Macro-Economic Trading

Durable Goods

This data is released three to four weeks after the end of the current month. Since the production of durable goods account for 15 percent of total GDP one would think this is data would be followed closely. Again, this data is volatile and subject to major revisions.

Factory Orders

The Department of Commerce releases the factory orders report approximately one week after releasing the durable goods report. The factory orders report consists of durable good and nondurable goods such as food and tobacco and paper goods. The factory orders report is mainly a repeat of the durable goods report because nondurable tend to grow at a fairly predictable clip. However, it features some new and useful information on manufacturing inventories. The inventory data will become acutely important at possible key turning points in the business cycle. In a growing economy with increasing demand, an inventory build-up points to more growth. In a contracting economy with decreasing demand, an inventory build-up points to “SELL, SELL, SELL”.

Business Inventories and Sales Report

This report includes inventory and sales statistics for all three stages of the manufacturing process including manufacturing, wholesale and retail. Technically, this report should be greeted with some zeal by Wall Street, but in practice it is not. Let’s examine the recessionary chain reaction. First, when sales start to slump and inventories begin to build, businesses start to cut back on production to halt the buildup in inventories and also begin layoffs. Secondly, these unemployed workers will have less to spend so inventories build some more as sales fall further. This leads to more production cutbacks and layoffs. Next, the downward recessionary spiral continues. This report is greeted with the same degree of apathy as both the durable goods and the factory orders report. This report contains no new information other than on retail inventories.

Industrial Production and Capacity Utilization

Capacity utilization provides a clear signal for inflation while industrial production is viewed as a signal of economic growth. The Index of Industrial Production reports on three main categories in the economy – manufacturing, mining and utilities and it has been designed to capture the physical volume of output. The interesting thing about this index is that it covers a large portion of our cyclical sectors including paper, chemicals, machinery and equipment. This makes the index well worth watching for most traders who use movements in the business cycle to rotate in and out of sectors. In fact, this measure is one of the four coincident indicators used by the Conference Board to help define key turning points in the business cycle.

The Fed’s measure of capacity utilization is simply the ratio of the Index of Industrial Production to a related index of capacity. It measures the extent to which manufacturing plants are being used to produce goods. Most economists believe that when the rate of capacity utilization is above 85 percent, inflationary pressures will begin to build. At this point (the threshold point for inflation), any further increase in demand will outstrip the ability to produce. Bottlenecks will emerge in the production process if the capacity levels increase further. This is a bearish signal since it raises the probability that the Federal Reserve will raise interest rates.

Leading Indicators What does it mean
The average workweek More overtime precedes an expansion and less a recession
Initial jobless claims for unemployment benefits Claims rise as the economy begins to enter a recession and fall with an expansion
Percent of companies receiving slower inventories Slower deliveries mean business is booming
New factory orders for consumer goods This is the first step in the production process. As orders increase, production soon follows. As they fall, there’s trouble in the horizon
New building permits As the Fed raises or lowers interest rates to slow or stimulate the economy, this sector is the first to feel it
Consumer confidence When consumer spirits soar, the economy will start to soar; when confidence falls the GDP goes with it
New orders for non-defense capital goods A bullish sign when rising investment foreshadows expansion; a bearish signal when falling investment signals contraction
S&P 500 Stock Market Index Historically, the market peaks months before a recession hits and troughs months before the recovery begins.
The Money Supply (M2) More money means lower interest rates and more investment; less means the opposite
The interest rate spread (10-year bond less Fed funds rate) An inverted yield curve (when short term rates rise above long term rates) signals recession

Inflation and News

I recently took some finance classes at the local university and the professor talked about the markets being efficient or semi-form efficient. He claims you cannot make any money on news that comes out in the Wall Street Journal or any such publication because that news is old news by the time you read it. Anyway, time and again I have seen news in the paper or on CNBC and make a killing on the news – even though it is “old news”.

If you do not know how to interpret the news you hear or read, you could lose your shirt. There was the time when we heard that the Producer Price Index was showing a sharp rise in inflation because of rising oil prices. We thought the Nasdaq would trend down on the news…instead it went up. Later we heard that the CPI numbers were blazing hot – due to a jump in the CPI’s core inflation rate. Now, having been burnt the first time around, which way should we place our bets this time.

To figure out which way the market will trend on inflation news, we have to understand the driving force behind the inflation numbers. First there is the demand-pull variety that comes during economic booms – here there is too much money chasing too few goods. Second there is the cost-push variety that results from supply shocks like oil price hikes or drought induced food price hikes. Finally, there is wage inflation. This latter kind is the most dangerous of all and it can be triggered by either the demand-pull or cost-push varieties of inflation. When faced with inflation news, Wall Street and the Federal Reserve will react differently.

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