Market Directions Sunday, October 14, 2007

• Credit markets amnesia, will the Central Banks put away their knives?
• The Europeans learn to love a strong Euro?
• The G7 meets and meets and meets?

The Week in Review October 8 - October 12

Two weeks of inconclusive movements have left traders looking outside the market for new impetus. If the Federal Reserve now appears much less likely to cut rates at its next meeting October 31, so to does the ECB when it convenes on November 8th. If the EMU economies seem to be defying the third and fourth quarter slowdown anticipated by many just four weeks ago, so the American consumer has hardly paused working and spending. The surmise that the US economy has more to fear from the sub-prime and credit markets has carried the Euro to historic levels against the Dollar, but is it still justified? Is the Euro really leading the way?

Because ECB and BOE rate cut expectations, predicated almost solely on the financial market turmoil which began in August, have diminished as well as that of the Fed, the Dollar has been left no better off. Officials of all three central banks have been at pains to remind the markets of the still extant inflation threat and their own determination to rein it in.

The G7 meeting this coming Friday in Washington will not produce an agreement to support the Dollar. As if to underline this American President George Bush said in a interview with the Wall Street Journal published Friday that a strong dollar policy is the "correct policy", and that the "best way [to value] a currency is through the market".

The basic assumption driving the Euro has been the risk evaluation that the Fed preventive rate cut was substantive, that the US economy courted recession in the coming months and the Fed would be forced to cut again. But so far the evidence has not proved the case. If anything it has pointed the other way with US job growth and consumer spending remaining strong. US GDP expansion could well be above 3.0% in the third and fourth quarters with European growth falling to 2.5% or less. Even in the 2nd quarter the differential between the US and EMU economies was 1.3% in favor of the Americans.

The decisive move of the past two weeks has been the resurgence of the Euro/Yen and the Yen crosses. These currencies thrive in a stable rate environment. If a retreating US economy promised further Fed rates decreases, market judgment would also assign a higher probability to a future ECB reduction. If the ECB was going to cut rates, even if only for precautionary reasons, where would that leave the Euro/Yen? Currency markets are predicting that the August credit market panic is history, that it will not foster a worldwide economic slowdown and that the US economy will emerge largely unscathed. Otherwise the risk averse Yen crosses would not be within a hair of their all time high. The Yen crosses are the bell weather of today's currency markets, not the Euro or even the Dollar.

Central Bank Rate Actions
Bank of Japan leaves the overnight call rate at 0.5%.
Reserve Bank of Australia keeps the cash rate at 6.5%.

The Week in Review October 8 -October 12

United States

The September 18th FOMC vote to cut the Fed Funds rate was unanimous. The minutes cited two reasons for this "prudent action". First was the concern for the impaired functioning of the financial markets, and second was the potential for reduced economic growth from that impact. Perhaps a bit surprisingly the FOMC members disregarded the August Non Farm Payroll numbers of -4,000. They assumed that "employment was probably not as weak as the most recent monthly data had suggested". The committee was right on target as the upward revision of the August number revealed a week ago.

Also from the FOMC minutes was the prescription for rate policy, "future actions would depend on how economic prospects were affected by market developments and other factors". The major economic statistics from this past week do not indicate a serious slowdown in the US economy. Weekly Jobless Claims have continued to decline. Retail Sales were much better than expected and PPI, particularly core PPI without the automobile price reductions, was very active. Clearly there are building price pressures in the consumer goods pipeline.

There are less than three weeks until the next Fed policy committee. This coming week we will see Industrial Production, core CPI and the 'Beige Book'. None of these are likely to convince the Fed that another rate cut is necessary to float the US economy. The 'moderate expansion' term of the last 'Beige Book' is more indicative of an economy poised for increased growth than one slipping. The US economy has been under stress and a cloud of worry since the third quarter of last year. It is important to remember this background when one charts future prospects. All is not as dire as the economic projections tell. Projections are by their nature linear, people and the economy are not. The statistics will tell the story; it behooves traders to listen to exactly what they are saying. Or, to paraphrase John Maynard Keynes, 'If the facts haven't change, why change your mind?"

Despite the greatly reduced expectations for a Fed Funds rate cut at the October 31st Fed meeting the Dollar Index is only 0.5% above its all time September 28th low.

Eurozone

ECB officials deployed their public comments this week promoting the dangers of EMU inflation and the bank's steadfast role in countering it. The commotion among the united currency's finance ministers early in the week when they met, ostensibly to consider the 'strong Euro' came to naught. The ministers could not even agree among themselves that the current Euro level was a problem. Except for France and Italy, none of the other finance ministers appeared to think it was.

Industrial Production recovered nicely in August and the second reading of GDP for the second quarter at 2.5% is one that the ECB can live with, wary as it may be of its effect on inflation. ECB economists consider that GDP rate near the limit for non inflationary growth.

Despite the curious comment from Jean Claude Trichet on Tuesday's that 'the headline M3 number may overstate [its] actual strength', in testimony before the EU parliament, the bank left no doubt that it still considerers inflation the primary threat. "We need further gathering of data but the baseline scenario [good economic growth and potential inflation] is very much confirmed at the present moment", said Mr.Trichet.

Germany

German Finance minister Peer Steinbrueck would rather have a strong Euro than a weak one. "I love a strong Euro", is his now famous formula. And as a finance minister who wouldn't adore a strong currency. It restrains domestic inflation, reduces government financing costs, draws private investment and promotes business efficiency. Hank Paulson, the American Treasury Secretary, and his predecessors have long said the same thing.

United Kingdom

British officials, like their continental counterparts, returned the focus to inflation. There were no hints in the Pre Budget Report of the Bank of England Governor Mervyn King that a rate cut is being considered. As a prescription for financial panic he said that the Monetary Policy Committee (MPC) will not "insulate" the banking sector from the re-pricing of risk. It is not likely he would have made such a comment if he thought there was real chance of returning credit market turmoil.

Chancellor of the Exchequer Alastair Darling reduced the government estimate for 2008 GDP growth forecast to 2.0%, specifically "because of the problems...coming out of America this summer are now affecting economies across the world..." But like King, he was careful not to infer monetary policy from his observation.

The Business and Financial Services sector is the largest industry in Britain, comprising one quarter of the economy and responsible for almost all private sector job growth. Though it has not yet showed in the statistics the financial market events of the past three months must necessarily have negative effects.

Japan

Economic Releases October 8 -October 12

United States

Thursday: the International Trade Balance sank in August to -$57.5 billion almost 2.5% under the median projection of -$59.8 billion; July's deficit was trimmed slightly to -$59.0 from -$59.2 billion. The Euro rose 30 points against the dollar on the release. Imports fell 0.4%, the most in six months; exports rose the identical amount. The 2.4% decline from July to August in the overall deficit came despite a 7.0% hike in the cost of oil imports, the biggest increase in five months. The trade balance is currently benefiting both side of the equation, with a slower US economy importing less and a weak dollar prompting foreign buying from American producers.

Weekly Jobless Claims for the week ending October 6th fell 12,000 to 308,000 substantially more than the expectation of -2,000 and 315,000. The four week moving average slipped to 310,250 continuing the downward trend begun a month ago.

Import Prices jumped 1.0% in September as predicted with a 5.4% rise in petroleum accounting for the entire increase. Non petroleum prices fell 0.2.

Friday: Retail Sales in September at +0.6% doubled estimates, the markets had been looking for +0.3%; August was unrevised at +0.3% but July added 0.1% to +0.6%. Sales ex auto was also better than forecast, +0.4% as opposed to +0.3%; August was unchanged at -0.4%. The Dollar gained 25 points against the Euro on the release but stalled and then reversed at 1.4150.

Most consumption estimates for the third quarter are now north of +3.5%, which should put GDP for the quarter near 3.25%, a very respectable number in the post sub prime world. Analysis of the details of the Retail Sales report varied with the beholder. Some commentators found the overall reading, twice the market expectation, indicative of an unworried consumer and robust spending heading into the holiday season. Others focused on the fact that price inflation in the two strongest selling categories, gasoline and food, accounted for almost all their increase.

The Produce Price Index (PPI) for September jumped 1.1% more than twice the predicted +0.4%. The PPI core (ex food and energy) rose only 0.1%, half the preliminary estimate. Automobile prices are included the PPI core measure and were the reason the core increase was moderate. Car prices fell 1.8% in September and light truck charges dropped 0.5%. Without this drag the core would have risen a much more inflationary 0.3%. Other categories displaying large increases were pharmaceuticals +0.5%, home furniture +0.5% and alcohol +0.6%, this last particularly worrisome heading into the holiday season.

Consumer Sentiment in October, according to the University of Michigan preliminary reading, deflated to 82.0, below the forecast of 84.0 and the lowest result since August 2006, when it was also 82.0.

Eurozone

Thursday: second quarter GDP was unrevised on its second issue at +0.3% for the quarter and +2.5% for the elapsed year. The yearly result for the first quarter was revised up 0.1% to +3.2%; the quarterly figure was unchanged at +0.7%.

