Morning Market Update: Bank of America Earnings Miss Target and Oil Hits New High (CEP News)

Market Updates | Written by CEP News | Apr 21 08 12:34 GMT |

(CEP News) - There is plenty for markets to digest this morning, with the Bank of America reporting disappointing first quarter earnings, crude oil reaching a new high, a European Central Bank official warning of increasing wages and the Bank of England announcing a plan to swap asset-backed securities for government bonds. North American fixed income markets are declining and equities are mixed with yields on U.S. 10-year Treasury notes up 2.5 bps to 3.73% and Canadian 10-year CGBs up 0.9 bps to 3.70%. Futures on the Dow Jones Industrial Average are trading down 16 points to 12794. The Canadian dollar is up 0.20 cents to 0.9977 USD and the euro up 0.80 cents to 1.59013 USD. Analysts surveyed by Bloomberg expected Bank of America first quarter profits of 41 cents per share but the banking giant earned only 25 cents. The company announced writedowns of $6.01 billion and CEO Kenneth Lewis said second-quarter U.S. GDP growth will be "minimal at best." Following the earnings report, U.S. equity futures and overseas bourses fell to session lows, the U.S. dollar neared an all-time low against the euro and Treasuries briefly rallied. Overseas fixed income has been outperforming the U.S. Yields on UK two-year bonds were down 7.4 bps to 4.29%, five-year yields down 7.9 bps to 4.33%, 10-year yields down 8.1 bps to 4.65% and 30-year yields down 5.6 bps to 4.54%. The UK rally followed a Bank of England plan to allow UK banks to swap mortgage-backed assets for government bonds, which is in the pipeline. The central bank said the preliminary size of the plan is likely to be around £50 billion, with an asset swap permitted for a period of one year, which may be renewed for a total of three years. UK government debt was also aided by a Rightmove report on UK housing that showed year-over-year house prices increased by only 1.3% in April following a 5.0% gain in March. The property website noted that the drop indicated sellers were recognizing that a decade of rising UK house prices had come to an end. In Germany, returns on two-year German Bunds were down 4.5 bps to 3.79%, five-year yields down 5.2 bps to 3.87%, 10-year yields down 3.0 bps to 4.10% and 30-year yields down 3.0 bps to 4.64%. European Central Bank council member Klaus Liebscher said record oil prices are beginning to push up wages and noted that "second-round effects are appearing in some countries in the euro area." Liebscher said that even though risks to the eurozone economy were on the "downside", there is no room to cut rates. Shortly following Liebscher's comments, crude rose to a record high of $117.40 a barrel at Nymex. Futures on WTI crude oil are up $0.14 to $116.83 while gold futures at the Chicago Board of Trade are up $7.20 to $922.40. U.S. equity market futures are mixed. Contracts on the Dow Jones Industrial Average are down 16 points to 12794, the S&P 500 down 2 points to 1386 and the NASDAQ up 6 points to 1901. European stock markets are declining, with the Eurostoxx down 33.75 points to 3164.68, the UK FTSE 100 down 20.20 points to 6036.30 and the German DAX down 63.71 points to 6779.37. Asian markets followed Friday's North American rally with the Japanese Nikkei closing up 220.10 points (0.42%) to 13696.55 and the Hang Seng Index up 523.89 points to 24721.67. Despite the Bank of America miss, North American sovereign debt continues to sell off. Yields on two-year Canadian government bonds were flat at 2.87%, five-year yields flat at 3.19%, 10-year yields up 0.9 bps to 3.70% and 30-year yields flat at 4.14%. U.S. two-year yields were up 1.7 bps to 2.15%, five-year yields up 2.8 bps to 2.93%, 10-year yields up 2.5 bps to 3.73% and 30-year yields up 2.0 bps to 4.52%. Strategists noted a stabilization in U.S. dollar libor. One-month libor increased to 2.90% from 2.87% while three-month rates increased to 2.92% from 2.91%. "The modest rise in libor overnight suggests the drama there is reaching its end. Second, with Fed Funds futures and our own call consistent that it's a 25 bps ease next week, we think the disappointment trade has largely been seen," wrote David Ader, U.S. government bond strategist at RBS Greenwich, in a note to clients. The Canadian dollar was up 0.20 cents to 0.9977 against the USD (1.00237 USD/CAD) and down 0.20 cents to 1.5939 (0.6274 CAD/EUR) against the euro. The U.S. dollar was down 0.25 to 103.42 against the yen and the euro up 0.80 cents, to 1.59013 against the U.S. dollar. The pound sterling was down 1.20 cents to 1.9858 USD and the Australian dollar was higher by 0.80 cents to 0.9423 USD. The U.S. Dollar Index was down 0.241 points to 71.683. All data taken at 8:09 a.m. EDT. By Adam Button, abutton@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , edited by Stephen Huebl, shuebl@economicnews.ca

