Kirkpatrick and Dahlquist, CMT2 Chapter 10

Part II: Markets and Market Indicators
Chapter 10: Flow of Funds

• Chapter Objectives
  • Understand why knowledge of the flow of funds is important to determining stock market valuation
  • Understand why liquidity plays an important role in potential stock market valuation
  • Be familiar with measurements of market liquidity
  • Understand the relationship between Federal Reserve policy and the cost of funds
• Intro
• Funds in the Marketplace
  • Intro
  • Money Market Funds
  • Margin Debt
  • Secondary Offerings
• Funds Outside the Security Market
  • Household Financial Assets
  • Money Supply
    • Measurements of the Money Supply
    • Money supply relative to the total value of the stock market
  • Bank Loans
• The Cost of Funds
  • Short-Term Interest Rates
  • Long-Term Interest Rates (or Inversely, the Bond Market)
  • Money Velocity
    • Measure of how fast money turns over in the economy
    • ratio of personal income to M2
    • related to inflation (the faster money circulates, the more pressure on prices)
    • leading indicator of long-term interest rates (because it reflects inflationary pressure)
    • Ned Davis Research
      • When money velocity (monthly figure) rises above its 13-month moving average, the stock market has advanced 3.4% per annum on average
      • When money velocity declines below its 13-month moving average, the stock market has advanced 10.1% per annum.
      • Inflationary pressures from increased money velocity put a damper on stock market prices
  • Misery Index
    • Economist Arthur Okum – 1960’s, during President Johnson’s administration
    • Inflation + High Unemployment = “Stagflation”
    • Stagflation measures the social and economic cost of high inflation and high unemployment.
    • Misery index can be calculated for any country by summing inflation and unemployment rates
    • Original Misery Index became the “American Misery Index” = inflation + unemployment + interest rates
    • Trading system: Whenever the American Misery Index falls by 0.3 points buy the DJIA, and whenever the index rises by 3.2 points, sell the DJIA.  Trading accuracy of this system = 75% favorable and gain is more than buy-and-hold by 4%.
• Fed Policy
• Fed Policy Futures
• The Federal Reserve Valuation Model
• Three Steps and a Stumble
• Yield Curve
  • The yield curve as a forecast of stock market direction
• Conclusion
• Review Questions