Friday: Industrial Production expanded 1.2% in August, much more vigorously than the expected +0.3%. July was adjusted higher by 0.1% to +0.7%. The yearly rate was 4.3% in August; the prediction had been +2.1%; the July rate was +3.7%. EMU planners can now look for Industrial Production to add substantially to GDP growth in the third quarter; it had slowed in the second.

Germany

Monday: Total Manufacturing Orders for August at +1.2% were well under the expectation of +2.0%, but as July was revised up by almost the same amount that August was under, to -6.1% from -7.1%, the effect was moot. The seasonally adjusted Trade Balance for August was +E15.3 billion, less than the +E16.4 billion median projection. Imports rose 5.6%, exports gained 3.0%. In July both had fallen, 2.8% for imports and 0.3% for exports. The overall July number was adjusted to +E16.5 billion from +16.4.

Tuesday: Industrial Production rose 1.7% in August, more than three times the forecast of +0.5%. The growth was led by manufacture of consumer durable goods. July's result gained slightly on revision, to +0.2% from +0.1%.

Wednesday: the German Chamber of Industry and Trade (DIHK) Balance of Business Expectations fell in September to 15 from 24 in August. This trade group polls 25,000 companies each month and calculates this indicator by subtracting the number of those firms whose business expectations to be poor from those firms who judge expectations to be good. "The economic euphoria is over", said DIHK. The trade group also cut its GDP forecast for 2007 to +2.5%, it had been +2.8%.

Thursday: Wholesales prices as recorded by the Federal Statistical Office (FSO) rose 0.9% in September, the highest monthly increase since April of last year. The annual rate was 4.0%; in August the yearly rate was 2.5%.

United Kingdom

Monday: Manufacturing Output in August reached its highest level in six years gaining 0.4% for the month and +0.6% year to year. July's results were -0.3% and +0.8% respectively. Industrial Production rose 0.1% in August, +0.7% on the year; the July statistics were -0.1% monthly and +0.9% yearly. Output Producer Prices jumped 0.1% in September, a +2.7% yearly rate. In August these prices rose 0.1% and 2.5%. Core Output Prices gained 0.2% m/m and 2.2% y/y in September. Input prices rose a dramatic 3.2% in September more than twice the forecast of +1.5%. The yearly rate was +6.4%, also well in advance of the prediction for +4.5%. In August the same 'input' statistics were -0.5% m/m and +0.6% y/y. Soaring crude oil prices were the greatest contributing factor in the input price rise.

Wednesday: British Retail Consortium (BRC) Retail Sales in September were twice as strong as forecast, +3.0% versus +1.5%.; August had registered +1.8%. British consumers seem to be unaffected by the Northern Rock bank rescue by the BOE early in the month.

Thursday: Royal Institute of Chartered Surveyors (RICS) House Price Survey which measures the difference between gainers and losers in house prices exhibited -14.6 in September, nearly three times the -5.0 forecast. The August reading was revised down to -3.3 from -1.8. House buyer inquiries were at the lowest level since 2003.

China

Friday: the Trade balance in September fell 4.3% to +$23.9 from Augusts' +$24.9 billion. Nevertheless, the balance for the first nine months of 2007 was +$185.66 billion an astonishing 69% higher than the same period in 2006.

The Week Ahead October 15 -October 19

United States

Tuesday: Treasury International Capital System (TICS) net long term securities transactions for August at 9:00 ET; July +$19.2 billion. Industrial production for September at 9:15 ET; August +0.2%. Capacity Utilization for September at 9:15 ET; expected 82.2%, August 82.2%. NAHB Housing Market Index for October at 13:00 ET; September 20.

Wednesday: CPI for September at 8:30 ET; August -0.1%, core +0.2%. Housing Starts for September at 8:30 ET; August 1.331 million units. Building Permits for September at 8:30 ET; August 1.322 million units. Federal Reserve Beige Book, September "moderate expansion' in 10 of 12 Federal Reserve districts.

Thursday: Jobless Claims for week ending October 13; prior week -12,000 to 308,000.

Eurozone

Tuesday: ZEW Survey for October at 9:00 GMT; 'Expectations' -20.3 in August, 'Current Conditions' 65.6.

Thursday: Preliminary Trade Balance for August at 9:00 GMT; seasonally adjusted -E0.6 billion, non seasonally adjusted +E4.6 billion in July. Final HICP for September at 9:00 GMT; preliminary +0.1% m/m, +1.7% y/y. Construction Production for August at 9:00 GMT; August 0.0% m/m, +1.7% y/y.

Germany

Tuesday: Final CPI for September at 6:00 GMT; preliminary -0.1% m/m, +1.9% y/y. Final HICP for September at 6:00 GMT; preliminary -0.1% m/m, +2.0% y/y. ZEW Survey for October at 9:00 GMT; September 'Economic Expectations' -18.1, 'Current Conditions' 74.4.

Friday: PPI for September at 6:00 GMT; September 0.1% m/m, +1.0% y/y.

United Kingdom

Sunday: Rightmove House Prices for October at 23:01 GMT; September -2.6% m/m, +9.6% y/y.

Monday: DCLG House Price Index for August at 8:30 GMT; July +12.4% y/y.

Tuesday: Core CPI for September at 8:30 GMT; August +1.8% y/y. HICP for September at 8:30 GMT; August +0.4% m/m, +1.8% y/y.

Wednesday: ILO Unemployment Rate for August at 8:30 GMT; July 5.4%. Average Earning including bonus for August at 8:30 GMT; July +3.5% y/y. BOE minutes for the October 3&4 Monetary Policy Committee meeting.

Thursday: Retail Sales for September at 8:30 GMT; August +0.6% m/m, +4.9% y/y.

Friday: Third quarter GDP, first estimate, at 8:30 GMT; second quarter +0.8% q/q, +3.1% y/y.

Japan

Monday: Consumer Confidence for September at 5:00 GMT; August 44.0. Industrial Output for August at 4:30 GMT; July -0.4%.

Wednesday: Tertiary Index for August at 8:50 GMT; July -0.5%. Revised Leading Index for August at 5:00 GMT; July 72.7, 'Coincident Index' 70.0.

China

No important releases

Market Directions Sunday, October 7, 2007

• The stoics-the Bank of England and the European Central Bank
• Job growth returns to the US, but not optimism to the Dollar
• The ECB wants a strong dollar but not a strong Euro?

The Week in Review October 1 - October 5

It was status quo in the central bank market this week. All three banks with decisions kept their fingers off rate button as the Bank of England, the European Central Bank and the Reserve Bank of Australia left their base rates unchanged. Only the American Federal Reserve has felt the need to chop rates in this post sub-prime world.

In the immediate aftermath of the recent credit problems the currency markets have placed the onus squarely on the Usd. The States were the source of the original problem and the most likely sufferer from its aftereffects. The Fed September rate cut and the admission it represented for the immediate health of the American economy drove the Usd down and down. The skein did not completely play out until this past Monday when the Euro reached its lifetime high at 1.4280.

The fears that financial markets would freeze up in credit scarcity brought on by defaults in the sub prime housing and asset backed sectors have subsided. And while another large bank or mortgage company failure would make headlines it is unlikely it would incite the worldwide panic of early August. One of the chief fears in August was the unknown extent of the problem. How much questionable debt was held and how much would come due for refinancing in the following weeks. The period until the end of October was seen as crucial. We are now more than two thirds through that period and the credit markets have returned to normal functioning, if not to entirely normal spreads. The Europeans and the British central bankers, while acknowledging the severity of the credit liquidity situation, have demonstrated their resolve. They judge that their economies do not require preventative medicine. The remaining question is the health of the US economy; it weighs heavily on the dollar.

The situation is similar to that of last December. From October to December the then relatively new housing market collapse was expected to crack the wider US economy and produce a severe slowdown if not recession. The dollar sank against the Euro through the last quarter of the year in anticipation of the economic result. However, the US economy did not falter and the statistics improved throughout December. In January the Dollar gained almost 3.4% against the Euro. The case here is not to predict a Dollar recovery but to underline the fact that the market assumption is not yet proven. The speculative urge that is driving down the Usd is produced by anticipation of events not the events themselves. It may prove to be correct and the American economy may slip to neutral or recession. But the two figure fall in the Euro on Thursday reminds traders of the potential fragility of that assumption.

The difference between the economic views of the ECB and the Fed as expressed in their actions and policy are driving the dollar lower. Both are based on projections of current economic trends that are not yet fully substantiated.

United States

The US economy has not rolled over; it is still growing and creating jobs, the basic value for a consumer economy. But most economic numbers are sliding. Both ISM numbers, manufacturing and services, and factory orders were below forecast. The slowing trends that are evident in most US statistics originated before the credit crisis surfaced. However, there does not seem to be a generalized depiction of weakness, moderating growth is still the order of the day. With the Christmas and Holiday season approaching and the credit crisis behind a return to more buoyant spending is always possible. The main forward looking statistics, the purchasing managers indices and the consumer sentiment numbers were no doubt swayed by the emotional effects of the credit market crisis.

The Fed and Chairman Bernanke should be pleased with the NFP report. Job growth was not unduly affected by the credit liquidity crisis and recession fears are reduced as a consequence. Moderate but not dramatic job growth can support consumer spending without aggravating inflation. And while the three month moving average has been falling steadily all year, from +190,000 in January to +97,300 in the latest month this may help spur productivity and forestall rising labor cost pressures. Average Hourly Earning gained in Sptember and with PCE Core Inflation at only +1.4% there is room for an increase in retail spending.

