Part II : Asset Building Through Equity

Part  II :   Asset  Building  Through  Equity

CHAPTER 9: BUSINESS CYCLE AND STOCKMARKET

“THE UNSEEN FORCE THAT MOVES THE MARKET”

The wise never undertake an enterprise

Which rashly risks existing capital to reach for potential profits.   

                                                                                                     THIRUKKURAL   Verse 463

INTRODUCTION:

Business cycles started with industrialization. They are not regular and are not all alike. They are not identical twins, but they are recognizable as belonging to the same family. Each cycle has different lengths and the turning points are hard to predict.

The financial markets and the real economy interact between themselves and in doing so they display cause and effect relationships. The outcome is business and financial cycles which last for about 5 to 7 years.

Modern Business Cycle:

Paul.A.Samuelson has described a modern business cycle as follows: “Business conditions never stand still. Prosperity is followed by a panic or crash. National income, employment and production fall. Prices and profits decline and men are thrown out of work. Eventually the bottom is reached, and revival begins. The recovery may be slow or fast. It may be incomplete, or it may be so strong so as to lead to a new boom. The new prosperity may represent a long sustained plateau of brisk demand, plentiful jobs, buoyant prices, and increased living standards. Or it may represent a quick, inflationary flaring up of prices and speculation, to be followed by another disastrous slump”.

When cycles are unusually long, it is the depression, rather than the prosperity, that is long.

ECONOMIC INDICATORS:

Economic indicators are useful in understanding business cycles.

The great majority of economic indicators fall into one of the following three categories: leading, coincident, and lagging indicators.

The basic thread tying together all the indicators is their lead-lag relationship and the important feedbacks which keep the system under control. These features make the prices move between extremes (over bought and over sold), creating investment opportunities.   The reason is that they are quite reliable in anticipating changes in the economy and the financial markets.

Important turning points in the growth of the money supply lead to turning points in the growth of the economy.

For a period extending to over 100 years, ‘The National Bureau of Economic Research’ (N.B.E.R.), New York, has established 26 Business Cycle indicators for the US economy. To mention a few below:

Leading  Indicators:

1.  Average work week, manufacturing

2.  Gross accession rate, manufacturing

3.  Housing starts

4.  Number of new incorporations

5.  Corporate profits after taxes

6.  Stock market price index of common stock

7.  Industrial raw materials, spot market price index

Coincident Indicators:

1.  Employment in non-agricultural establishments 

2.  Unemployment rate

3.  Total industrial production index

4.  Gross National Product

5.  Personal income

6.  Wholesale price index excluding form products

Lagging Indicators:

1.  Plant and equipment expenditure, total

2. Wage and salary cost per unit of output, 

    Manufacturing

3. Consumer installment debt

4. Bank interest rates

The leading indicators provide a clue to the future of economy. Their behavior has forecasting significance. A forecast may be made on their performance and subsequently confirmed by the performance of the other indicators. The ideal indicator does not exist. If it did, then the other indicators would be superfluous.

Monitoring over the decades has proved that the leading indicators have performed remarkably well. In particular the stock market price index has been found equally dependable.  

Business Cycle & Stock Performance

Why is this analysis crucial for the investor? The answer is that it tells you about the level of risk in the stock market and about alternative investment opportunities. It provides you with a blueprint of how to manage your investments. As new information becomes available you know the position of the stock market relative to the economy and other markets. But what is even more important for the investors is the understanding of knowledge of the relationship existing between them to know what is to expect.

ECONOMIC CYCLE AND STOCK CYCLE

The above chart shows a typical business cycle and the points at which various economic sectors tend to outperform the broader market. The chart is a historical representation of stock performance movements relative to the business cycle and is not intended to convey any current or future economic outlook.

Conclusion:

“The 28 year record of Indian Stock market (1938 to 1966) shows that the Indian Stock Market price index is cyclical – that is, it has distinct crests and troughs, separated by long intervals of time”.                                                       Business Forecasting – G.R.Mansukhani

The trend of stock price index has been a subject of research for the past many decades. Dependable and reliable method of determining the trend has been evolved. The basic principles for determining stock trends were laid down by Charles H.Dow around 1900; popularly known as Dow Theory. Let us have an insight on Dow Theory in the next chapter.

