The Tycoon Report

Conquer the 'P-C Condition' in Your Trading

Monday, April 27, 2009 | Barbara Cohen

After trading for years, teaching others to trade, answering questions in my chat room, and reading hundreds of comments on blogs, it would seem that daytraders, futures traders, stock traders, options traders and investors in general fall prey to the "P-C Condition" on a daily basis. 

Until and unless you can become the master over this most troubling condition, your ability to do well as a trader will be an uphill battle.

Mastering the P-C Condition

What is the "P-C Condition?"  Simple ... Pre-Conceived. 

And this condition affects those whose actions might, in turn, have some impact on yours.

How so?

Every morning, investors worldwide begin their trading day with a pre-conceived idea of where the market is going.  Whether you are trading the DAX in Germany, the CAC in France, the FTSE in London, the Nikkei in Japan, or the NYSE in America, the market's movement is -- in the mind of the average trader -- already cast in concrete.

Some traders are bullish on the market; others are bearish.  It is the old "How much water is in the glass?" routine.  Put four ounces of water in an eight-ounce glass and ask people how much water is in the glass.  Some will answer, "It's half-full."  Others will say, "It's half-empty."  This either/or mindset also applies to most traders.

The problem with having pre-conceived ideas about the market is that you tend to trade accordingly.  If you have a bullish tendency, you'll wait for an opportunity where you can go long -- at the expense of ignoring potentially excellent shorting signals. And vice versa.

Listen for the 'Whispers'

This past week in the markets proved why pre-conceived ideas about market reaction and direction are dangerous.

A very common trading style among many traders, and futures traders in particular, is playing quarterly earnings announcement releases. 

In the past, if an S&P 500 stock beat analysts' earnings estimates, the market soared and futures traders would immediately go long. If a company's earnings couldn't top forecasts or simply came in line with expectations, the market dropped, and everyone would go short.  Traders learned which stocks were big enough to move the market and showed up every earnings season to trade when those particular earnings were released.

The only thing traders had to be careful of was the "whisper number."  Analysts publish their earnings estimates based upon company fundamentals.  But kind of "under the table," they create a "whisper" number -- the number they really think the stock's earnings will hit.  Web sites such as WhisperNumber.com provide traders with this inside scoop.

But much of that has changed now.  Analysts still make forecasts. WhisperNumber.com still provides the inside skinny.  But coming to your desktop trading application with the pre-conceived strategy of going long or short based on announcements is dangerous.

For example, this past Monday, Bank of America (BAC) topped analysts' estimates with a Q1 $4.25 billion profit, saying that was more than it earned in all of 2008.  The announcement was made before the market opened.  The initial reaction was negative, with the stock losing nearly 7% in pre-market trading.

The same day, after the market closed, IBM (IBM) reported Q1 results.  Revenue fell more than 11%.  The company said revenues from its software business were down 6% and global-services revenue was down 10%.  The stock rose above $100 per share from $99 on the announcement.

The next day (Tuesday), Yahoo! (YHOO) announced earnings after market hours.  The company posted a nearly 80% drop in Q1 profit as online advertisers cut back on their spending.  That's right, 80%. 

So, what happened? Well, the stock skyrocketed nearly 10% on the announcement (along with the market) because Yahoo! said it would cut jobs.

It's just downright amazing, the dichotomy of reactions to earnings news, whether good or bad. Imagine if Yahoo! had reported a 90% earnings reduction -- the stock would have doubled! 

Is it Earnings Season or a Parallel Universe?

In other earnings-related news, Altria's (MO) Q1 profit dropped 76% with fewer smokers worldwide.  But because Altria beat estimates (39 cents instead of 38 cents), the stock soared and took the market with it.

T-Rowe Price's (TROW) Q1 profits were down 65% after being down 87% in Q4.  Assets under management fell another 3% after the 20% drop the month earlier, down 33% from a year earlier.   However, the stock soared because they also announced 288 layoffs.

Similarly, ConocoPhillips (COP) dropped 80% in Q1 profits and closed a buck higher.  Fifth Third Bank (FITB) posted a loss of 4 cents per share vs. 54-cents-per-share profit a year earlier.  Fifth Third rose 4% because the loss was lower-than-expected.

Finally came Microsoft (MSFT), reporting after the market closed on Thursday.  Its Q3 profit plunged as sales of computers with Windows fell.  Net income was 33 cents per share vs. 47 cents the year before.  Analysts had predicted 39 cents, so the actual 33 cents was well-below forecasts.  The results followed Q2 dismal earnings when the company announced plans to ax 5,000 jobs. Microsoft expected "weakness to continue through at least the next quarter."

