FUNDAMENTAL ANALYSIS – AN INTRODUCTION
Fundamental analysis is the study of economic, social and political data that represents and quantifies the economy in question with the goal of determining future movements in a financial market.
Analysts have been grouped into either Technical or Fundamental camps for many years, but actually there are very few pure technicians or fundamentalists. Technical analysts cannot really ignore the effect and timing of economic announcements, and fundamental analysts cannot really ignore various signals derived from the study of historic prices and volatility.
It is fairly difficult to take into account all the different economic announcements as well as the political and social situations that affect an economy, particularly in today's global market. However by understanding the basics and delving deeper into the various fundamentals of the economies one’s understanding of the financial markets can improve dramatically.
There are a myriad of economic announcements, and while it may be important to be familiar with schedules and understand the nature and possible impact of the announcements, it is very easy to be bogged down by too much information to the point where one may simply not be able to come up with an effective basis for trading.
Because of the vast number of fundamentals out there, it may be more important to focus on the main price movers as a basis, rather then try to know a little about a lot.
ECONOMIC INDICATORS
Economic indicators are quantitative announcements released as data reflecting the financial, economic and social atmosphere of an economy. They are published by various agencies of the government or private sector. These statistics are anticipated by the public and are released at predetermined times according to a schedule. They are used by many to monitor the health and strength of an economy. With so many players anticipating the release, the announcements themselves often create a surge in volume and may often move the price of various instruments very quickly.
With so many economic releases made daily, it is more important to be aware of a few major announcements and then to try to be up to date with them all.
The following is a basic guide to economic announcements:
1. ECONOMIC CALENDAR
Know exactly when each economic indicator is due to be released. Try keeping a calendar on your desk or trading platform or station that contains the name of the indicator, the date and time as well as the expected release. Often it's not just the announcement itself that moves the market but the anticipation of the announcement, which can move the market sometimes days or weeks prior to the actual release.
2. UNDERSTAND THE ANNOUNCEMENT
Understand what particular aspect of the economy is being revealed in the data. There are several aspects of an economy that are measured by growth, such as GDP; by inflation, such as PPI or CPI; by employment, such as Non-Farm Payrolls; by interest rate announcements; by confidence, such as Consumer Confidence or Spending, and so on. After you follow the data for a while, you'll become very familiar with each economic indicator and what part of the economy they are relating to.
3. KNOW THE INDICATORS TO CONCENTRATE ON
As mentioned before, there are a myriad of indicators that are released daily. It would be impossible to follow them all religiously, and it may well be a waste of time. Some move markets and others don't – concentrate on the ones that do. However economic indicators are not static over the years. Some have gained greater importance and others have become less important. Keep up to date.
4. ANTICIPATION
The data itself may not be as significant as the difference between market expectation and the actual result. As mentioned earlier, it is important to know the expectation by the market. Expectations are then built into the price of the instrument. What is not built in is an unexpected figure or event. This is sometimes felt not only by the announcement itself but by the wording joined with the announcement. For instance, an expected 0.25% rate hike may not change the market as expected, however the wording following the announcement, that there will not be any further hikes, for example, may in fact move the price.
5. UNDERSTAND THE RELEASE
Not all unexpected releases trigger a move in the market. Contained in each new economic indicator released to the public are revisions to previously released data. Sometimes these can be ambiguous. For instance, if durable goods rise by 0.4% in the current month and the market is anticipating them to fall, the unexpected rise could be the result of a downward revision to the prior month. Compare the revisions to older data because, in this case, the previous month's durable goods figure might have been originally reported as a rise of 0.4% but now, along with the new figures, is being revised lower to say a rise of only 0.1% Therefore, the unexpected rise in the current month is likely the result of a downward revision to the previous month's data.
6. CURRENCY CROSSES
Instruments are traded as one currency against another, therefore knowing one side of the game may not be enough. One currency may be down but the other one even worse, so the effect may be the opposite of what you expect.
TYPES OF INDICATORS
Economic indicators are often described as either leading or lagging indicators. Leading indicators relate to economic indicators that change before the economy starts to follow a particular pattern or trend; they are used to predict changes in the economy. Lagging indicators are economic indicators that change after the economy has already begun to follow a particular pattern or trend.
US ECONOMIC INDICATORS
NON-FARM PAYROLLS, (NEW JOBS CREATED) NOT INCLUDING AGRICULTURE.
- Released on the 1st Friday of every month at 8:30 am NY time.
- Importance – Market mover
TRADE BALANCE OR US TRADE DEFICIT
Trade Balance, calculates the difference between the total amount of exports versus imports in goods and services; the balance has been in a deficit since the 1970s.
Released on approximately the 10th of every month at 8:30 am NY time.
Importance – Market mover
CORE CPI, CONSUMER PRICE INDEX
The CPI calculates the difference in price of a basket of goods and services that are influenced by the surroundings and paid by urban consumers; the Core CPI eliminates those same goods (food and energy) that are strongly influenced.
Released on approximately the 15th of every month at 8:30 am NY time.
Importance – Market mover
MANUFACTURING ISM, (INCLUSIVE OF MANUFACTURING)
Institute for Supply Management inclusive of Manufacturing gives an indication of activities in the manufacturing sector.
Released on the first business day of every Month at 10:00 am NY time.
Importance – Market mover.
RETAIL SALES
Calculates the monthly differential in sales by retail shops to the consumer.
It is the timeliest indicator of broad consumer spending patterns and is adjusted for normal seasonal variation, holidays, and trading-day differences.