Dr.Felisleo

26.12.2010

PART II: CHART PATTERNS

PART II: CHART PATTERNS

 8 - B: CLASSIFICATION OF CHARTS  

5.  ‘OPEN HIGH LOW CLOSE’- (Bar) - Chart

An open-high-low-close chart (also OHLC chart or simply Bar chart) is typically used to illustrate movements in the price of a financial instrument over time.

 Each vertical line on the chart shows the price range (the highest and lowest prices) over one unit of time, e.g. one day or one hour. Tick marks project from each side of the line indicating the opening price (e.g. for a daily bar chart this would be the starting price for that day) on the left, and the closing price for that time period on the right. The bars may be shown in different colors depending on whether prices rose or fell in that period.

* To enlarge the chart Double click by keeping the cursor above the chart.

The Japanese candlestick chart is another way of displaying market price data, with the opening and closing prices defining a rectangle within the range for each time unit. Both charts show exactly the same data, i.e. the opening, high, low, and closing prices during a particular time frame. Some traders find the candlestick chart easier to read.

6.  Candlestick Chart

 

A candlestick chart is a kind of bar-chart used primarily to describe price movements of a security, derivative, or currency over a period of time.

It is a combination of a line-chart and a bar-chart, in which each bar represents the range of price movement over a given time interval. It is most often used in technical analysis of equity and currency price patterns.

Candlesticks are usually composed of the body (black or white), and an upper and a lower shadow (wick). The area between the open and the close is called the real body, price excursions above and below the real body are called shadows.

CANDLESTICK

The wick illustrates the highest and lowest traded prices of a security during the time interval represented. The body illustrates the opening and closing trades. If the security closed higher than it opened, the body is white or unfilled, with the opening price at the bottom of the body and the closing price at the top. If the security closed lower than it opened, the body is black, with the opening price at the top and the closing price at the bottom. A candlestick can have either a body or a wick or both.

To better highlight price movements, modern candlestick charts (especially those displayed digitally) often replace the black or white of the candlestick body with colors such as red (for a lower closing) and blue or green (for a higher closing).  

Candlestick charts are a visual aid for decision making in stock, forex, commodity, and options trading. For example, when the bar is white and high relative to other time periods, it means buyers are very bullish. The opposite is true for a black bar. 

GOLD CANDLESTICK

TATA STEEL CANDLESTICK

It is not necessary to master all kinds of chart reading. In my opinion mastering the Bar Chart is more than enough. Candle stick chart can be useful for some short term trading.

Hence we will be discussing the chart patterns and its implications using OHLC charts in our next session

Dr.Felisleo

23.12.2010

Part II : Asset Building through Equity

Part  II :   Asset  Building  Through  Equity

CHAPTER 8: BUSINESS CYCLE

“THE UNSEEN FORCE THAT MOVES THE MARKET”

Embark upon an action after careful thought. It is folly to say,

"Let us begin the task now and think about it later."    

                                                                              THIRUKKURAL   Verse 467

WHAT IS BUSINESS CYCLE?

A business cycle refers to periods of expansion and contraction. A peak is the high point following a period of economic expansion. A trough is the low point following a period of economic decline.

It is a long-term pattern of alternating periods of economic growth (recovery) and decline (recession), characterized by changing employment, industrial productivity, and interest rates. Also called as economic cycle.

A business cycle is not a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock. Its timing is random and, to a large degree, unpredictable. A business cycle is identified as a sequence of four phases:

 “Schumpeter” labeled the "four-phases" of a cycle as: 

                                   Boom – Recession – Depression - Recovery.

Depression:

 When the economy is characterized by large unemployment rates, a decline in annual income, and overproduction, it is said to be in a state of depression. The point at which the real GDP stops declining and starts expanding is the lowest point. Sooner or later, the recession will reach the bottom of the business cycle. How long the cycle will remain at this low point varies from a matter of weeks to many months. During some depressions, such as the one in the 1930s, the low point has lasted for years.

