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PersonalProfit Guide

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About James Stack…

Recognized as one of the nation’s leading technical analysts, James Stack was formerly a project manager with IBM Research and has a number of domestic and international patents to his credit. After founding InvesTech Research in 1979, he began publishing the InvesTech newsletter in 1982. Over the years, InvesTech has earned widespread recognition for our unique analysis of the key forces behind the stock market, and for safety-first returns with an allocation strategy described by Forbes as “more or less impervious to declines.”

In addition to addressing major investment conferences worldwide, Jim has been a regular guest on the “Nightly Business Report” (on PBS stations), CNBC, CNN, and appeared as a feature guest on “Wall $treet Week” with Louis Rukeyser. He is often quoted in such popular publications as Barron’s, The Wall Street Journal, Money Magazine, Forbes, and U.S. News & World Report.

Working and living in the beautiful Flathead Valley in Northwest Montana, just a short jaunt from majestic Glacier National Park (a feature for which a Barron’s article was titled “Far From the Madding Crowd”), Jim spends his rare spare time skiing and hiking.

Dear Investor:

Successful investing in the volatility and uncertainty of today's investment climate has become a demanding task. But consistent profits on Wall Street have never come easy. Whether investors found themselves in the Roaring 1920s, the Depressionary ’30s, the Go-Go Fund ’60s, the Inflationary ’70s, the Savings and Loan Crisis of the ’80s, the High Tech Mania of the ’90s, or the Financial Crisis of the 2000s the results have always been the same. The individuals who had the foresight and conviction to look “across the valley” or “over the peak” have been among the small minority to ride the charging bull markets… yet sustain those profits when the major bear markets strike.

While most investors continue to base investment decisions on current earnings or economic news, InvesTech also uses technical analysis to look forward… ahead to the future stock market environment.

InvesTech seeks to transform the “guesswork” of investing into a more precise strategy by utilizing a sophisticated (yet easy to understand) blending of economic, monetary, and technical analysis. At first, proprietary indicators such as our Negative Leadership Composite, Pressure Factor, A/D Divergence Index, and Bellwether Index may sound strange and unfamiliar. However, such tools have been the key to InvesTech’s safety-first track record. More importantly, investing in the stock market is a learning experience. Within a matter of months, most subscribers begin to feel at ease with the detailed analysis which has earned InvesTech its reputation as one of the nation’s leading advisory services.

Through our unique and objective research, we will strive to provide you with the vital information you need to make safe, profitable investment decisions as we travel through the uncharted waters ahead.

Cordially,

James B. Stack President, InvesTech Research

(406) 862-7777 625 WISCONSIN AVENUE(406) 862-7707 – FAX WHITEFISH, MT 59937

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A Special Note for New Subscribers to InvesTech

The InvesTech Model Portfolio is designed for individual investors who want to follow our allocation and sector recommendations for the equity/fund portion of their portfolio. The following information will assist you in getting started with InvesTech. It involves the decisions that must be made by an investor who wishes to bring their portfolio allocation more into alignment with InvesTech’s strategy:

1) Determine your current invested allocation by totaling the amounts you have invested in equities (individual stocks, stock mutual funds, ETFs, and international stocks/funds). Divide this by your total equity portfolio size. This is your percent invested allocation.

2) Refer to the InvesTech “percent” invested recommendation and allocations listed in the Model Fund Portfolio. If you are holding a portfolio that is similar in composition, sector weighting, and percent invested allocation to what we are currently recommending in the Model Fund Portfolio, it is unnecessary to make any changes at this time. Just wait for InvesTech’s next recommendation, generally made on the Friday Financial Hotline, to either add new positions or take profits… and act accordingly with your own holdings.

3) Adjust your portfolio, if necessary. Purchases after our initial recommendations must be made at your discretion; however, if your portfolio mix is dramatically different from our current recommendations and sector weightings, you may wish to consider changes to more closely align your portfolio with our model. For example, check your mutual funds for their weightings in each sector. If the combination of your stocks, ETFs, and mutual funds give your portfolio significantly more or less exposure to a particular sector or category (such as international or small-cap) than what we recommend, you may wish to adjust your holdings to bring them more in line with our recommendations.

An exception to Step 3 above would be if we warn on the Hotline or in the newsletter against new purchases in a particular area. This usually means that we believe sector leadership is changing or most of the profits on a position have already been achieved and new investment would not be advisable. In that case, it is better to wait in the safety of a money market fund for our next recommendation. Depending on market conditions, we may advise bringing your portfolio in line with our recommendations by phasing into the market. Please review the Model Fund Portfolio published in the current issue for more information.