Dow Theory: The Three-Trend Market

Before we can get into the specifics of Dow theory trend analysis, we need to understand trends. First, it's important to note that while the market tends to move in a general direction, or trend, it doesn't do so in a straight line. The market will rally up to a high (peak) and then sell off to a low (trough), but will generally move in one direction. (For related reading, see Peak-and-Trough Analysis.)

Figure 1: an uptrend

An upward trend is broken up into several rallies, where each rally has a high and a low. For a market to be considered in an uptrend, each peak in the rally must reach a higher level than the previous rally's peak, and each low in the rally must be higher than the previous rally's low.

A downward trend is broken up into several sell-offs, in which each sell-off also has a high and a low. To be considered a downtrend in Dow terms, each new low in the sell-off must be lower than the previous sell-off's low and the peak in the sell-off must be lower then the peak in the previous sell-off.

Figure 2: a downtrend

Now that we understand how Dow theory defines a trend, we can look at the finer points of trend analysis.

Dow theory identifies three trends within the market: primary, secondary and minor. A primary trend is the largest trend lasting for more then a year, while a secondary trend is an intermediate trend that lasts three weeks to three months and is often associated with a movement against the primary trend. Finally, the minor trend often lasts less than three weeks and is associated with the movements in the intermediate trend.

Let us now take a look at each trend.

Primary Trend
In Dow theory, the primary trend is the major trend of the market, which makes it the most important one to determine. This is because the overriding trend is the one that affects the movements in stock prices. The primary trend will also impact the secondary and minor trends within the market. (For related reading, see Short-, Intermediate- and Long-Term Trends.)

Dow determined that a primary trend will generally last between one and three years but could vary in some instances.

Figure 3: an uptrend with corrections

Regardless of trend length, the primary trend remains in effect until there is a confirmed reversal. (For more insight, see Retracement Or Reversal: Know The Difference and Support And Resistance Reversals.)

For example, if in an uptrend the price closes below the low of a previously established trough, it could be a sign that the market is headed lower, and not higher.

When reviewing trends, one of the most difficult things to determine is how long the price movement within a primary trend will last before it reverses. The most important aspect is to identify the direction of this trend and to trade with it, and not against it, until the weight of evidence suggests that the primary trend has reversed.

Secondary, or Intermediate, Trend
In Dow theory, a primary trend is the main direction in which the market is moving. Conversely, a secondary trend moves in the opposite direction of the primary trend, or as a correction to the primary trend.

For example, an upward primary trend will be composed of secondary downward trends. This is the movement from a consecutively higher high to a consecutively lower high. In a primary downward trend the secondary trend will be an upward move, or a rally. This is the movement from a consecutively lower low to a consecutively higher low.

Below is an illustration of a secondary trend within a primary uptrend. Notice how the short-term highs (shown by the horizontal lines) fail to create successively higher peaks, suggesting that a short-term downtrend is present. Since the retracement does not fall below the October low, traders would use this to confirm the validity of the correction within a primary uptrend.

Figure 4: a secondary trend w/ a primary uptrend

In general, a secondary, or intermediate, trend typically lasts between three weeks and three months, while the retracement of the secondary trend generally ranges between one-third to two-thirds of the primary trend's movement. For example, if the primary upward trend moved the DJIA from 10,000 to 12,500 (2,500 points), the secondary trend would be expected to send the DJIA down at least 833 points (one-third of 2,500).

Another important characteristic of a secondary trend is that its moves are often more volatile than those of the primary move.

Minor Trend
The last of the three trend types in Dow theory is the minor trend, which is defined as a market movement lasting less than three weeks. The minor trend is generally the corrective moves within a secondary move, or those moves that go against the direction of the secondary trend.

Figure 5

Due to its short-term nature and the longer-term focus of Dow theory, the minor trend is not of major concern to Dow theory followers. But this doesn't mean it is completely irrelevant; the minor trend is watched with the large picture in mind, as these short-term price movements are a part of both the primary and secondary trends.