Eurozone

The ECB program for rate policy is clear and well expressed in the statement accompanying the rate decision. The reference to an "accommodative' rate policy was eliminated and replaced by "upside risks...to price stability". The wording may be different but it is hard to see how the rate stance has changed. Economic "fundamentals...support a favorable outlook for economic activity...on balance risks to the outlook for growth are judged to lie on the downside...[but] these downside risks relate mainly to the potential for a broader impact from the ongoing reappraisal of risk in financial markets..". In brief, except for the financial and credit market problems, the EMU economies are expanding at or above trend, producing a serious future potential for inflation that remains the bank's central concern. By implication, if the credit problems disappear then the bank will have no reason to be other than vigilant against inflation and the governing council will raise rates when and if it deems necessary.

Earlier in the week Jean Claude Trichet, ECB President speaking in Valetta Malta, reminded his audience that the US Treasury and Federal Reserve Bank have historically supported a strong dollar. His point was not to lecture the dignitaries that a strong Euro is good for the EMU economies and that the Europeans should stop complaining, but to remind the US officials of their traditional stance.

On Tuesday French Finance Minister Christine Lagarde had suggested that US Treasury Secretary Henry Paulson should say "loud and clear that a strong dollar is good for the US economy". If a strong Dollar is good for the US economy why wouldn't a strong Euro be good for the EMU economies? Would not all the advantages that a strong currency confers on the US also accrue to the EMU? Are the laws of economics different in the Old world than the New?

Or as one commentator, Barbara Rockefeller of Rockfeller Treasury services put it, as quoted by Market News International, "the chance of ECB or G7 intervention is nearly zero, especially if it depends on the US participation". The Fed does not appear to be worried about the Dollar and the Treasury is unlikely to be either with exports up over 12%. While the US say "a strong dollar [is in its] best interest", it does nothing to support such a policy. "The real policy is let the markets decide". As for the Euro, the European have long said that they wanted a currency that could compete with the dollar's reserve status, "now let them live with it". No major industrial country predicates its economic, fiscal or monetary policy on exchange rates. The overriding operational factor is the health of the domestic economy; the Europeans are no different.

Japan

The Tankan Survey for the third quarter from the Bank of Japan held ground with large manufacturing firms reporting sentiment the same as in the second quarter, 23. Since GDP contracted 1.2% in that quarter according to the latest government figures the status quo reading was a small victory, reflecting strong demand from non US customers.

Economic Releases October 1 - October 5

United States

Monday: the Institute for Supply Management Survey of Manufacturing for September recorded a decline for the third month in a row at 52.0. This is consistent with a 2.5% growth in manufacturing. The median prediction had been 52.9, the same as the August reading. "Prices Paid' fell to 59.0 from 63.0, "New Orders' to 53.4 from 55.3. Only the result for 'Employment' increased to 51.7 from 51.3.

Tuesday: the Pending Home Sales Index from the National Association of Realtors (NAR) plunged 6.5% in August to 85.5. It is down 21.5% from the same period last year. Pending sales are those where a price between the seller and buyer has been agreed but the sale has not closed. The decline reflects the increased difficulty in mortgage financing for retail home buyers. The Pending Index acts as a leading indicator for 'existing home sales' and promises further weakness in the largest category of home purchase in the US. It also underlines the still lively potential for wider economic impact from the year long decline in the residential housing market.

Wednesday: the Institute for Supply Management Non-Manufacturing Index (ISM) at 54.8 was slightly better than the 54.5 forecast but below the August reading of 55.8. Though this was a bit less than the 56.6 average for the past it is nevertheless indicative of continued moderated growth into the fourth quarter. The 'Employment' Index staged a recovery to 52.7 from 47.9 in August; 'New Orders' fell to 53.4 from 57.0.

Thursday: Factory Orders for August underperformed expectations at -3.3% against the median forecast of -2.8%. It was the largest monthly drop since January when they fell 5.7%. The Euro climbed 50 points immediately after the release.

Friday: Non Farm Payrolls returned to positive territory in September as excepted adding 110,000 jobs. More interestingly the August deficit of -4,000 was erased with the adjustment to +89,000 for the month, most of the addition being in government payrolls. July's number was adjusted higher to +93,000 from +68,000 for a total revision of 118,000 over the two months. The unemployment rate moved 0.1% higher to 4.7%. The three months moving average has almost halved since the beginning of the year: January 180.7, February 159.3, March 142.3, April 129.0, May 162.3, June 127.0, July 117.3, August 83.7, September 97.3. Average Hourly Earning moved up 0.4% for the month, now 4.1% annually, a gain of 0.2% over July and August and slightly better than the average for the past year.

Eurozone

Monday: The final issue for the September PMI manufacturing number was 52.3 as expected and unchanged from the preliminary issue. It is the third monthly decline since June registered 55.6 and the lowest reading since February of last year.

Tuesday: the Produce Price Index gained 0.1% in August as expected, flattening the yearly rate to 1.7% from 1.8% in July. Energy prices ebbed 2.2% in August helping to lower the overall result but prices have since surged higher in September and were the chief cause for the spike to 2.1% in the preliminary HICP rate as reported last week. The ECB is unlikely to take much ease with this number. Unemployment in the EMU was steady at 6.9% in August, the third month in a row that it has sustained the historic low for this series which began in 1993. German unemployment fell to 6.2% from 6.4%; French to 8.6% from 8.7%. The jobless rate in the US is 4.6% and in Japan it is 3.8%.

Wednesday: Retail Sales rose only 0.1% in August, a quarter of the +0.4% forecast. The annual rate was +0.5% as predicted. The July result was revised to +0.4 from +0.1% monthly, and to +1.3% from +0.5%. The Euro was unmoved by the disappointing monthly number, the July adjustment negating the August result.

Germany

Monday: the NTC/BME Manufacturing Purchasing Managers Index (PMI) dropped to 54.9 in September 1.1 points lower than August.

Wednesday: the NTC PMI Report on Services registered a sharp drop to 53.1 in September from the August reading at 59.8. It was the lowest result in more than a year. NTC Economics is a private British economics date and research firm that produces a wide array of data on the economies of 20 of the worlds largest industrial countries.

United Kingdom

Monday: the CIPS/NTC Manufacturing Purchasing Managers Index (PMI) for September fell slightly to 55.1 from 56.1.

Wednesday: Reuters Services PMI for September eased to 56.7 from 57.6, a tad below the 56.8 median forecast and the weakest result in 13 months. "Employment' fell to 51.8 from 43.7 and "Prices Charged" jumped to 53.7 from 53.1. The British Retail Consortium (BRC) Shop Price Index in September gained 0.2% and was 0.4% ahead of last year's prices. Food prices were the main culprit, up 0.6% in September, and 2.7% annually. It was the largest increase since last December. In August the yearly inflation rate for food prices was only 2.1%. Non-food prices sank 0.1% in September, a +0.7% annual rate. The 'final' RBS/NTC Report on Services PMI added 0.2 to 54.2, a substantial drop from the 58.0 reading in August. Nationwide Consumer Confidence rose to 99 in September a major improvement over the 94 reading in August. However, the current relevance of the September score is questionable because 90% of the data was collected before the BOE rescue of Northern Rock.

Japan

Monday: The BOJ Quarterly Tankan Report presented a mixed picture for the Japanese economy. Business confidence at large manufacturing companies remained at 23, as it was in the second quarter but better than the forecast of 21. All other major categories of business confidence recorded losses: 'small manufacturing firms' were 20 against 22 in quarter two; 'large service firms' were 20 versus 22 in the second quarter and 'small service sector firms' categories were -10 as opposed to -7 in the second quarter. Firms were polled for their opinion between August 28th and September 28th.

The Week Ahead October 8 - October 12

United States

Monday: Columbus Day Holiday US markets closed

Tuesday: FOMC minutes at 2:00 ET for the September 18th meeting when the Fed unexpectedly cut rate 0.5%.

Thursday: International Trade Balance for August at 8:30 ET; July -$59.2 billion

Friday: Retail Sales for September at 8:30 ET; August +0.3%. Retail Sales ex Food and Auto for September at 8:30 ET; August -0.4%. Producer Price Index (PPI) September at 8:30 ET; August -1.4%. PPI for September at 8:30 ET; August +0.2%. University of Michigan Consumer Sentiment for October at 10:00 ET; September 83.4.

Eurozone

Thursday: GDP for the second quarter (second issue) at 9:00 GMT; first quarter +0.7% q/q, +3.1% y/y. EU Commission GDP forecast at 9:00 GMT; Q3 2007 +0.3%-0.8%, Q4 2007 +0.2%-0.8%, Q1 2008 +0.2%-0.8%.

Friday: Industrial Production for August at 9:00 GMT; Jul +0.6% m/m, +3.7% y/y.

Germany

Monday: Total manufacturing Orders for August at 10:00 GMT; expected +2.0% m/m, +4.3% y/y. July -7.1% m/m, +6.1% y/y.