Remember, InvesTech’s strategy is not a short-term market timing system, but rather a long-term “risk allocation” strategy based on highly sophisticated indicators. Our objective is NOT to try to forecast stock movements in advance, but to correctly assess the market environment. When market indicators point to a strong, low-risk buying opportunity, we will recommend an aggressively invested position and growth oriented sectors. Conversely, we will inform you when our indicators show risk has risen to an unacceptable level so that you can take steps to protect your portfolio. This risk-averse strategy will help you to preserve capital in times of market vulnerability so that you will be ready and able to take advantage of the next low-risk buying opportunity when it arrives.

IMPORTANT DISCLOSURE INFORMATION: Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategy recommended and/or undertaken by InvesTech) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Please see additional IMPORTANT DISCLOSURE INFORMATION at www.investech.com.

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Table of Contents

Welcome to InvesTech

A Special Note for New Subscribers to InvesTech ................................................................................. 4

About your Subscription ......................................................................................................................... 6

About the InvesTech Publications ........................................................................................................... 6

About Money Management Services ...................................................................................................... 7

Using InvesTech

Using InvesTech Research ....................................................................................................................... 8

Using the InvesTech Financial Hotline ................................................................................................... 8

Using the InvesTech Internet Website ..................................................................................................... 9

InvesTech’s Key Proprietary Indicators

Technical Analysis – An Introduction .................................................................................................... 10

The Monetary Exposure Profile (MEP) ................................................................................................... 13

The InvesTech Bellwether Index ............................................................................................................ 15

The Negative Leadership Composite ...................................................................................................... 17

The Leadership Index ............................................................................................................................. 19

The A/D Divergence Index ...................................................................................................................... 21

The Coppock Guide ................................................................................................................................. 23

Short-Term Indicators

The Pressure Factor .......................................................................................................................... 25

The CBOE Call/Put Ratio .................................................................................................................. 26

Bond Market Indicators ........................................................................................................................... 27

Glossary of General Market Terms ...................................................................................................... 30

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Welcome to InvesTech

InvesTech was originally founded as a private investment firm dedicated to research of the financial markets. Since its inception in 1979, InvesTech has grown to include on-site financial data banks extending back more than 120 years. Our computerized capabilities permit analysis of the Federal Reserve, economy, and stock market that is virtually unparalleled on or off Wall Street. This research and analysis is made available to subscribers through the InvesTech Research newsletter, as well as the InvesTech Online Interim Bulletin.

From its unique blending of monetary and technical analysis to sector and asset allocation recommendations, InvesTech presents unhedged advice and a valuable perspective that you simply cannot find anywhere else. Each issue of InvesTech attempts to answer not just where the market is heading, but why – and also focuses on investment strategy and portfolio allocation, including specific exchange-traded fund (ETF) and mutual fund recommendations.

Together, the InvesTech Research newsletter and Online Interim Bulletin provide the straightforward, unhedged investment advice you need to negotiate the precarious years ahead. Subscribers also have access to the InvesTech Financial Hotline and InvesTech website, providing up-to-date information on our market outlook, changes in key market indicators, as well as recommendations for the Model Portfolio.

About your Subscription…

When does my subscription begin?Your subscription will begin with the first issue published after your subscription order was received. Your introductory package includes complimentary back issues of InvesTech Research.

How can I tell when my subscription expires?Your subscription expiration is printed on your newsletter mailing envelope, and is also shown on the "Member Services" page of the InvesTech website. The expiration is the date of the last InvesTech Research issue included in your current subscription term. You will be sent a renewal notice prior to the expiration of your subscription.

What if I have questions about my subscription or problems accessing the Hotline or website?Most problems can be quickly resolved with a call to our office at 406-862-7777 (Monday-Friday, 8:30am-5pm Mountain Time). However, due to SEC regulations, our research team is unable to answer questions about your specific investments or portfolio.

About the InvesTech Publications…

How often does InvesTech publish the InvesTech Research newsletter and the Online Interim Bulletin?The InvesTech Research newsletter is published on the third Friday of the month. The Online Interim Bulletin is available electronically on our website, and is posted on the first Friday of the month, mid-way between issues of the newsletter. In December, a calendar with the dates of publication for the coming year is printed in the newsletter. The Publication Schedule is also available on our website.

What indicators does InvesTech use in analyzing the market?InvesTech utilizes over 100+ technical and fundamental indicators (monetary, economic, leadership, breadth, momentum, and sentiment) – approximately one-third of these are proprietary indicators developed through years of research. While the details of our proprietary indicators are confidential, we openly present their background and use their graphics in support of our analysis… often comparing current readings with the past historical performance of these indicators.