Under normal conditions, this type of announcement would have sent the market reeling.

For Microsoft, though, this was its first year-over-year decline since its Initial Public Offering in 1986.  What was the initial reaction? The stock soared and closed more than 10% higher.  In fact, Microsoft's announcement sent the market skyrocketing Friday, with the Dow closing up by more than 100 points.

Leave All 'Expectations' Behind Before You Trade

With lowered analysts' earnings expectations across all sectors, it seems that if a company didn't close its doors in the last quarter, it is considered to be good news.  The market has changed and, to remain a consistently profitable trader, you must change with it.  Trade what is in front of you. Don't trade with a pre-conceived strategy.

So, what will this week hold for us?  The last week of the month always brings lots of economic news.  Tuesday is consumer confidence.  Anything below 50 is considered a contraction, and last month it ticked down to 26.  Estimates are at 28, which is still pretty low, so that should be an OK report. (Even a report that comes in line with expectations will be considered good.) 

But be careful trading on Monday and Tuesday.  The market won't do much trading because Wednesday holds both Gross Domestic Product numbers (at 8:30 a.m.) and the Federal Open Market Committee meeting with interest rate decisions on the line at 2:15 p.m. 

Right now, it's best to make your trading light; go for less profit and shorter trades.  Remember, the only truly realistic expectations in the market may be your own!





Barbara Cohen
Contributing Editor
The Tycoon Report


Economic Calendar for the Week of April 27-May 1   

TUESDAY, APRIL 28

8 a.m. Consumer Confidence

    * Importance (A-F):  This release merits a B-.
    * Source: The Conference Board.
    * Release Time: 10:00 ET on the last Tuesday of the month (data for current month).
    * Raw Data Available At: http://www.tcb-indicators.org

The Conference Board conducts a monthly survey of 5000 households to ascertain the level of consumer confidence. The report can occasionally be helpful in predicting sudden shifts in consumption patterns, though most small changes in the index are just noise. Only index changes of at least five points should be considered significant. The index consists of two subindexes - consumers' appraisal of current conditions and their expectations for the future. Expectations make up 60% of the total index, with current conditions accounting for the other 40%. The expectations index is typically seen as having better leading indicator qualities than the current conditions index.

Highlights

    * The hurdle rate for the March Consumer Confidence report was low. That's a good thing, too, because the Conference Board reported confidence levels edged up only slightly from a record-low reading of 25.3 in February to 26.0 in March.

    * The consensus estimate stood at 28.0, so the headline provoked an initial sense of disappointment. That disappointment was mitigated, however, by a pickup in the expectations index to 28.9 from 27.3.  That variable is why the market was able to stomach a dip in the present situation index to 21.5 from 22.3.

    * There was an increase in the perception that jobs are hard to get to 48.7% from 46.9%, yet the employment outlook implied slightly less pessimism than was registered in February, as 42.6% of respondents anticipated there would be fewer jobs versus 47.0% in the prior month.

    * Fewer respondents than seen in February had plans to buy a car, a home, or a major appliance, which speaks to the underlying concern about job security and income potential.

Key Factors

    * The improvement in the expectations index is still a long way from suggesting consumers are optimistic, but it does suggest they are less pessimistic than before, which is an important distinction as the market embraces the possibility the economy might be in a bottoming process.

Big Picture

    * Consumer sentiment indices get way too much attention.  The simple fact is that sentiment does not correlate with consumer spending and thus has little predictive value.  Consumer spending correlates more closely with income.  Sentiment tends to reflect well known factors such as unemployment rates and gas prices more than it predicts future spending patterns.


WEDNESDAY, APRIL 29

8:30 a.m. Gross Domestic Product

    *  Importance (A-F): This release merits a B.
    * Source: Bureau of Economic Analysis, U.S. Department of Commerce.
    * Release Time: Third or fourth week of the month at 8:30 a.m. Eastern for the prior quarter, with subsequent revisions released in the second and third months of the quarter.
    * Raw Data Available At: http://www.bea.doc.gov/bea/dn1.htm

Gross Domestic Product (GDP) is the the broadest measure of economic activity. Annualized quarterly percent changes in GDP reflect the growth rate of total economic output. The figures can be quite volatile from quarter to quarter. Inventory and net export swings in particular can produce significant volatility in GDP. The final sales figure, which excludes inventories, can sometimes be helpful in identifying underlying growth trends as inventories represent unsold goods, and a large inventory increase will boost GDP but might be indicative of weakness rather than strength. The broad components of GDP are: consumption, investment, net exports, government purchases, and inventories. Consumption is by far the largest component, totaling roughly 2/3 of GDP.

