Letters of the Week

Transport weakness, small cap signposts, and interbank lending.

Transport warning signs

From a technical perspective, the Dow Jones Transportation Index looks very weak to me, particularly since January this year. Doesn't this totally conflict with the increase in bullish sentiment towards shares and recent pre-QE3 performance in the Dow, Nasdaq and S&P 500? Isn't the transport index a leading indicator?

Also, the NYSE VIX volatility index has declined to lows not seen since 2007 and doesn't this suggest complacency?

L Heffes

Getting technical

Another Eureka Report gem. Inside Line, featuring James Kirby and Roger Montgomery on small cap signposts, portrays the tyranny of attempting to make any sense of fundamentals and getting acquainted with company goings on, in the midst of the current global economic mayhem.

The time may therefore be opportune to get technical about trading. Multiple moving averages can help patient investors to spot interesting opportunities during quiet periods, when the market often drifts sideways before exploding up or down.

Using three consecutive cycle lengths, for example a five-day moving average to represent the weekly cycle, a 21-day moving average to represent the monthly cycle and a 63-day moving average to represent the quarterly cycle would be particularly useful to determine up or down trends.

V Massonic

Why all the lending?

With the ability now of money able to be transferred at the press of a button, and the fact that, in the USA at least, the banks have hundreds of billions on deposit at the Fed, why do they need interbank transfers?

S Sturgess

Editor’s response: Interbank lending is incredibly important to the structure of the financial system broadly for three main reasons. Firstly, banks need to hold very large amounts of very liquid assets at the end of each day. Short term funding at the low rates banks offer each other is a cheap and easy way to ‘smooth’ out the bumps of liquidity and reserve requirements. Secondly, as you point out, the US banks have Fed fund balances but banks in the rest of the world do not. It is also important to note these deposits are how the US government transmits monetary policy. Finally, perhaps most importantly, interbank lending creates benchmarks for other financial instruments. Variable rate financial products like mortgages or floating rate notes need a variable to ‘solve’ for so the market for them can function. Something like the London Interbank Offered Rate (LIBOR) is the reference for trillions of dollars of derivatives that have to reference something.

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