How should I use the Model Fund Portfolio?The objective is to bring your own portfolio into alignment with the Model Fund Portfolio allocation as quickly as possible. However, it is important to review the “For New Subscribers” section of the Model Fund Portfolio in the current issue of InvesTech Research, as well as the most recent Financial Hotline,

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prior to taking any new positions in the funds. NOTE: Initial recommendations regarding portfolio changes are generally announced first on the InvesTech Financial Hotline (available on our website).

What if the Model Fund Portfolio has a high-cash position?Depending on the stock market outlook when you subscribe, you may indeed discover that InvesTech’s Model Fund Portfolio is defensively invested in T-bills or a money market fund. This cash reserve is adjusted according to market risk and may constitute as much as 80-100% of the portfolio when risk is extreme. This reflects our “safety-first” approach to investing in the stock market – a strategy that has proven itself through InvesTech’s long-term track record.

How does InvesTech select ETFs and mutual funds to recommend?Recommended ETFs must pass a number of criteria for selection which include prior track record, composition of the underlying portfolio, index correlation, total assets, trading liquidity, expense ratio, and the stability and experience of the sponsoring firm. Leveraged, esoteric, or infrequently traded ETFs are avoided.

The first criterion for mutual funds is a performance record which ranks among the top funds in the category. In addition, the fund should be no-load or low-load and easily switchable on the Internet or by telephone, either directly through a fund family or through a brokerage service such as Charles Schwab or Fidelity. We also look at the fund’s size, annual portfolio turnover, and expense ratio, among other attributes.

Are you able to answer specific questions about my investments?Unfortunately, no. Our extensive subscriber base and commitment to research only permit us to respond to general questions or requests within the newsletter. However, each piece of individual correspondence is carefully reviewed and any suggestions for improving our service are very much appreciated.

How can I get more specific information on the funds you recommend?A substantial amount of fund research is available from services such as Morningstar. Additional ETF and mutual fund information is also generally available on the Internet at the fund's website. It is recommended that all subscribers carefully evaluate the suitability of a fund for their own portfolio objectives and overall tolerance for risk.

About Money Management Services…

Do you provide money management for individual accounts?Stack Financial Management (SFM) was incorporated in 1994 in response to demand from InvesTech subscribers for personal portfolio management. SFM is separate and independent of InvesTech Research, yet employs the same safety-first philosophy and technical indicators developed by InvesTech Research over 35 years ago. Professional money management services are available for individual clients, corporations, trusts, and retirement accounts. Clients may choose between Capital Appreciation and Value & Dividend portfolios designed to meet the client’s specific objectives.

The minimum balance required to open an account is $750,000 in cash or securities. For further information or to request a complete information packet, please contact:

Stack Financial Management, Inc.625 Wisconsin Avenue F Whitefish, MT 59937

1-800-790-5001 [email protected]

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Using InvesTech Research

In today’s volatile markets, a long-term investor is jokingly described as “an individual who holds onto a new purchase long enough to receive his next brokerage statement in the mail.” However, history has proven that the true long-term investor, who aims for a one year holding period or longer, is typically rewarded by the most consistent capital growth from the stock market.

InvesTech uses a number of proprietary indicators to monitor the long-term “health” of the market. Among these are our Negative Leadership Composite, Pressure Factor, and InvesTech Bellwether Index. When our technical tools are universally bullish, we will recommend an aggressive long position and have up to 100% of our Model Fund Portfolio invested in the ETFs or mutual funds listed in the newsletter. Later, as key indicators deteriorate, we will shift allocation to more conservative sectors and funds and/or reduce the percentage invested in the market by cutting back on positions in more cyclical sectors.

Even if you invest in stocks or funds other than the funds recommended by InvesTech, you should still reduce holdings when advised. By doing so, you reduce exposure as the market enters a more vulnerable stage. And more importantly, by the time a bear market strikes, a substantial portion of your investment portfolio should be safely in T-bills or a money market fund.

The Model Fund PortfolioOur Model Fund Portfolio is constructed as described above by specifying the allocation percentage in each exchange-traded fund (ETF) or mutual fund, with the remainder in T-bills or a money market fund. This portfolio focuses primarily on sector ETFs. However, we may also incorporate ETFs and mutual funds in the portfolio that are not specifically sector related, such as international funds, small-cap funds, or an inverse index fund when warranted. If mutual funds are held in the portfolio, we will generally list an ETF alternative for the position.

