Lecture 9 (relative strength & flow of funds) Flashcards
What is relative strength?
It is the idea of comparing one or a group of stocks to the market as a whole to determine if the stock or group of stocks is outperforming or underperforming the market in general
How is relative strength calculated?
It is done by dividing one market over the othe
What does a rising ratio relative strength mean?
the numerator is stronger than the denominator
What does a falling ratio relative strength mean?
the denominator is stronger than the numerator
What is the presumption of relative strength? (similar to the trends)
Presumption that relative strength will continue
In relative strength, If the numerator is rising, what do you do?
You would buy the numerator and sell the denominator
In relative strength, if the the denominator is rising, what do you do?
You would buy the denominator and sell the numerator
What relationship can relative strength be used for?
intermarket relationships, compare investments, sectors, industries, index averages, commodities, etc.
This is done to see which is outperforming the other
What does the trend in the Relative strength indicate?
Indicates whether or not a stock or a group of stock is acting better than or worse than the general market
When may TA’s use relative strength
TA’s may use RS to determine future market leadership or the potential loss of leadership
What can be said about groups of stocks that end well in the tail end of a bear market?
They often emerge as the new bull market’s leaders
What happens to the leaders in a bull market if RS “divergence” beginds to profile a mature trend?
Leaders in the bull market may show signs of losing their status
What do you use to see if sub sectors of the market are outperforming or underperforming the general market?
You divide these sub sectors against the S&P 500
What may trendlines or moving averages on the RS line do?
May be used to spot important changes
What is the idea with the sectors that have rising and falling relative strengths?
Idea is to rotate your funds into these sectors with rising RS and rotate out of the ones with falling RS
What is an important conclusion regarding RS
Like other tools, it should probably not be a sole application or the only tool used
What is the idea of studying flow of funds?
Looking at where funds are spend. These indicators are not typically a buy/sell signal but examine the current conditions and their effect on the stock market
What characterstics do investors have at the beginnning of a major uptrend
investors are risk averse. Small percentage in financial assets and high percentage in bonds & cash
Who starts an uptrend?
Investors, people with long-term horizons, willing to look beyond the current uncertainties. These people are motivated by price & value
What motivates traders
Motivated by the trend, and tend to gain greater and greater confidence as a trend persists
When money is unavailable or expensive, what happens to the supply of stocks?
The supply of stocks increases as investors sell their stocks to raise funds for other purposes.
So: Money less available = more stocks available
When money is available or less expensive, what happens to the supply of stocks?
more money is available to be put into the stock market
What are the 4 major topics in the study of flow of funds?
1) money available
2) availability of funds not currently invested in the market
3) the cost of funds
4) influence of the U.S. federal reserve’s policy on these variables
What are the 3 sub sections that make up “money available”
1) money market mutual funds
2) margin debt
3) secondary offerings
What is “money market mutual funds” in money available
It is an indicator that shows the liquidity or illiquidity available to the stock market. However, having large amount of available cash doesn’t mean that it will be invested into the stock market
What is “margin debt” in money available
The amount of money that customers at brokerage firms borrow to buy stocks
How do you analyze margin debt?
Use a 15 month rate of change indicator. When the signal crosses above -21% you buy and when the signal crosses below 48% you sell
What is “secondary offerings” in money available
It looks at the amount of secondary offerings on the market, which is a sign of increasing supply of stock being sold on the market
Why is the number of offerings more important than the dollar amount
Since the dollar amount is reflected by the number of offerings on the market
What are the 2 reasons why secondary offerings are bearish
1) more supply = price goes down
2) the seller, who are usually insiders, are liquidating which could mean they are trying to get highest price
What are the 3 sub sections that make up “fund outside the securities market”
1) household financial assets
2) money supply
3) bank loans
What is household financial assets
A ratio of liquid family assets (cash, bank deposits, etc) to illiquid assets (pension funds, mortgages, etc)
What is the idea behind the ratio in household financial assets
It shows how liquid families are in raising cash if they need it. The more liquid a family is, the more chances they will invest in stocks
True or False: If household liquidity is high, it is favourable for the stock market
True
True or False: If household liquidity is LOW, it is negative for the stock market
True
What is money supply
it is looking at the supply of money and its affects it has on economic growth and productivity
->Inc in money supply = inc in economic and productivity
What is the definition of M1 in money supply
money supply measures the most liquid assets: currency and checking accounts
What is the definition of M2 in money supply
Similar to definition of M1 but also includes various forms of savings accounts
What is the point of M1 and M2 definitions
Year over year change that is analyzed to determine liquidity
What does bank loans have to do with funds outside of the security market
An increase in loan activity is a sign of increase business activity
-> loan demand inc = upward pressure on interest rates
-> loan demand dec = downward pressure on interest rates
What happens to the stock market when bank liquidity declines to -5.4% or below
The stock market declines on average by 4.8% annually
What are the 3 sub sections that make up the cost of funds
1) short term interest rates
2) long term interest rates (bond market)
3) misery index
What does increasing short term rates point to
If short term rates are increasing, then investing in interest bearing securities become more attractive than investing in equities
-because higher return without additional risk that comes from equities
What must happen to attract an investor?
Expected equity return must exceed short term interest rates
-> ER > cost of borrowing
What can be said about the relationship between the stock market and long term bonds
-Long term BOND prices move in the same direction as the stock market
-Long term RATES move in the opposite direction to the stock market
-the bond market tends to lead the stock market
What is the misery index
It is the attempt to measure the social and economic cost of high inflation and unemployment
How is the misery index calculated
summing up the country’s inflation and unemployment rates together
What does high misery index indicate?
stressful market and poorly acting stock market
What determines short term interest rates?
Money supply
How may the federal reserve policy adjust money supply? Name 3
1) changing the amount of reserves that banks are requires to hold
2) changing the discount rate
3) buying and selling US treasuries
Which of the three ways of adjuting money supply is most used?
The third, buying and selling US treasuries
How can buying and selling US treasuries impact bank loans?
When the Fed buys securities, it adds money to the banking system, allowing for more loans and lower interest rates.
When the Fed sells securities, less money is in the banking system, so lower bank loans and higher interest rates
How does the Federal open market committee (FOMC) know what needs to be done in terms of interest rate control
They meet every 6 weeks to establish a fed funds target. Unexpected changes in this rate/target has drastic and instantaneous changes on the equity market
What is the three steps and stumble in the fed policy? (answer is in the name)
Rule that if Fed raises target rate, margin requirements or reserve requirements 3 consecutive times without decline, stock market is likely to suffer a substantial, perhaps serious setback
What is two tumbles and jump
Rule that if two consecutive declines in the fed funds target rate, margin requirements and reserve requirements, the stock market tends to rise as a result
What do yield curves show in the Fed policy
relationship of short term, medium term and long term bonds.
What are the 2 types of yield curves
1) normal yield curve
2) Inverted yield curve
What are normal yield curves
Upward sloping (longer term rates > than short term rates)
->banks are profitable and make money on the spread
->favourable for the stock market
What are inverted yield curves
Downward slopping (longer term rates < shorter term rates)
->unfavourable for the stock market, and may predict a recession
What are the 4 types of non-conventional monetary policies
1) Quantitative easing (QE)
2) Zero interest rate policy (ZIPR)
3) Negative interest rate policy (NIRP)
4) Helicopter Money