 Peak:

The point at which the real GDP stops increasing and begins its decline signifies the highest point. At the top or peak of the business cycle, business expansion ends its upward climb. Employment, consumer spending, and production hit their highest levels. A peak, like a depression, can last for a short or long period of time. When the peak lasts for a long time, we are in a period of prosperity.

One of the dangers of peak periods is that of inflation. During periods of inflation, prices rise and the value of money declines. Inflation is more of a threat during peak periods because employment and earnings are at high levels With more money in their pockets, people  are willing to spend more than before In this way, demand is increased and   prices rise.

How we measure business cycle?

The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in Real GDP and other macroeconomic variables.

What are Real GDP and Nominal GDP?

Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. In other words, it also considers the effect of inflation on the value of goods and services.

The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. It does not consider the effect of inflation on the value of goods and services.

 Stages of Business Cycle :

Expansion: A speedup in the pace of economic activity, resulting in expansion of production and employment.

Peak: The upper turning of a business cycle is characterized by peak production, highest employment and highest inflationary pressure. Low levels of both unemployment and labour shortage push up wage rates. High levels of consumer borrowing and spending occurs. During peak, Firms work at full capacity, profit levels will be high, and inflation and interest rate will be increasing. There will be a “boom” in housing market.

Contraction: A slowdown in the pace of economic activity. During contraction, Industrial production and employment go down.

Trough: (Recession) Recession is a general slowdown in economic activity over a long period of time, or a business cycle contraction. Production as measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization, household incomes, business profits and inflation fall during recessions. Bankruptcies and the unemployment rate rises. Production and employment hit the lowest levels.

 Revival: The lower turning point of a business cycle, where a contraction turns into an expansion. Consumer confidence grows leading to increased borrowing and spending. Firms increase output, build up stock levels, Spare capacity used, then Investment increases and Unemployment falls. It may take more than a year of recovery for large changes in unemployment.

How the real economy and financial markets interact? We will discuss in the following chapter.

Dr.Felisleo

19.12.2010

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PART II: CHART PATTERNS

PART II: CHART PATTERNS

 8 A :  CLASSIFICATION OF CHARTS 

Introduction:

In stock and commodity markets charts represents the pattern of price movement over a period of time. In these charts y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis) represents the time scale.

CHARTS USED BY ANALYST

 1.  Point and Figure Chart

In this chart time is not taken for plotting the chart. Plotting is done based on day to day price movement. Point and figure charts are composed of a number of columns that either consists of a series of stacked ‘X’s or ‘O’s. A vertical line of ‘X’s is used to illustrate a rising price, while ‘O’s represent a falling price.

2.  Three Line Break Chart

This is a popular financial charting method used in Japan. This chart also ignores the time element.  These charts display a series of vertical boxes

 ‘lines’ that reflects changes in price values.

3.  Kagi Chart

Once again a chart developed by the Japanese in the 1870s that uses a series of vertical lines to illustrate general levels of supply and demand for certain assets. Thick lines are drawn when the price breaks above the previous high price and is interpreted as an increase in demand.  Thin lines are used to represent increased supply when the price falls below the previous low. This chart also does not give importance to time.

4. Renko charts

The filled and hollow squares that make up a Renko chart are often referred to as "bricks." Renko charts have a pre-determined "Brick Size" that is used to determine as to when new bricks need to be added to the chart.

 If prices move more than the Brick Size above the top (or below the bottom) of the last brick on the chart, a new brick is added in the next chart column. Hollow bricks are added if prices are rising. Black bricks are added if prices are falling. Only one type of brick can be added per time period. Bricks are always with their corners touching and no more than one brick may occupy each chart column.

Renko charts may not change for several time periods. Prices have to rise or fall "significantly" in order for bricks to be added. Hollow bricks are bullish, black bricks are bearish.

TO BE CONTINUED

Dr.Felisleo

16.12.2010