the Dow Jones Industrial average dropped 366 points, as the market began to worry about the prospects for the economy.
By the same token, as expected, the bond market staged a nice rally.
Homing in on housing starts
Bond and stock traders like housing starts, because housing is a central portion of the U.S. economy, given its dependence on credit and the fact that it uses raw materials and provides employment for a significant number of people in related industries, such as banking, the mortgage sector, construction, manufacturing, and real-estate brokerage.
Big moves often occur in the bond market after the numbers for housing starts are released.
Released every month, housing starts are compiled by the U.S. Commerce Department and reported in three parts:
Building permits
Housing starts
Housing completions
The markets focus on the percentage of rise or fall in the numbers from the previous month for each component.
For example, the April 2005 report showed a 5.3 percent growth in the number of building permits, an 11 percent growth in housing starts (with a 6.3 percent growth in single-family homes), and a 3.4 percent growth rate in housing completions.
By contrast, the housing start numbers in the years 2006 and 2007 were dismal, as the housing boom contracted. These reports were closely correlated to the fall in the housing sector in the United States.
The problem comes when the weather clears, the projects get underway, and the numbers swell. Markets look at the seasonally adjusted numbers, which are smoothed out by statistical formulas used by the U.S. Department of Commerce.
Even then, this set of numbers is tricky. The Commerce Department disclaimer notes that it can take up to four months of data to come up with a reliable set of indicators.
Staying Awake for the Index of Leading Economic Indicators
The Conference Board looks at ten key indicators in calculating its Index of Leading Economic Indicators. Included are the
Index of consumer expectations
Real money supply
Interest-rate spread
Stock prices
Vendor performance
Average weekly initial claims for unemployment insurance
Building permits
Average weekly manufacturing hours
Manufacturers’ new orders for nondefense capital goods
Manufacturers’ new orders for consumer goods and materials
In April 2005, the overall index dropped and so did much of the economic data for that month. At the same time, the trend of economic growth remained up, once again confirming the notion that interest rate increases ordered by the Federal Reserve were starting to slow down the economy, but they weren’t dragging it into a recession.
Grossing out with Gross Domestic Product (GDP)
The report on Gross Domestic Product (GDP) measures the sum of all the goods and services produced in the United States. Although GDP can yield confusing and mixed results on the trading floor, it sometimes is a big market mover whenever it’s far above or below what the markets are expecting it to be. At other times, GDP is not much of a mover. Multiple revisions of previous GDP data accompany the monthly release of the GDP and tend to dampen the effect of the report. Although the GDP is not a report to ignore by any means, it usually isn’t as important as the PPI and CPI and the employment report.
Getting slick with oil supply data
Oil supply data became a central report outside of the oil markets in 2004 and 2005 as the price of crude oil soared to record highs during the war in Iraq. The Energy Information Agency (EIA), a part of the U.S. Department of Energy, and the American Petroleum Institute (API) release oil supply data for the previous week at 10:30 a.m. eastern time every Wednesday.
Traders want to know the following:
Crude oil supply
Gasoline supply
Distillate supply
A build is when the stockpiles of crude oil in storage are increasing. Such increases are considered bearish or negative for the market, because large stockpiles generally mean lower prices at the pump. A drawdown, on the other hand, is when the supply shrinks. Traders like drawdown situations, because prices tend to rise after the news is released.
Every week, oil experts and commentators guess what the number will be. Although they almost never are right in their predictions, the fact that they’re wrong sets the market up for more volatility when the number comes out and gives you a trading opportunity if you’re set up to take advantage of it.
Although crude oil supply is self-explanatory as the basis for the oil markets and is important year-round, two other supply factors are affected by these seasonal tendencies:
Distillate supply figures are more important in winter, because they essentially represent a measure of the supply of heating oil.
Gasoline supplies are more important as the summer driving season approaches.
Other holidays sometimes can affect oil supply numbers. The market tends to factor their effect into the numbers, though, so for other holidays to have a big effect on trading, the surprises have to be very big.
The market has changed, however, because of problems with refinery capacity in the United States and the aftereffects of two major hurricanes (Katrina and Rita) in 2005 in the Gulf of Mexico region. Volatility in the markets and supply numbers will evolve over the next few years. See Chapter 13 for a full rundown of the energy markets.
Enduring sales, income, production, and balance of trade reports
The hodgepodge of data that trickle out of the woodwork throughout the month about retail sales, personal income, industrial production, and the balance of trade sometimes causes a bit of commotion in the futures markets, but these individual reports mostly cause only a few daily ripples, unless, of course, the effect of the data is dramatic.
As a futures trader, you need to know that these reports are coming, but a good portion of the time, they come and go without fanfare or trouble, unless the economy is at a critical turning point and one of these reports happens to be the missing piece to the puzzle.
Trading the Big Reports
The greatest effect that each of the reports highlighted in this chapter can have is on the futures markets associated with bonds, stock indexes, and currencies. Thus, the best strategies for trading based on these reports are found in those markets.
Any report can make the market move up or down if the market finds something in the report to justify the move, but some general tendencies to keep in mind include the following:
Reports that show a strengthening economy are less friendly to the bond market and tend to be friendlier toward stock-index futures and the dollar. Although this isn’t a hard and fast rule, as always, trade what’s happening, not what you think ought to happen (see Chapters 10, 11, and 12).
Signs of slowing growth or a weak economy tend to be bullish, or positive, for bonds and less friendly toward stock indexes and the dollar.
Short-term interest-rate futures, such as in Eurodollars (see Chapter 10), may move in the opposite direction of the 10-year Treasury note (T-note) or long-term (30-year) bond futures.
Gold, silver, and oil markets may respond aggressively to these reports. (To find out more about the markets in these commodities, see Chapters 13 and 14.)
The Federal Reserve may make comments that accelerate or reverse the reactions and responses to economic reports.
Keeping It Simple
Futures traders can set up complicated strategies in advance of the release of a big economic report, but you can make trading these reports simple by keeping your eye on the trend before the report is released.
Say the trend is up in the stock market, and you are long a position in the S&P 500 stock index futures. You also know that the market is waiting for the employment report, and that it anticipates the number of new jobs to decrease.
A small number of new jobs usually means that the market is expecting the economy to weaken, which could mean that the stock market will rise or fall, depending on which way the market handicaps the response of the Federal Reserve.
If you are cautious and have a nice profit on your S&P 500 futures, you could offset it, take your profits, and wait to see what happens with the report.
Another approach is to hedge your bets in the stock market by using the bond market. Economic weakness usually leads to higher bond prices. That means that you can establish a long position in the U.S. Ten Year note futures one or two days before the employment report in hopes that if the report comes in weak, you can profit from a rally in the bond market, and thus protect any gains that you have in your stock position.
The market will respond when the report is released. If the number is weak, watch what happens in bonds and stocks in response. You can watch it on your computer, or you can watch the response on CNBC.
If things are not going your way, you can offset either one position or both of them depending on what’s happening at the time. If both the stock and bond market like the report, you can hold both positions and offset them later, either based on your price targets or if the trend turns against them.