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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