Released on approximately the 15th of every month
Importance – Market mover.
MICHIGAN CONSUMER CONFIDENCE
Indicates consumer confidence in the US Economy, based on a monthly survey of 5,000 households in the US
The preliminary report is released on approximately the 15th of every month, the final report on the last Tuesday of every month.
Importance – Market mover
GROSS DOMESTIC PRODUCT - GDP
The output of goods and services produced by labor and property located in the United States.
GDP indicates the pace at which the country's economy is growing (or shrinking) and is considered the broadest indicator of economic output and growth.
Quarterly data revised monthly, released about four weeks after month end.
Importance – Market mover
INSTITUTE FOR SUPPLY MANAGEMENT INDEX
The ISM is a composite index based on the seasonally adjusted diffusion indexes of five of the indicators (New Orders, Production, Supplier Deliveries, Inventories and Employment) with different weights.
Importance - High.
NATIONAL SAVINGS (%)
Personal saving as a percentage of disposable personal income.
The rate of savings has a direct impact on economic activity. A high rate of savings implies that little money is being directed into the economy. A lower rate of savings suggests that consumers are spending more, thus fueling the economy. However, a negative rate of savings means that the public is putting itself in debt - a situation that may drive growth in the short-run, but is unsustainable.
Importance - High
The Weekly Leading Index is a composite index based on the following seven indicators: the JOC-ECRI materials price index, mortgage activity, bond quality spreads, stock prices, bond yields, and jobless claims.
The WLI measures leading indicators and shows economic trends quickly and reliably by using indicators that measure drivers of business cycles. It shows troughs a median of three months ahead and peaks a median of ten and a half months ahead.
Importance - Medium.
NEW ORDERS FOR DURABLE GOODS (IN BILLIONS)
- Seasonally adjusted.
- Durable Goods orders measures new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods.
- A Durable Good is defined as a good that lasts an extended period of time (over three years) during which its services are extended.
- Durable Goods orders are volatile, but can serve as an indicator of future economic activity. An increase in orders must occur before manufacturers will increase production. Conversely, a decrease in orders tends to result in a cutback in production.
- Importance - Medium.
PPI – FINISHED GOODS
Producer Price Index - Finished Goods, not seasonally adjusted.
Measures inflation at the producer level, and does not include services. Typically a sharp rise in the PPI triggers a decline in both the
stock trading and bond markets.
The PPIs most often used for economic analysis are those for finished goods, intermediate goods, and crude goods.
Importance - Medium
U.S UNEMPLOYMENT RATE (%)
- Ratio between the number of unemployed persons and the total labor force, seasonally adjusted.
- The unemployment rate is an indicator of overall economic health. A low rate indicates a strong economy where job seekers can find employment quickly, whereas a high rate may indicate a weaker economy. On the other hand, businesses can find employees more easily when the unemployment rate is high.
- Importance - Medium
RESIDENTIAL BUILDING PERMITS
New privately owned housing units authorized by building permits, not seasonally adjusted. Figures are for total permits, including both single-unit and multi-unit structures.
The housing market tends to be a leading indicator of economic activity. Aside from seasonal fluctuations, sharp increases (decreases) in home construction or sales lead to a corresponding increase (decrease) in the economy due to the fact that housing accounts for between one quarter and one third of investment spending and five percent of the overall national economy. Construction employment is also impacted by the housing market. A decline in the number of permits issued signals a decrease in construction employment.
Importance - Medium.
INDUSTRIAL PRODUCTION
A chain-weighted measure of the change in the production of the nation's factories, mines and utilities as well as a measure of their industrial capacity and of how many available resources among factories, utilities and mines are being used (commonly known as capacity utilization).
The manufacturing sector accounts for one-quarter of the economy.
The capacity utilization rate provides an estimate of how much factory capacity is in use.
Importance - Medium.
PURCHASING MANAGERS INDEX (PMI)
The National Association of Purchasing Managers (NAPM), now called the Institute for Supply Management, releases a monthly composite index of national manufacturing conditions,
Constructed from data on new orders, production, supplier delivery times, backlogs, inventories, prices, employment, export orders, and import orders.
Divided into manufacturing and non-manufacturing sub-indices.
Importance – Medium.
HOUSING STARTS
The Housing Starts report measures the number of residential units on which construction is begun each month.
A start in construction is defined as the beginning of excavation of the foundation for the building and is comprised primarily of residential housing.
Housing is very interest rate sensitive and is one of the first sectors to react to changes in interest rates.
Significant reaction of start/permits to changing interest rates signals that interest rates are nearing trough or peak. To analyze, focus on the percentage change in levels from the previous month.
Report is released around the middle of the following month.
Importance – Medium.
EMPLOYMENT COST INDEX (ECI)
Payroll employment is a measure of the number of jobs in more than 500 industries in all states and 255 metropolitan areas.
Employment estimates are based on a survey of larger businesses and count the number of paid employees working part-time or full-time in the nation's business and government establishments.
Importance – Medium-Low.
GERMANY ECONOMIC INDICATORS
IFO SURVEY (INCOME FROM OPERATIONS)
Business Confidence
Importance – Medium.
JAPAN ECONOMIC INDICATORS
TANKAN SURVEY
Climate Survey or Confidence Survey.
An economic survey of Japanese business issued by the Central Bank of Japan, which uses it to formulate monetary policy.
The report is released four times a year in April, July, October and mid-December.
Importance – Medium.
MACHINERY ORDERS
