Chart of the Week July 25, 2004

Chart of the Week – July 25, 2004

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com

Take a look at the charts below from Barchart.com, a site that I have found quite helpful in following a variety of markets. Notice the intermarket dynamics that led to the May bottom, which—thus far—has represented a momentum low in the averages: weak euro and yen/strong dollar; strong crude oil; weak bonds; weak gold; and smaller-cap weakness relative to large cap stocks. The weak Euro has been in evidence during the past four trading sessions, a period in which the TWAP for the ES has dropped from 1104 to 1087. Also over the past four sessions, we have seen crude oil approach its recent highs, knocking at the door of $42.00/barrel and gold drop below $400/oz.

There are discrepancies relative to May as well, however. The one glaring discrepancy over the past four days—and indeed since the May lows—is the bond market. The bonds are stronger now than during the May weakness. Moreover, despite hovering near the March and May lows on the large cap equity indexes (S&P 500, NASDAQ 100), we remain above those lows on the smaller caps and in the Japanese market. Furthermore, while the euro and yen have been weak in the past several days, they remain well above their May lows, just as the dollar is well off its May highs.

So what are we to make of this? The high price of crude oil is surely taking its toll on the world economies. Not so long ago, the market was worried about stronger economic statistics and Fed interest rate tightening. The recent strength in bonds suggests that large rate hikes are not in the offing, and this may be moderating both strength in the dollar relative to other currencies and weakness in the growth-sensitive smaller cap stocks. If crude prices were to screamingly break above $42, I would expect a major selloff in stocks and relative hurt put on the euro and yen relative to the dollar (as both Euro and Asian economies are more dependent on oil imports). Conversely, if oil cannot break to new highs and returns to the thirties, I would expect the dollar to weaken relative to the other major currencies and stocks—particularly smaller cap—to benefit. Thus far, comparing the market today to the May market, the currencies and equities are not anticipating an upside breakout in crude. Neither are the bond or gold markets shouting inflationary messages. Those are some reasons I am not a bear despite recent market lows.

Brett N. Steenbarger, Ph.D. is Director of Trader Development for Kingstree Trading, LLC in Chicago and Clinical Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY. He is also an active trader and writes occasional feature articles on market psychology for a variety of publications. The author of The Psychology of Trading (Wiley; January, 2003), Dr. Steenbarger has published over 50 peer-reviewed articles and book chapters on short-term approaches to behavioral change. His new, co-edited book The Art and Science of Brief Therapy is a core curricular text in psychiatry training programs. Many of Dr. Steenbarger’s articles and trading strategies are archived on his website, www.brettsteenbarger.com