Tuesday: Industrial Output for August at 10:00 GMT; expected +0.5% m/m, +3.9% y/y. July +0.1% m/m, +4.4% y/y. Manufacturing Sector Output for August at 10:00 GMT. July +0.2% m/m, +5.7% y/y.

Thursday: Wholesale Prices for September a 6:00 GMT. August +0.5% m/m, +2.5% y/y.

United Kingdom

Monday: Manufacturing Output for August at 8:30 GMT; July -0.3% m/m, +0.6% y/y. Industrial Production for August at 8:30 GMT; July -0.1% m/m, +0.9% y/y.

Wednesday: RICS House Price Survey for September at 23:01 GMT.

Market Directions Sunday, September 30, 2007

Market Directions Sunday, September 30, 2007

The Week in Review September 24 - September 28

• The US Dollar sinks, is there a lifeline?
• Oil prices remain at historic highs, the world yawns
• The BOJ looks for inflation and finds deflation

The Dollar fell to a series of record lows against the Euro this week as markets remained focused on the Federal Reserve rate cut and worries that the US economy will slip into recession. Unmarked but on the horizon are the next rate decisions of the European Central Bank (ECB) and the Bank of England (BOE). Neither bank will be raising rates this coming Thursday, with the BOE reporting its decision first. But the possibility that one or both central banks might cut rates has been ignored by all. The economic and interest rate situation in the EMU and the United Kingdom is similar to that of the United States, though perhaps less advanced. Ben Bernanke did not drop the Fed Funds rate 0.5% because the American economy was in a tailspin but because the Fed Governors feared what the recent financial and housing market turbulence might exact from the economy in the future. The economic situation is the same on the continent and in England with the added drag that very expensive currencies inflict on a nation's export trade. A reduction in European rates or moderation in the ECB economic risk outlook is wholly unpriced for the currency markets.

Oil prices have also cast a pall over economic growth prospects in the industrial world but the effect is different on either side of the Atlantic. The European Monetary Union (EMU) exports more goods and services to the Middle Eastern oil producers that does the United States. Higher oil revenues in the Gulf States and Iran translate into more purchases by Middle Eastern consumers and governments and higher export earning by the EMU economies. Such exports will help to offset the already evident declines in EMU domestic consumption. The US economy, because it exports proportionally less to the Middle East, will have less income returned as payment for US products and less support for domestic production.

Another factor in the oil price effect in Europe is the ECB definition of inflation. The EMU wide HICP statistic, which the ECB has targeted at 2.0%, includes energy prices. A rise in oil and gasoline prices is a direct contribution to inflation accounting. This effect is somewhat mitigated by the overall value of the currency which lowers the prices of imports and reduces the pricing power of domestic firms. In the US the Fed watches core inflation, without the monthly changes in food and energy prices. A sustained rise in oil prices will still contribute to inflation but in a more diffuse fashion as a basic industrial product rather than a first line consumer price increase.

For both reasons rising oil prices tend to keep greater upward pressure on European interest rates than they do in the United States and to support the Euro more than the Dollar.

United States

A raft of secondary statistics pointed to an American economy more resilient than depicted, despite the ongoing housing collapse. Personal Income, Personal Expenditures, Construction Spending and the Chicago Purchasers Index all met or surpassed forecasts. Only the two consumer confidence numbers, easily the most emitionally laden of the forward looking statistics, were weaker than forecasts. Personal Income and Expenditures seem to belay worries of a pending consumer spending collapse. Despite concerns of falling consumer spending, constrained by the decline in the housing market and worries about pending job losses due to credit market contractions, the American consumer seems to have, at least temporarily, resumed normal spending habits in August. Expenditures rose half again as much as predicted and doubled the rise in personal income. Core PCE Prices further moderated in August and have now been at or within the Fed range of 1-2% for four months. Core PCE Prices peaked at 2.5% in February.

Weekly Jobless claims unexpectedly fell for the second week in a row chopping the four week moving average to 311,500 from 321,000 and easing concerns about job creation. Estimates for this Friday's September Non Farm Payrolls number remain at +115,000. The unemployment rate is predicted to stay at 4.7%.

Eurozone

Last week Jean Claude Trichet, the ECB President, said that the central bank has been successful in "very solidly" anchoring price stability in the EMU. This week, in an interview on Dutch television, he said that the ECB will do what is needed to anchor inflation around 2.0%. Last week inflation was anchored, this week the anchor has slipped. At the risk of a parse too far the significant difference in the two comments is the phrase 'around 2.0%', instead of 'at or below 2.0%'. The ECB has long forecast that inflation would rise above 2.0% despite it year long sojourn below that level. This projection has been the prime rationale for increasing interest rates and in August the flash HICP rate finally climbed to 2.1%. A target of 'around 2.0%' is considerably more expansive than one 'at 2.0%'. Is the ECB introducing the notion of a rate cut despite an inflation rate higher than 2.0%?

Admittedly this is a heavy burden for one small phrase. But central bankers do not free associate during interviews and the interpretative leeway between the two phrases would give the ECB much room to maneuver that it does not now have.

Another question for the ECB is does the 8% money supply target matter anymore? Would the M3 number, by itself, prevent the ECB from cutting rates? The answer is already evident. M3 did not prevent the bankers from halting their series of rate hikes last month; it will make no difference should the governors decide to cut rates.
The EMU economies are showing fatigue. Not dramatic but noticeable. As we noted last week, GDP peaked in the fourth quarter of 2006. Business sentiment and consumer confidence are falling in the EMU as a whole and specifically in its largest economy, Germany. What is to prevent the ECB governors from taking the same much applauded precautionary view as the FOMC? The ECB may now be learning one of the drawbacks of a public target for inflation.

Germany

All German statistics this week indicated a slowing economy, falling consumer spending and decreasing business confidence in the immediate future.

The IFO Survey came in with its lowest reading in more than 18 months, undercutting hopes for a sustained expansion in the EMU's largest economy. Chief Economist of the IFO Survey Gernot Nerb said that domestic demand in Germany was sluggish. At the beginning of almost every European economic expansion government and private officials express hope and sometimes confidence that 'this expansion' will be borne to a greater degree by domestic consumption and so be less susceptible to external factors. The results almost always disappoint.

GfK Consumer confidence fell for the second month in a row. "As was already evident in August the positive consumer mood has been affected…of late… the entire credit crisis in the USA and rising food prices are responsible for the somewhat less than euphoric consumer attitudes", said GfK in a written statement.

Retail Sales in August, as collected by the Federal Statistical Office, fell 1.4%, the worst result since May's 3.2% collapse. As business investment turns uncertain, as shown in the IFO report above, and by last week's ZEW Survey, the German consumer has, once again, been sought as a source of spending and continued growth. Once again it does not seem that the German consumer is willing to oblige.

Japan

Yasuo Fukuda was elected presidents of the Liberal Democratic Party (LDP) by a vote of 330 to 197 over Taro Aso and thereby becomes the next Prime Minister of Japan. Mr. Fukuda is 71 years old, was first elected the Diet in 1990 and has served in various leadership roles in the LDP since 1997. He is considered a moderate on foreign policy. His first task will be to extend a law that permits the Japanese military to assist American naval operations in the Indian Ocean as part of the war in Afghanistan. This was the issue that forced Shinzo Abe to resign. The opposition Democratic Party of Japan (DJP) controls the upper house of the Diet and the blocked passage of the extension legislation. The head of the Democratic Party of Japan, Ichiro Ozawa, has promised to end LDP control of Japanese politics. Except for one brief period in the mid 1990s the LDP has ruled Japan since its formation in 1955.

It is in domestic and economic policy the Mr. Fukuda will face his greatest challenges. Under the stewardship of Shinzo Abe the LDP lost much of the public approval and popularity it had enjoyed with the previous Prime Minister Junichiro Koizumi. If Mr. Fukuda does not improve his and the LDP's standing with the electorate his party could very well lose the next election for the lower house of the Diet. The majority party in the lower house of the Diet elects the Prime Minister. The DJP would like to hold an election for the lower house as soon as possible before Mr. Fukuda can effect any positive change in the LDP's popularity. Mr. Fukuda has said he will not call an election until the spring at the earliest. The LDP simply cannot afford to add a faltering economy to its rooster of problems.

National CPI in August fell for the seventh month in a row keeping deflation fears current. GDP in the second quarter declined 1.2%, surprising everyone, and though Retail Sales rose in August one half of one percent, it was the first gain in three months. . Japanese industry and finance faces serious constraints in the years ahead. Its population is aging and falling, shivering the economic backbone of domestic consumption. Its main competitor across the Sea of Japan will soon be following the Japanese economic model, building high value-added industries, like cars and electronics, that have long been a Japanese specialty. The Korea auto and steel industries have already accomplished this transformation.

China is not only an economic giant; the Beijing government has been busily creating a military that can project power into the seas surrounding the mainland. The Japanese central government will soon have the twin financial burdens of a growing military and a growing pensioner roll. It cannot meet these obligations with a static or falling GDP.

