Sector Investing

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Charts on the Yield Curve at the following two links:

http://stockcharts.com/charts/YieldCurve.html

YIELD Curve A plot of treasury YIELDs across the various maturities at a specific point in time. At the front (left) of the YIELD curve are T-Bills with maturities of 12, 26 and 52 weeks. In the middle are Treasury Notes with maturities of 2, 5 and 10 years. At the end (right) of the YIELD curve are Treasury Bonds with maturities of 20 and 30 years. In a normal YIELD curve, YIELDs rise as the maturities increase. If the YIELD on shorter maturities is higher than that of longer maturities, then an inverted YIELD curve exists. An inverted YIELD curve is a sign of tight money and is bearish for stocks.



Among investment professionals an old rule of thumb is, "Don't fight the Fed." Monetary policy has a profound effect on interest rates, the economy and the stock market. The discount rate is one of the most important tools of the Federal Reserve. As a result, movements in the discount rate are widely analyzed for insight into the future direction of Fed policy, the economy, interest rates and the stock market. A simple model can often identify when Fed moves are likely to significantly affect the stock market.

Calculation & Significant Levels

Discount Rate Model: A model based on a range of values from 3 to -3. The list below details how to change the model to accurately reflect the economy and stock market.

When the Fed raises the discount rate subtract 1 (-1) from model.
When the Fed raises the discount rate subtract 1 (-1) from model.
When the Fed lowers discount rate add 1 (+1) to model.
Every change is effective for 6 months after which the point is dropped from the model.
When the Fed changes direction from raising rates to lowering rates, the model becomes a +2.
When the Fed changes direction from lowering rates to raising rates, the model becomes a -2.
Gauge Elements: Magnitude, Time
Updated: Weekly (as of Friday close)

Strategy

The model calculates a number ranging from -3 to +3. A positive number indicates the Fed has been accommodative, which is bullish for stocks. The larger the positive number, the more bullish this indicator becomes. It is also extremely bullish when the Fed reverses its policy from raising rates to easing. Conversely, a negative value from the model is a strong warning. It is also important to look for a confirmation in the other monetary indicators. For example, in late 1994 and early 1995 the Fed was raising the discount rate. However, the negative effect of this was offset by the significant rise in the treasury bonds which led to a stock market rise.