From the November 01, 2010 issue of Futures Magazine • Subscribe!

Getting technical with economic data

One of the most notable positive industrial production divergences occurred in 1987. Heading into the fall of that year, the stock market had just completed all-time highs when the DJIA reached an unheard of price of 2752.07 in August. Within two months, the bloom came off the rose and the DJIA had plummeted more than 40%. As in 1929, there was investor panic. As in 1974, there were calls for the start of a new Depression with suggestions by some that the index was headed back to the 1974 lows (616.08) or worse.

But unlike 1929, industrial production was rising as it had done in 1937 and 1962 when the stock market was doing its best to eviscerate portfolios. When the stock market was undergoing a massive consolidation from 1966 until the upside breakout in 1982, industrial production gained nearly 50% during the same 16-year period. Later, the measure rallied to a new all-time high in August 1988 and nearly a year before the stock market hit new highs in August 1989. Another instance of a major diversion from the stock market occurred when industrial production hit a statistical bottom at the end of November 2001 and more than a year before the equity market reached its lows in October 2002 (see "Chasing production," below).

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This brings us up to the most recent stock market and economic cycle, the period from the fall of 2007 to date. Industrial production data peaked in September 2007, a month before equity market data stalled out in early October. Stock market prices hit their lows in March 2009 while industrial production data were late with a low hit three months later at the end of June 2009. Since then, both series of data have risen, with an exception.

While stock market prices as measured by the DJIA have threatened to penetrate the trailing 50-month moving average, industrial production data have, as yet, been unable to move upward through the same average. While, admittedly, industrial production has only a short distance to go before it penetrates its average to the upside, not since the 1929 crash has industrial production taken so long to do so. While that hesitation could be preceding more strength in both the market and industrial production, as neither series is overbought as yet, the disparity nevertheless bears watching in the fourth quarter of 2010.

Exceptions make a difference

When looking for linkage between data sets, be prepared for exceptions to the rule. When the linkage works, and the data makes a statistical bottom at the same time as stock market prices and then stochastics rise, so much the better. If equities are weak when industrial production data are strong, for example, different conclusions can be inferred. Sometimes, though, the fundamental data signals will be out of synch with equity market prices. The analyst then tries to determine the importance of the disparity by looking for the next point of synchronicity, which could offer new opportunities.

With analysis underway, it is important to know that when combined with a second fundamental data stream, such as housing starts, two separate markets are being considered. Improvement in housing starts, for example, could have a positive effect on the earnings of home builders, on employment in general and on retail sales as consumers ramp up home-related purchases leading to a commensurate rise in the prices of related equities. Then there are those points when the relationship dissipates, which happened in early 2006. Starts peaked and housing construction and real estate prices sank. But it wasn’t until nearly a year and a half later that the broad stock market began a major decline.

It is possible that economic data can lead equities and be measured by slow stochastics or other classic technical analysis indicators, despite historical presumptions. When both economic data and stocks are oversold, the odds are good both will rise thereafter on the longer term. Notice also that when industrial production remains strong and the stock market is declining, equity weakness may be suspect. Such a bias has been the case many times with industrial production since 1920. While this information has little practical short-term value, knowing the status of major trends can help you avoid some pitfalls of long-term investing.

While technical analysis has been traditionally applied to data in the financial markets, primarily equities, there is a wide array of economic and fundamental data that can hold a wealth of information when technical indicators are similarly applied to that data. Knowing the status of an economic series as compared to a traditional stock market index, such as the DJIA or the S&P 500, can provide a useful perspective on not only the stock market, but also the economy. Simply put, while the argument will no doubt continue as to which market approach, technical or fundamental, offers the best approach for traders, statistical knowledge based on the application of the same indicators to apparently unrelated streams of data on a similar cycle could provide answers that no true believer in either camp might imagine — or deny.

Robert McCurtain is a technical analyst, market timer and private investor based in New York City. He can be reached at 
traderbob@nyc.rr.com.

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