The Bank of Japan is more deferential to the desires of the Tokyo politicians than any other central bank is to its own political establishment. The BOJ has tried hard over the past year to keep inflation and future rate hikes in the political mix. Miyako Suda, BOJ board Member said, the "Japanese economy is growing in line with our forecast…risk[ing]…an inflationary rate rise faster than our forecast". The BOJ wants to keep its field of action as wide as possible. But with falling consumer prices, a 2nd quarter GDP decline, the Fed cutting rates and the Europeans soon perhaps to follow, and an unpopular and tired LDP in charge in Tokyo there will be no rate increase this year. In reality, Japan may be in for a prolonged stay at the 50 basis point mark.

United Kingdom

The Bank of England September policy statement and the minutes of that meeting suggest that the members of the Monetary Policy Committee (MPC) feel more time is needed before they reach a conclusion about the impact of the credit market problems on the real economy and inflation. The subsequent Northern Rock rescue by the BOE, which has ballooned to over eight million pounds, may have concentrated minds on the MPC as to the real economy risks ahead. Andrew Sentence, an external member of the MPC and normally considered a rate hawk, hinted a such a recognition. "Global forces can…inject volatility into the real economy…recent changes in global financial market conditions could weaken demand conditions". This is logic that would play very well on Capitol Hill in Washington. As with the Euro, any change in rate policy by the BOE is not priced into the value of the Sterling.

Economic Releases September 24 – September 28

United States

Tuesday: the Case Shiller Home Price Index for July fell to 215.94, 0.6% lower than June and the steepest decline in 16 years. The index is now 4.5% lower than last year. The Conference Board Consumer Confidence Index sank to 99.8 in September, well below the median forecast of 104.0 and below the August reading of 105.00. Existing Home Sales in August slid to their lowest level in five years at 5.5 million units, a 4.5% monthly drop. It was the second largest fall in over a year; the biggest fall was the 7.93% drop from February to March this year. The market supply of unsold homes at current prices rose to 10.0 months from 9.5 months in July.

Wednesday: Durable Goods Orders declined 4.9% in August; a drop of 3.1% had been anticipated. The July statistic was revised up to +6.1% from +5.9%.

Thursday: In August New Home Sales sank to 795,000 units, an 8.3% fall in one month and well under the 835,000 units that had been expected. The July return was adjusted down to 867,000 from 870,000. The unsold market supply climbed to 8.2 months from 7.5 in July. The median sale price fell 8.3% to $225,700, off 7.5% on the elapsed year. In its third and final release second quarter GDP lost 0.2% to 3.8%; the initial or 'advanced' release was 3.4%; the second or 'preliminary' was 4.0%. Weekly Jobless Claims for the week ending September 22nd fell by 15,000 to 298,000; a rise of 9,000 to 320,000 had been forecast. It was the second week in a row that claims dropped rather than rising as anticipated.

Friday: Personal Income rose 0.3% in August as expected but Personal Consumption Expenditures (PCE) outstripped predictions climbing 0.6%, +0.4 had been forecast. It was the best performance for this gauge of consumer spending since July 2005. Core PCE Prices moved ahead 0.1% in August as expected, dropping the year on year increase to 1.8%. It was the lowest yearly rate since February of 2004 and below the preferred Fed target of 2.0%. The September Chicago Purchasers Index surprised at 54.2, bettering both the median prediction of 52.9 and the August result of 53.9. 'New Orders' fell to 56.2 from 58.4 in August and 'Prices Paid' diminished to 59.0 from 71.8. Construction Spending in August was substantially better than expected at +0.2% on a predicted decline of 0.5%. Non-residential construction moved up 2.3% but was partially negated by the 1.5% drop in residential building. The August result was revised higher to -0.4% from -0.5%. The final return of the University of Michigan Consumer Confidence for September dropped four tenths to 83.4; the preliminary issue had been 83.8.

Eurozone

Monday: Industrial New Orders for July dropped 4.0% from June, greater than the predicted 3.0% decrease. The June result was revised up 0.1% to +4.5%. Orders for July 2007 were 10.9% ahead of the prior year, this was a better result than the +10.2% predicted. The June year on year figure was adjusted 0.2% higher to 14.0%.

Thursday: the European Monetary Union Money Supply (M3) rose 11.6% in August as expected, a slight but welcome decrease from July's 11.7% reading. The three months moving average was +11.4% as predicted; in July it had been +11.1%. The August 11.6% increase in M3 was the first decline in the rate of increase in four months.

Friday: the European Commission Economic Sentiment Indicator for September came in at 107.1 well below the expectation of 109.0. The August result was revised lower to 109.9 from 110.0. It was the sharpest one month fall since October 2001 and the lowest reading of the past year. Even so it remains well above the long term average of 100.0 The Business Climate Indicator for September was 1.09 a precipitous drop from the August reading of 1.37, which was itself a revision from 1.41. It is the lowest reading since May of 2006. Consumer Confidence dropped to -5 in September from -4 in August but it is still well above the long term mean of -11.0. The 'flash' Harmonized Index of Consumer Prices (HICP) result for September arrived at +2.1% as expected, much higher than the 1.7% rate in August. It is the first time in a year that the headline HICP number has topped the 2.0% ECB target.

Germany

Tuesday: the IFO Survey of Financial Experts one of the most followed German business indicators fell across all categories in September: 'Business Sentiment was 104.2 on expectation of 105 and July's reading of 105.8; 'Current Assessment' was 109.9 on expectations of 111.0 and the August issue of 111.5; 'Business Expectations' were 98.7, on a prediction of 99.6 and an August result of 100.4. GfK Consumer Confidence fell in October to 6.8, well under the median prediction of 7.1. The September statistic was revised lower to 7.4 from 7.6. It was the 2nd monthly drop in a row.

Thursday: the 'flash' or first issue of the September (HICP) showed a 0.2% gain for the month and a 2.7% year over year rate. Both results were higher than the median forecasts, for a flat month and a 2.5% increase for the year. The Consumer Price Index also beat expectations in September coming in at +0.2% for the month and +2.5% yearly; 0.0% and +2.3% had been anticipated. This was the first national CPI number over 2.0% since July 2006 when it registered +2.1% and the highest since September 2005 when it was also 2.5%.

Friday: Retail Sales in August fell 1.4%, an unusually large distance from the predicted rise of 0.3%. The drop was greater than all polled forecasts. It was the largest fall in consumer purchases since the 3.2% drop this past May. The July result was also adjusted lower to +0.6% from +0.7%. The year on year rate for Retail Sales was 2.2% less than the previous August, shrinkage of 1.6% had been expected; the decrease from last July to this July was 1.9%.

United Kingdom

Tuesday: Total Business Investment in the second quarter was revised down to +0.4% from +0.8%, and the yearly figure was adjusted up to +7.8% from +7.4%. Manufacturing investment fell 6.0% in the quarter, leaving it 1.3% higher for the elapsed year. Investment in the services sector climbed 0.8% in the quarter and 7.9% yearly.

Thursday: the Nationwide House Price Survey rose 0.7% in September over August, a 9.0% yearly rate. In August the increases were +0.7% monthly and +9.6% yearly.

Japan

Friday: Retail Sales gained 0.5% in August, it was the first rise in three months; in July they had fallen 2.3%. Industrial Production gained 3.4% in August a major improvement on July's 0.4% contraction. The unemployment rate rose 0.2% to 3.8% as expected and left behind the 3.6% rate which had been the lowest since 1998. Core National CPI fell for the seventh month in a row, dropping 0.1%, deflation fears are uncomfortably alive. Household spending rose 1.6% year on year; in July it sank 0.1%.

The Week Ahead October 1 – October 5

United States

Monday: ISM Manufacturing Index for September at 10:00 ET; expected 52.9, August 52.9.

Tuesday: NAR Pending Home Sales for August at 10:00 ET; July 89.9.

Wednesday: ADP National Employment Report for September at 8:15 ET; August +38,000. ISM Non Manufacturing Index for September at 10:00 ET; expected 54.5, August 55.8.

Thursday: Jobless Claims for the week ending September 29 at 8:30 am ET; expected +12,000 to 310,000, prior week -15,000 to 298,000. Factory Orders for August at 10:00 ET; July +3.7%.

Friday: Non Farm Payrolls for September at 8:30 ET; expected +115,000, August -4,000. Unemployment Rate for September at 8:30 ET; expected 4.7%, August 4.7%.

Eurozone

Monday: Manufacturing Purchasing Managers Index (PMI) for September at 8:00 GMT: August 54.3.

Tuesday: EMU Unemployment for August at 9:00 GMT; expected 6.9%, July 6.9%. Industrial PPI for August at 9:00 GMT; expected +0.1% m/m, +1.8% y/y, July +0.3% m/m, +1.8% y/y.

Wednesday: Services PMI for September at 9:00 GMT; August 58.0. Retail Trade for August at 9:00 GMT; expected +0.4% m/m, +0.5% y/y, July +0.1% m/m, +0.5% y/y.

Thursday: ECB rate announcement and press conference.

Germany

No important statistical releases

United Kingdom

Monday: CIPS Manufacturing PMI for September at 9:30 GMT; expected 55.7, August 56.3.

Wednesday: Nationwide Consumer Confidence for September at 23:01 GMT; August 94. CIPS Services PMI for September at 9:30 GMT; expected 56.8, August 57.6.