In addition to the GDP figures, there are GDP deflators, which measure the change in prices in total GDP and for each component. Though the consumer price index is a more closely watched inflation indicator, the GDP deflator is another key inflation measure. Unlike CPI, it has the advantage of not being a fixed basket of goods and services, so that changes in consumption patterns or the introduction of new goods and services will be reflected in the deflator.

    * Q4 real GDP decreased at an annual rate of 6.3% versus a previously estimated -6.2% in the preliminary report and -3.8% in the advance report. According to the government, the decrease primarily reflected negative contributions from exports, personal consumption expenditures, equipment and software, and residential fixed investment (i.e. most of the major components) that were partially offset by none other than a positive contribution from government spending.

    * Personal consumption expenditures declined at a 4.3% annual rate in Q4 versus an originally reported 3.5%. That accounted for 3 percentage points alone of the GDP decline. Net exports, meanwhile, knocked off 0.15 percentage points versus adding 0.1 percentage point for the advanced number.

    * Equipment and software took off 2.18 percentage points and residential fixed investment subtracted 0.80 percentage points. Government spending added 0.26 percentage points.

    * Reflecting the rapid deterioration in demand, final sales of domestic product, which is GDP less the change in private inventories, decreased 6.1% in the fourth quarter compared to a 1.3% decrease in the third quarter.

Key Factors

    * The final Q4 GDP report serves as a startling reminder of how quickly things turned down in Q4. The trends for Q1 are a bit better, but the ultimate outcome should still be a relatively large contraction in real GDP, which Briefing.com currently estimates to be 4.0%.

Big Picture

    * The trends in the economy were moderately poor through the summer.  Then, in September, the trends tanked along with the stock market.  Some tech firms noted a significant dropoff in demand right after the mini-panic of mid-September.  These worsening trends are apparent in the fourth quarter GDP numbers, and will remain so into 2009 as well.  Consumer spending is weakening and will only take a significant turn for the better once the declines in payroll moderate.  Business investment is also in retreat.  The stronger dollar clearly hurt export demand.  A lot now depends on overall psychology and perceptions of how well the government responds to the financial market and other problems such as exist in the auto industry.  The economic outlook is now as much a function of government action as it is of the traditional correlations and trends among macro-economic variables.


THURSDAY, APRIL 30

8:30 a.m. Employment Cost Index

    * Importance (A-F): This release merits a B .
    * Source: U.S. Department of Labor, Bureau of Labor Statistics
    * Release Time: 8:30 ET, near the end of the first month of the quarter for the prior quarter.
    * Raw Data Available At: http://stats.bls.gov/news.release/eci.toc.htm

The Employment Cost Index (ECI) is designed to measure the change in the cost of labor. The ECI compensation series includes wages and salaries and employer costs for employee benefits. The sum of the change in these two components equals the change in total compensation. Benefits covered by the ECI include paid leave, insurance benefits, and retirement and saving benefits. Because these account for roughly 30% of total employment costs, their absence in the monthly earnings series leaves us with an incomplete picture.

Big Picture

    * Employment costs are the major component of business costs.  The trend in these data therefore have important implications for cost-push inflationary pressures and for profit margins.  In recent quarters, the trend has been relatively steady to lower.  The year-over-year total increase in the ECI has now dropped below 3% for the first time in years. Weak overall demand in the economy should keep the ECI cost index on the current trend.  At 2.6% this does not represent much inflationary pressure, as productivity gains of close to 2% leave unit labor costs rising at a modest pace near 1%.  Now, with commodity prices having turned lower and economic demand softening, there simply is not much overall inflationary pressure at all.


9:45 a.m. Chicago Purchasing Managers Index

    * Importance (A-F): The Chicago PMI merits a B.
    * Source: Chicago Purchasing Managers Association.
    * Release Time: Last business day of the month at 10 a.m. Eastern for the current month.
    * The full report is available at www.kingbiz.com

There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The New York and Philadelphia Fed's surveys are the first each month followed by the Chicago purchasing managers' report on the last day of each month. The Chicago PMI index, which is released on the last business day of the month (with data for the same month), has an impressive 91% correlation with the national Institute for Supply Management's manufacturing survey data.

