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Tuesday, May 12, 2009

About Economic tides and Stock Market trends

In a book written nearly 70 years ago but which is still relevant today, Edwards and Magee compared stock market trends to tides, waves and ripples in the ocean.

Major or Primary trends - 'bull market' for an up trend and 'bear market' for a down trend - last for a year or more. A 'bull market' can be compared to an incoming tide 'which carries the water farther and farther up the beach until finally it reaches high-water mark and begins to turn. Then follows the receding or ebb tide, comparable to a Bear Market'.

Intermediate or Secondary trends - that last for 3 weeks to a few months - are declines or 'corrections' in a 'bull market' and rallies or 'recoveries' in a 'bear market'. 'While the tide is rising, each succeeding wave pushes a little farther up onto the shore and, as it recedes, does not carry the water quite so far back as did its predecessor. During the tidal ebb, each advancing wave falls a little short of the mark set by the one before it, and each receding wave uncovers a little more of the beach. These waves are the Intermediate trends - Primary or Secondary depending on whether their movement is with or against the direction of the tide'.

Minor trends are part of Intermediate or Secondary trends that last for only a few days, and are meaningless for investment purposes and often prone to manipulation. 'The surface of the water is constantly agitated by wavelets, ripples and "catspaws"
moving with or against or across the trend of the waves - these are analogous to the market's Minor trends, its unimportant day-to-day fluctuations'.

The vast majority of the world's population have neither any interest, nor any inclination towards investing, in the stock markets. For them, the state of the economy - the rising cost of daily groceries, interest on mortgage payments, cost of petrol are of greater significance.

To extend the ocean analogy further, I would like to compare the ebb and flow of the ocean's tide to the state of the economy. During economic up turns, production booms, jobs are plentiful, consumption of household goods and luxury goods go up - leading to expansion in production, more jobs, more consumption, till finally, inflation and higher interest costs take its toll and the economic tide turns.

Over the past several years, the economic tide is gradually flowing towards the emerging markets and ebbing from the developed markets. It didn't happen in a day and the economic balance has still not shifted completely. But the signs of this shift are becoming apparent.

A look at the world market indices will suffice. While the Shanghai Composite, Hang Seng, TSEC, KOSPI, Sensex, Bovespa are all trading above their long term averages, the Dow, FTSE, CAC, DAX are still struggling to cross their 200 day EMAs.

This gives a clear indication of where the economic recoveries will happen first. Irrespective of whether we are in an intermediate bear market rally or in the primary stages of a bull market.

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