Thursday: BOE rate announcement at 12:00 GMT.

China

No statistical releases

Japan

No statistical releases

part 56 ===== Candlesticks and Resistance

Bearish reversal candlesticks and patterns suggest that buying pressure was suddenly overturned and selling pressure prevailed. Such a quick reversal of fortune indicates overhead supply and a resistance level may form.

The hanging man, long black candlestick and black marubozu signify increased selling pressure rather than an actual reversal. After an advance, the hanging man's long lower shadow indicates intra-session selling pressure that was overcome by the end of the session. Even though the security finished above its low, the ability of sellers to drive prices lower raises a yellow flag. The long black candlestick and black marubozu signify sustained selling pressure that moved prices significantly lower from beginning to end. Such intense selling pressure signals weakness among buyers and a resistance level may be established.

The doji and spinning top show indecision and are generally considered neutral. These non-reversal patterns indicate decreased buying pressure, but no noticeable increase in selling pressure. For an advance to continue, new buyers must be willing to pay higher prices. As noted by the spinning top and doji, a standoff shows lack of conviction among buyers and a possible resistance level.

Note: All of the above patterns will be covered in this candlestick series in the next week or two.

In late May, Veritas (VRTS) advanced from 90 to 140 in about two weeks. The final jump came with a gap up and two doji. These doji marked a sudden stalemate between buyers and sellers, and a resistance level subsequently formed. After a resistance test in mid June, another doji formed to indicate that buyers lacked conviction. This led to a decline and subsequent reaction rally in early July. The advance carried the stock from 105 to 140, where another doji formed to confirm resistance set in early June.

Lucent (LU) traded in a range bound by 53 and 42 for about 4 months. Resistance was first established in late April with a shooting star and dark cloud cover. Both of these bearish reversals were confirmed with a gap down two days later and a test of resistance at 52. As the stock neared support at 42, candlesticks with long lower shadow started to form and a reversal occurred at the end of May. After a sharp advance, resistance was met at and another dark cloud cover formed at resistance in early June. Buyers clearly lacked conviction near 53 and sellers were all too eager to unload their stock. A final resistance test occurred in mid July. After a breakout above 53, the stock reversed course and closed back below 52. The rest is history.

After a spring advance, Delta Air Lines (DAL) first established resistance at 57 in early April with the high of a shooting star. The stock declined sharply, but rebounded to test resistance at 57 again in May. While at resistance in May, a whole slew of shooting stars formed as well as the odd spinning top and long legged doji. The decline that broke below 56 confirmed these as bearish and the stock tested support around 50. After another advance to 57, the stock appeared to be on the verge of a breakout. However, a small white candlestick formed in mid July (black circle). The gap up may have been a positive, but the lack of follow through signaled by the small white candlestick raised the yellow flag. The subsequent gap down formed a bearish evening star and the stock fell back to support again.

part 55 ===== Candlesticks and Support

Bullish reversal candlesticks and patterns suggest that early selling pressure was overcome and buying pressure emerged for a strong finish. Such bullish price action indicates strong demand and that support may be found.

The inverted hammer, long white candlestick and marubozu show increased buying pressure rather than an actual price reversal. With its long upper shadow, an inverted hammer signifies intra-session buying interest that faded by the finish. Even though the security finished well below its high, the ability of buyers to push prices higher during the session is bullish. The long white candlestick and white marubozu signify sustained buying pressure in which prices advanced sharply from open to close. Signs of increased buying pressure bode well for support.

The doji and spinning top denote indecision and are generally considered neutral. These non-reversal patterns indicate a decrease in selling pressure, but not necessarily a revival of buying pressure. After a decline, the appearance of a doji or spinning top denotes a sudden letup in selling pressure. A stand-off has developed between buyers and sellers, and a support level may form.

Note: All of the patterns above will be covered in this candlestick series in the next few weeks.

Electronic Data Systems (EDS) traded in a range bound by 58 and 75 for about 4 months at the beginning of 2000. Support at 58 was first established in early January and resistance at 75 in late January. The stock declined to its previous support level in early March, formed a long legged doji and later a spinning top (red circle). Notice that the doji formed immediately after a long black Marubozu (long black candlestick without upper or lower shadows). This doji marked a sudden decrease in relative selling pressure and support held. Support was tested again in April and this test was also marked by a long legged doji (blue arrow).

Broadcom (BRCM) formed a bullish engulfing pattern to mark a new support level just below 210 (green oval) in late July 2000. A few days later a long white candlestick formed and engulfed the previous 4 candlesticks. The combination of the bullish engulfing and long white candlestick served to reinforce the validity of support around 208. The stock has since tested support around 208 once in early September and twice in October. A piercing pattern (red arrow) formed in early October and a large hammer in late October.

Medtronic (MDT) established support around 46 in late February with a spinning top (red arrow) and early March with a harami. The stock declined sharply in April and formed a hammer to confirm support at 46 (green arrow). After a reaction rally to resistance around 57, the stock again declined sharply and again found support around 46 (blue arrow). The black candlestick with the long lower shadow marked support, but the body was too big to qualify as a hammer.

part 54 ===== Candlestick Pattern Dictionary

• Abandoned Baby: A rare reversal pattern characterized by a gap followed by a Doji, which is then followed by another gap in the opposite direction. The shadows on the Doji must completely gap below or above the shadows of the first and third day.
• Dark Cloud Cover: A bearish reversal pattern that continues the uptrend with a long white body. The next day opens at a new high then closes below the midpoint of the body of the first day.
• Doji: Doji form when a security's open and close are virtually equal. The length of the upper and lower shadows can vary, and the resulting candlestick looks like, either, a cross, inverted cross, or plus sign. Doji convey a sense of indecision or tug-of-war between buyers and sellers. Prices move above and below the opening level during the session, but close at or near the opening level.
• Downside Tasuki Gap: A continuation pattern with a long, black body followed by another black body that has gapped below the first one. The third day is white and opens within the body of the second day, then closes in the gap between the first two days, but does not close the gap.
• Dragonfly Doji: A Doji where the open and close price are at the high of the day. Like other Doji days, this one normally appears at market turning points.
• Engulfing Pattern: A reversal pattern that can be bearish or bullish, depending upon whether it appears at the end of an uptrend (bearish engulfing pattern) or a downtrend (bullish engulfing pattern). The first day is characterized by a small body, followed by a day whose body completely engulfs the previous day's body.
• Evening Doji Star: A three day bearish reversal pattern similar to the Evening Star. The uptrend continues with a large white body. The next day opens higher, trades in a small range, then closes at its open (Doji). The next day closes below the midpoint of the body of the first day.
• Evening Star: A bearish reversal pattern that continues an uptrend with a long white body day followed by a gapped up small body day, then a down close with the close below the midpoint of the first day.
• Falling Three Methods: A bearish continuation pattern. A long black body is followed by three small body days, each fully contained within the range of the high and low of the first day. The fifth day closes at a new low.
• Gravestone Doji: A doji line that develops when the Doji is at, or very near, the low of the day.
• Hammer: Hammer candlesticks form when a security moves significantly lower after the open, but rallies to close well above the intraday low. The resulting candlestick looks like a square lollipop with a long stick. If this candlestick forms during an advance, then it is called a Hanging Man.
• Hanging Man: Hanging Man candlesticks form when a security moves significantly lower after the open, but rallies to close well above the intraday low. The resulting candlestick looks like a square lollipop with a long stick. If this candlestick forms during a decline, then it is called a Hammer.
• Harami: A two day pattern that has a small body day completely contained within the range of the previous body, and is the opposite color.
• Harami Cross: A two day pattern similar to the Harami. The difference is that the last day is a Doji.
• Inverted Hammer: A one day bullish reversal pattern. In a downtrend, the open is lower, then it trades higher, but closes near its open, therefore looking like an inverted lollipop.
• Long Day: A long day represents a large price move from open to close, where the length of the candle body is long.
• Long-Legged Doji: This candlestick has long upper and lower shadows with the Doji in the middle of the day's trading range, clearly reflecting the indecision of traders.
• Long Shadows: Candlesticks with a long upper shadow and short lower shadow indicate that buyers dominated during the session and bid prices higher. Conversely, candlesticks with long lower shadows and short upper shadows indicate that sellers dominated during the session and drove prices lower.
• Marubozo: A candlestick with no shadow extending from the body at either the open, the close or at both. The name means close-cropped or close-cut in Japanese, though other interpretations refer to it as Bald or Shaven Head.
• Morning Doji Star: A three day bullish reversal pattern that is very similar to the Morning Star. The first day is in a downtrend with a long black body. The next day opens lower with a Doji that has a small trading range. The last day closes above the midpoint of the first day.
• Morning Star: A three day bullish reversal pattern consisting of three candlesticks - a long-bodied black candle extending the current downtrend, a short middle candle that gapped down on the open, and a long-bodied white candle that gapped up on the open and closed above the midpoint of the body of the first day.
• Piercing Line: A bullish two day reversal pattern. The first day, in a downtrend, is a long black day. The next day opens at a new low, then closes above the midpoint of the body of the first day.
• Rising Three Methods: A bullish continuation pattern in which a long white body is followed by three small body days, each fully contained within the range of the high and low of the first day. The fifth day closes at a new high.
• Shooting Star: A single day pattern that can appear in an uptrend. It opens higher, trades much higher, then closes near its open. It looks just like the Inverted Hammer except that it is bearish.
• Short Day: A short day represents a small price move from open to close, where the length of the candle body is short.
• Spinning Top: Candlestick lines that have small bodies with upper and lower shadows that exceed the length of the body. Spinning tops signal indecision.
• Stars: A candlestick that gaps away from the previous candlestick is said to be in star position. Depending on the previous candlestick, the star position candlestick gaps up or down and appears isolated from previous price action.
• Stick Sandwich: A bullish reversal pattern with two black bodies surrounding a white body. The closing prices of the two black bodies must be equal. A support prices is apparent and the opportunity for prices to reverse is quite good.
• Three Black Crows: A bearish reversal pattern consisting of three consecutive black bodies where each day closes near below the previous low and opens within the body of the previous day.
• Three White Soldiers: A bullish reversal pattern consisting of three consecutive white bodies, each with a higher close. Each should open within the previous body and the close should be near the high of the day.
• Upside Gap Two Crows: A three day bearish pattern that only happens in an uptrend. The first day is a long white body followed by a gapped open with the small black body remaining gapped above the first day. The third day is also a black day whose body is larger than the second day and engulfs it. The close of the last day is still above the first long white day.
• Upside Tasuki Gap: A continuation pattern with a long white body followed by another white body that has gapped above the first one. The third day is black and opens within the body of the second day, then closes in the gap between the first two days, but does not close the gap.