Highlights

    * The Chicago Purchasing Managers Index wasn't quite up to snuff, as it checked in at 31.4 for March. That was down from 34.2 in February and below the consensus estimate of 34.3, which is also the 6-month average for the report. 50.0 is the dividing line between expansion (above) and contraction (below).

    * A drop in order backlogs to 21.3 from 29.3 jumped out as a key drag, but notably, the new orders component rose slightly to 30.9 from 30.6.  The new orders component hasn't shown any appreciable deterioration in recent months as it stood at 29.2 in November, 31.5 in December, 30.7 in January, and 30.6 in February.

    * Also of note is that the employment index improved to 28.1 from 25.2, indicating that there was a slowdown in the pace of deterioration in job losses. That indication fits with the steadying nature seen of late in the initial jobless claims report.

    * Prices paid dipped to 34.1 from 37.8; production dipped to 32.7 from 34.7; inventories rose to 34.9 from 33.0; and supplier deliveries fell to 48.4 from 51.0.

Key Factors

    * The takeaway from the report is that end demand for the manufacturing sector remains in a weakened condition, although the overall report fits the view that the pace of deterioration has slowed.

Big Picture

    * The Chicago PMI has little overall economic value, and is only watched by the financial markets because it is usually released one day in advance of the similar national ISM manufacturing survey. A significant move in this regional survey will therefore sometimes be seen as having predictive value for the ISM index.


FRIDAY, MAY 1

9:55 a.m. University of Michigan Consumer Sentiment Index

    * Importance (A-F): This release merits a B-.
    * Source: The University of Michigan.
    * Release Time: Preliminary: 10 a.m. Eastern on the second Friday of the month (data for current month); Final: 10 a.m. Eastern on the fourth Friday of the month (data for current month).

The Michigan index is almost identical to the Conference Board Consumer Confidence index, though there are two monthly releases, a preliminary and final reading. Like the Conference Board index, it has two subindexes - expectations and current conditions. The expectations index is a component of the Conference Board's Leading Indicators index.

Big Picture

    * Sentiment readings are a reflection of a variety of events rather than an accurate tool for forecasting consumer spending.  Gas prices and political events can have an outsized impact on sentiment.  In general, these data are of very little economic value.


10 a.m. Institute for Supply Management Index

    * Importance (A-F): This release merits an A-.
    * Source: Institute for Supply Management
    * Release Time: 10 Eastern on the first business day of the month for the prior month.
    * Raw Data Available At: http://www.ism.ws

The ISM report is a national survey of purchasing managers which covers such indicators as new orders, production, employment, inventories, delivery times, prices, export orders, and import orders. Diffusion indexes are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.

The total index is calculated based on a weighted average of the following five sub-indexes, with weights in parentheses: new orders (30%), production (25%), employment (20%), deliveries (15%) and inventories (10%).

The ISM is one of the first comprehensive economic releases of the month, typically preceding the employment report. Though it covers only the manufacturing sector, it can often provide accurate hints regarding the tone of subsequent releases. During periods of inflation concerns, the prices paid and vendor deliveries indexes often determine the bond market's reaction to the report.

Highlights

    * The ISM Index rose slightly in March to 36.3 from 35.8.  A number below 50 indicates contraction, so the read on the March number is that the manufacturing sector is still contracting, only at a slower rate than before.

    * Every component index, with the exception of customers' inventories (54.0 vs. 51.0 in Feb.), is below 50.  What's more is that a number above 50 for customers' inventories isn't good as it implies inventories are at a higher-than-desired level, which will curb new orders.

    * The new orders index, incidentally, jumped to 41.2 from 33.1, which suggests new orders are still contracting, but not as fast as before.

    * Production held steady at 36.4; employment edged up to 28.1 from 26.1; supplier deliveries dipped to 43.6 from 46.7; prices moved up to 31.0 from 29.0; the backlog of orders rose to 35.5 from 31.0; export orders went to 39.0 from 37.5; and import orders moved to 33.0 from 32.0.

Key Factors

    * The March ISM Index reading is relatively good news for a market that is anxious to see a bottoming process for the economy. One should be careful, though, not to interpret the ISM as distinctly good economic news. It isn't, but it does show things aren't getting worse in a meaningful way.

Big Picture

    * This is a highly overrated index.  It is merely a survey of purchasing managers.  It is a diffusion index, which means that it reflects the number of people saying conditions are better compared to the number saying conditions are worse.  It does not weight for size of the firm, or for the degree of better/worse.  It can therefore underestimate conditions if there is a great deal of strength in a few firms.  The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle.  It must be recognized that the index is not hard data of any kind, but simply a survey that provides broad indications of trends.