FINANCIAL MARKETS

AND THE BUSINESS CYCLE

Our principal objective here is to explain the benefits of the technical
approach, but it is also important to understand that primary trends of stocks,
bonds, and commodities are determined by the attitude of investors toward
unfolding events in the business cycle. Each market has a tendency to peak
and trough at different points during the cycle in a consistent, chronological
manner.
 THE DISCOUNTING
MECHANISM OF FINANCIAL
MARKETS
The primary trend of all financial markets is essentially determined by
investors’ expectations of movements in the economy, the effect those
changes are likely to have on the price of the asset in which A specific
financial market deals, and the psychological attitude of investors to these
fundamental factors.
 Expectations of an expanding level of economic activity are usually
favorable for stock prices. Anticipation of a weak economy is bullish
for bond prices, and prospects for capacity constraints offer a favorable
tailwind for industrial commodity prices. These three markets often
move in different directions simultaneously because they are
discounting different things. Through stock bond and commodity mkts
 Figure 2.1, revolves around a point of balance known as equilibrium.
Roughly speaking, equilibrium can be thought of as a period of zero growth in
which business activity is neither expanding nor contracting. In practice, this
state of affairs is rarely, if ever, attained, since an economy as a whole
possesses tremendous momentum in either the expansionary or the
contractionary phase, so that the turnaround rarely occurs at an equilibrium
level.
MAJOR TECHNICAL PRINCIPLE
The business cycle is nothing less than a
set series of chronological events that are
continually repeating.
 MARKET MOVEMENTS
AND THE BUSINESS
CYCLE
The major movements of interest rates, equities, and commodity prices are
related to changes in the level of business activity. Please note that the term
“commodity prices” refers to industrial prices that are sensitive to business
conditions, as opposed to weather-driven commodities such as grains. Figure
2.2 represents a business cycle, which typically has a life of between 3 and 5
years between troughs. The horizontal line reflects a level of zero growth,
above which are periods of expansion and below which are periods of
contraction.
Figure 2.2 show the idealized peaks and troughs of the financial markets as
they relate to the business cycle.
 Figure 2.3 shows the hypothetical trajectories of bond prices, commodities,
and equities during the course of a typical business cycle.
We can see that the bond market is the first financial market to begin a bull
phase. This usually occurs after the growth rate in the economy has slowed
down considerably from its peak rate, and quite often is delayed until the
initial stages of the recession.
 THE SIX STAGES

These the six stages, and they can be used as reference points for
determining the current phase of the cycle. The six stages are
indicated in Figure 2.4.
When identifying a stage, it is important to look at the long term
technical position of all three markets so they can act as a cross-
check on each other.
LONGER CYCLES
 Figure 2.5. A double cycle developed in the 1980s and another in the
1990s. In the mid-1980s, for example, commodity and industrial parts of
the country were very badly affected as a result of the unwinding of the
commodity boom that ended in 1980, but the east and west coasts
continued their expansions unabated.
CYCLE THAT IS MORE THAN 1 YEAR
 THE ROLE OF TECHNICAL ANALYSIS

Technical analysis comes into play by helping to determine when the various
markets have turned in a primary way. This is achieved by applying the various
techniques outlined in subsequent chapters, moving average crossovers, changes
in the direction of long-term momentum, and so forth. Each market can then be
used as a cross-check against the other two. For example, if the weight of the
technical evidence suggests that bonds have bottomed but that commodity prices
remain in a bear market, then the next thing to do would be to look for technical
signs pointing to a stock market bottom and so forth.
This analysis has also formed the basis of the Dow Jones Pring U.S. Business
Cycle Index (symbol DJPRING) as shown in Chart 2.1.