part 53 ===== Introduction to Candlesticks

History

The Japanese began using technical analysis to trade rice in the 17th century. While this early version of technical analysis was different from the US version initiated by Charles Dow around 1900, many of the guiding principles were very similar:

• The "what" (price action) is more important than the "why" (news, earnings, and so on).
• All known information is reflected in the price.
• Buyers and sellers move markets based on expectations and emotions (fear and greed).
• Markets fluctuate.
• The actual price may not reflect the underlying value.

According to Steve Nison, candlestick charting first appeared sometime after 1850. Much of the credit for candlestick development and charting goes to a legendary rice trader named Homma from the town of Sakata. It is likely that his original ideas were modified and refined over many years of trading eventually resulting in the system of candlestick charting that we use today.

Formation

In order to create a candlestick chart, you must have a data set that contains open, high, low and close values for each time period you want to display. The hollow or filled portion of the candlestick is called "the body" (also referred to as "the real body"). The long thin lines above and below the body represent the high/low range and are called "shadows" (also referred to as "wicks" and "tails"). The high is marked by the top of the upper shadow and the low by the bottom of the lower shadow. If the stock closes higher than its opening price, a hollow candlestick is drawn with the bottom of the body representing the opening price and the top of the body representing the closing price. If the stock closes lower than its opening price, a filled candlestick is drawn with the top of the body representing the opening price and the bottom of the body representing the closing price.

Compared to traditional bar charts, many traders consider candlestick charts more visually appealing and easier to interpret. Each candlestick provides an easy-to-decipher picture of price action. Immediately a trader can see compare the relationship between the open and close as well as the high and low. The relationship between the open and close is considered vital information and forms the essence of candlesticks. Hollow candlesticks, where the close is greater than the open, indicate buying pressure. Filled candlesticks, where the close is less than the open, indicate selling pressure.

Long Versus Short Bodies

Generally speaking, the longer the body is, the more intense the buying or selling pressure. Conversely, short candlesticks indicate little price movement and represent consolidation.

Long white candlesticks show strong buying pressure. The longer the white candlestick is, the further the close is above the open. This indicates that prices advanced significantly from open to close and buyers were aggressive. While long white candlesticks are generally bullish, much depends on their position within the broader technical picture. After extended declines, long white candlesticks can mark a potential turning point or support level. If buying gets too aggressive after a long advance, it can lead to excessive bullishness.

Long black candlesticks show strong selling pressure. The longer the black candlestick is, the further the close is below the open. This indicates that prices declined significantly from the open and sellers were aggressive. After a long advance, a long black candlestick can foreshadow a turning point or mark a future resistance level. After a long decline a long black candlestick can indicate panic or capitulation.

Even more potent long candlesticks are the Marubozu brothers, Black and White. Marubozu do not have upper or lower shadows and the high and low are represented by the open or close. A White Marubozu forms when the open equals the low and the close equals the high. This indicates that buyers controlled the price action from the first trade to the last trade. Black Marubozu form when the open equals the high and the close equals the low. This indicates that sellers controlled the price action from the first trade to the last trade.

Long Versus Short Shadows

The upper and lower shadows on candlesticks can provide valuable information about the trading session. Upper shadows represent the session high and lower shadows the session low. Candlesticks with short shadows indicate that most of the trading action was confined near the open and close. Candlestick with long shadows show that traded extended well past the open and close.

Candlesticks with a long upper shadow and short lower shadow indicate that buyers dominated during the session, and bid prices higher. However, sellers later forced prices down from their highs, and the weak close created a long upper shadow. Conversely, candlesticks with long lower shadows and short upper shadows indicate that sellers dominated during the session and drove prices lower. However, buyers later resurfaced to bid prices higher by the end of the session and the strong close created a long lower shadow.

Candlesticks with a long upper shadow, long lower shadow and small real body are called spinning tops. One long shadow represents a reversal of sorts; spinning tops represent indecision. The small real body (whether hollow or filled) shows little movement from open to close, and the shadows indicate that both bulls and bears were active during the session. Even though the session opened and closed with little change, prices moved significantly higher and lower in the meantime. Neither buyers nor sellers could gain the upper hand and the result was a standoff. After a long advance or long white candlestick, a spinning top indicates weakness among the bulls and a potential change or interruption in trend. After a long decline or long black candlestick, a spinning top indicates weakness among the bears and a potential change or interruption in trend.

Doji

Doji are important candlesticks that provide information on their own and as components of in a number of important patterns. Doji form when a security's open and close are virtually equal. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. Alone, doji are neutral patterns. Any bullish or bearish bias is based on preceding price action and future confirmation. The word "Doji" refers to both the singular and plural form.

Ideally, but not necessarily, the open and close should be equal. While a doji with an equal open and close would be considered more robust, it is more important to capture the essence of the candlestick. Doji convey a sense of indecision or tug-of-war between buyers and sellers. Prices move above and below the opening level during the session, but close at or near the opening level. The result is a standoff. Neither bulls nor bears were able to gain control and a turning point could be developing.

Different securities have different criteria for determining the robustness of a doji. A $20 stock could form a doji with a 1/8 point difference between open and close, while a $200 stock might form one with a 1 1/4 point difference. Determining the robustness of the doji will depend on the price, recent volatility, and previous candlesticks. Relative to previous candlesticks, the doji should have a very small body that appears as a thin line. Steven Nison notes that a doji that forms among other candlesticks with small real bodies would not be considered important. However, a doji that forms among candlesticks with long real bodies would be deemed significant.

Doji and Trend

The relevance of a doji depends on the preceding trend or preceding candlesticks. After an advance, or long white candlestick, a doji signals that the buying pressure is starting to weaken. After a decline, or long black candlestick, a doji signals that selling pressure is starting to diminish. Doji indicate that the forces of supply and demand are becoming more evenly matched and a change in trend may be near. Doji alone are not enough to mark a reversal and further confirmation may be warranted.

After an advance or long white candlestick, a doji signals that buying pressure may be diminishing and the uptrend could be nearing an end. Whereas a security can decline simply from a lack of buyers, continued buying pressure is required to sustain an uptrend. Therefore, a doji may be more significant after an uptrend or long white candlestick. Even after the doji forms, further downside is required for bearish confirmation. This may come as a gap down, long black candlestick, or decline below the long white candlestick's open. After a long white candlestick and doji, traders should be on the alert for a potential evening doji star.

After a decline or long black candlestick, a doji indicates that selling pressure may be diminishing and the downtrend could be nearing an end. Even though the bears are starting to lose control of the decline, further strength is required to confirm any reversal. Bullish confirmation could come from a gap up, long white candlestick or advance above the long black candlestick's open. After a long black candlestick and doji, traders should be on the alert for a potential morning doji star.

Long-Legged Doji

Long-legged doji have long upper and lower shadows that are almost equal in length. These doji reflect a great amount of indecision in the market. Long-legged doji indicate that prices traded well above and below the session's opening level, but closed virtually even with the open. After a whole lot of yelling and screaming, the end result showed little change from the initial open.

Dragon Fly and Gravestone Doji

Dragon Fly Doji

Dragon fly doji form when the open, high and close are equal and the low creates a long lower shadow. The resulting candlestick looks like a "T" with a long lower shadow and no upper shadow. Dragon fly doji indicate that sellers dominated trading and drove prices lower during the session. By the end of the session, buyers resurfaced and pushed prices back to the opening level and the session high.

The reversal implications of a dragon fly doji depend on previous price action and future confirmation. The long lower shadow provides evidence of buying pressure, but the low indicates that plenty of sellers still loom. After a long downtrend, long black candlestick, or at support, a dragon fly doji could signal a potential bullish reversal or bottom. After a long uptrend, long white candlestick or at resistance, the long lower shadow could foreshadow a potential bearish reversal or top. Bearish or bullish confirmation is required for both situations.

Gravestone Doji

Gravestone doji form when the open, low and close are equal and the high creates a long upper shadow. The resulting candlestick looks like an upside down "T" with a long upper shadow and no lower shadow. Gravestone doji indicate that buyers dominated trading and drove prices higher during the session. However, by the end of the session, sellers resurfaced and pushed prices back to the opening level and the session low.

As with the dragon fly doji and other candlesticks, the reversal implications of gravestone doji depend on previous price action and future confirmation. Even though the long upper shadow indicates a failed rally, the intraday high provides evidence of some buying pressure. After a long downtrend, long black candlestick, or at support, focus turns to the evidence of buying pressure and a potential bullish reversal. After a long uptrend, long white candlestick or at resistance, focus turns to the failed rally and a potential bearish reversal. Bearish or bullish confirmation is required for both situations.

Before turning to the single and multiple candlestick patterns, there are a few general guidelines to cover.

Bulls Versus Bears

A candlestick depicts the battle between Bulls (buyers) and Bears (sellers) over a given period of time. An analogy to this battle can be made between two football teams, which we can also call the Bulls and the Bears. The bottom (intra-session low) of the candlestick represents a touchdown for the Bears and the top (intra-session high) a touchdown for the Bulls. The closer the close is to the high, the closer the Bulls are to a touchdown. The closer the close is to the low, the closer the Bears are to a touchdown. While there are many variations, I have narrowed the field to 6 types of games (or candlesticks):

1. Long white candlesticks indicate that the Bulls controlled the ball (trading) for most of the game.
2. Long black candlesticks indicate that the Bears controlled the ball (trading) for most of the game.
3. Small candlesticks indicate that neither team could move the ball and prices finished about where they started.
4. A long lower shadow indicates that the Bears controlled the ball for part of the game, but lost control by the end and the Bulls made an impressive comeback.
5. A long upper shadow indicates that the Bulls controlled the ball for part of the game, but lost control by the end and the Bears made an impressive comeback.
6. A long upper and lower shadow indicates that the both the Bears and the Bulls had their moments during the game, but neither could put the other away, resulting in a standoff.

What Candlesticks Don't Tell You

Candlesticks do not reflect the sequence of events between the open and close, only the relationship between the open and the close. The high and the low are obvious and indisputable, but candlesticks (and bar charts) cannot tell us which came first.

With a long white candlestick, the assumption is that prices advanced most of the session. However, based on the high/low sequence, the session could have been more volatile. The example above depicts two possible high/low sequences that would form the same candlestick. The first sequence shows two small moves and one large move: a small decline off the open to form the low, a sharp advance to form the high, and a small decline to form the close. The second sequence shows three rather sharp moves: a sharp advance off the open to form the high, a sharp decline to form the low, and a sharp advance to form the close. The first sequence portrays strong, sustained buying pressure, and would be considered more bullish. The second sequence reflects more volatility and some selling pressure. These are just two examples, and there are hundreds of potential combinations that could result in the same candlestick. Candlesticks still offer valuable information on the relative positions of the open, high, low and close. However, the trading activity that forms a particular candlestick can vary.

Prior Trend

In his book, Candlestick Charting Explained, Greg Morris notes that for a pattern to qualify as a reversal pattern, there should be a prior trend to reverse. Bullish reversals require a preceding downtrend and bearish reversals require a prior uptrend. The direction of the trend can be determined using trend lines, moving averages, peak/trough analysis or other aspects of technical analysis. A downtrend might exist as long as the security was trading below its down trend line, below its previous reaction high or below a specific moving average. The length and duration will depend on individual preferences. However, because candlesticks are short-term in nature, it is usually best to consider the last 1-4 weeks of price action.

Candlestick Positioning

Star Position

A candlestick that gaps away from the previous candlestick is said to be in star position. The first candlestick usually has a large real body, but not always, and the second candlestick in star position has a small real body. Depending on the previous candlestick, the star position candlestick gaps up or down and appears isolated from previous price action. The two candlesticks can be any combination of white and black. Doji, hammers, shooting stars and spinning tops have small real bodies, and can form in the star position. Later we will examine 2- and 3-candlestick patterns that utilize the star position.

Harami Position

A candlestick that forms within the real body of the previous candlestick is in Harami position. Harami means pregnant in Japanese and the second candlestick is nestled inside the first. The first candlestick usually has a large real body and the second a smaller real body than the first. The shadows (high/low) of the second candlestick do not have to be contained within the first, though it's preferable if they are. Doji and spinning tops have small real bodies, and can form in the harami position as well. Later we will examine candlestick patterns that utilize the harami position.

Long Shadow Reversals

There are two pairs of single candlestick reversal patterns made up of a small real body, one long shadow and one short or non-existent shadow. Generally, the long shadow should be at least twice the length of the real body, which can be either black or white. The location of the long shadow and preceding price action determine the classification.

The first pair, Hammer and Hanging Man, consists of identical candlesticks with small bodies and long lower shadows. The second pair, Shooting Star and Inverted Hammer, also contains identical candlesticks, except, in this case, they have small bodies and long upper shadows. Only preceding price action and further confirmation determine the bullish or bearish nature of these candlesticks. The Hammer and Inverted Hammer form after a decline and are bullish reversal patterns, while the Shooting Star and Hanging Man form after an advance and are bearish reversal patterns.

Hammer and Hanging Man

The Hammer and Hanging Man look exactly alike, but have different implications based on the preceding price action. Both have small real bodies (black or white), long lower shadows and short or non-existent upper shadows. As with most single and double candlestick formations, the Hammer and Hanging Man require confirmation before action.

The Hammer is a bullish reversal pattern that forms after a decline. In addition to a potential trend reversal, hammers can mark bottoms or support levels. After a decline, hammers signal a bullish revival. The low of the long lower shadow implies that sellers drove prices lower during the session. However, the strong finish indicates that buyers regained their footing to end the session on a strong note. While this may seem enough to act on, hammers require further bullish confirmation. The low of the hammer shows that plenty of sellers remain. Further buying pressure, and preferably on expanding volume, is needed before acting. Such confirmation could come from a gap up or long white candlestick. Hammers are similar to selling climaxes, and heavy volume can serve to reinforce the validity of the reversal.

The Hanging Man is a bearish reversal pattern that can also mark a top or resistance level. Forming after an advance, a Hanging Man signals that selling pressure is starting to increase. The low of the long lower shadow confirms that sellers pushed prices lower during the session. Even though the bulls regained their footing and drove prices higher by the finish, the appearance of selling pressure raises the yellow flag. As with the Hammer, a Hanging Man requires bearish confirmation before action. Such confirmation can come as a gap down or long black candlestick on heavy volume.

Inverted Hammer and Shooting Star

The Inverted Hammer and Shooting Star look exactly alike, but have different implications based on previous price action. Both candlesticks have small real bodies (black or white), long upper shadows and small or nonexistent lower shadows. These candlesticks mark potential trend reversals, but require confirmation before action.

The Shooting Star is a bearish reversal pattern that forms after an advance and in the star position, hence its name. A Shooting Star can mark a potential trend reversal or resistance level. The candlestick forms when prices gap higher on the open, advance during the session and close well off their highs. The resulting candlestick has a long upper shadow and small black or white body. After a large advance (the upper shadow), the ability of the bears to force prices down raises the yellow flag. To indicate a substantial reversal, the upper shadow should relatively long and at least 2 times the length of the body. Bearish confirmation is required after the Shooting Star and can take the form of a gap down or long black candlestick on heavy volume.

The Inverted Hammer looks exactly like a Shooting Star, but forms after a decline or downtrend. Inverted Hammers represent a potential trend reversal or support levels. After a decline, the long upper shadow indicates buying pressure during the session. However, the bulls were not able to sustain this buying pressure and prices closed well off of their highs to create the long upper shadow. Because of this failure, bullish confirmation is required before action. An Inverted Hammer followed by a gap up or long white candlestick with heavy volume could act as bullish confirmation.

Blending Candlesticks

Candlestick patterns are made up of one or more candlesticks and these can be blended together to form one candlestick. This blended candlestick captures the essence of the pattern and can be formed using the following:

• The open of first candlestick
• The close of the last candlestick
• The high and low of the pattern

By using the open of the first candlestick, close of the second candlestick, and high/low of the pattern, a Bullish Engulfing Pattern or Piercing Pattern blends into a Hammer. The long lower shadow of the Hammer signals a potential bullish reversal. As with the Hammer, both the Bullish Engulfing Pattern and the Piercing Pattern require bullish confirmation.

Blending the candlesticks of a Bearish Engulfing Pattern or Dark Cloud Cover Pattern creates a Shooting Star. The long, upper shadow of the Shooting Star indicates a potential bearish reversal. As with the Shooting Star, Bearish Engulfing, and Dark Cloud Cover Patterns require bearish confirmation.

More than two candlesticks can be blended using the same guidelines: open from the first, close from the last and high/low of the pattern. Blending Three White Soldiers creates a long white candlestick and blending Three Black Crows creates a long black candlestick.