In selecting ETFs we focus on funds with solid track records that have demonstrated a close correlation with the sector or category index that we want to target. For instance, if we are establishing a position in small-cap stocks, we might seek an ETF that has tracked the performance of the Russell 2000 Index very closely over the past ten years. We also look at how the fund’s portfolio is constructed, the level of assets in the fund, the expense ratio and the reputation and experience of the fund’s sponsor.

Selection of mutual funds is based on objective, size, ease of access, and performance – with an emphasis on the 5-year and 12-month rates of return. After all, when you purchase a mutual fund, you’re actually buying the skill, knowledge, and track record of the management team running that fund. Specialty funds such as gold and bear market funds are recommended only if we see an opportunity for profit or the need to provide a hedge for our long positions.

Using the InvesTech Financial Hotline

When is the Financial Hotline updated?The InvesTech Financial Hotline is updated on Friday, after 12:00 Noon EST, and is accessible 24 hours a day on our website (www.investech.com). Simply select the "Hotline Update" option under "Member Services."

In addition, Special Hotline Updates are posted on the website when changes to the Model Fund Portfolio are recommended or when market conditions warrant a special notice. An email notification is sent to subscribers when Special Hotline Updates are posted on our website.

Please Note: To receive email notifications, we must have your current email address on record. We also recommend adding our email address ([email protected]) to your email program's "Safe Sender" list and that you confirm emails from our address are not blocked by your spam filter or other security software.

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Using InvesTech's Website: www.investech.com

What is available to subscribers on InvesTech’s Internet website?Investech.com is a vital tool for keeping up-to-date with all the analysis and recommendations that InvesTech provides. This service is FREE with your subscription and provides the opportunity for you to…

• Read the InvesTech Research newsletter on the day of publication.• Review the Online Interim Bulletin – released between regular issues of the newsletters.• Access the Financial Hotline – where Model Fund Portfolio changes are announced first.• Analyze the Daily Data Report for a timely update on market indexes and indicators.• Visit the InvesTech Library to access the complete Personal Profit Guide –your step-

by-step guide to using InvesTech’s safety-first strategy– as well as Special Research Reports on timely investment topics.

• Renew your subscription, update your address, or request a sample issue for friends, family and associates.

In addition, an email notification is sent to subscribers when the newsletters are available on our website, as well as when changes are recommended to the Model Fund Portfolio or if a Special Hotline Update is posted. To receive these email notifications, we must have your current email address on record.

How do I register for online subscriber access to InvesTech?Visit investech.com and click on the “New Subscriber? Register Now” link in the Subscriber Login box located in the top right corner of our home page. You must have your PIN (personal identification number) – printed on the mailing label of your envelope or in your confirmation email. Instructions are provided for you to select your own personal Username and Password.

What if I have questions or problems in accessing the website?Most website issues can be quickly resolved by calling our office at 406-862-7777 (Monday-Friday, 8:30am-5pm Mountain Time). Please keep in mind that your web browser must be set to accept cookies and you will need Adobe Reader to download the InvesTech publications (available free at www.adobe.com).

Copyright Do’s and Don’tsInvesTech Research is protected by copyright law and a subscription is intended for the use of just one individual or household per subscription. To avoid copyright violation, following are guidelines on what is permitted under copyright law… and what is not:

It’s okay for InvesTech subscribers to… • Share your mailed newsletter with someone• Discuss the contents of an issue with others• Ask us to send a sample newsletter to your friends, family, or associates

It’s not okay for anyone to…• Reproduce or distribute (email, photocopy, scan, fax, etc.) newsletters, bulletins, hotline updates,

or email notifications• Print multiple copies of an electronic issue, bulletin, or hotline update• Share your InvesTech username and password

We sincerely appreciate your cooperation and understanding. For more information on copyright issues, simply call our office at 406-862-7777 or send us an email at [email protected].

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Technical Analysis – An Introduction

Sorting Facts from Mythical Malarkey

The term “Technical Analysis” sometimes conjures up visions of crystal balls, tea leaves, phases of the moon, and bizarre cycles in the search to unlock the secret of the stock market. And while there are those who profess to forecast using astrology and other esoteric indicators, this picture of technical analysis is for the most part – wrong.

The more reputable market technician today usually comes from a strong mathematical or engineering background. Education and previous employment often provide the basis for a logical, well-planned method of analyzing the stock market – the internal strength as well as the effect of outside influences.

Unrealistic Expectations…

“What will be this year’s high/low/close for the DJIA?”

“When will this bull market peak, and at what level?”

“How far could stocks fall before the market bottoms?”

…all questions commonly asked of market technicians by investors or financial editors. The public perceives the technician as a market forecaster, who can predict actual levels and dates of future market turning points. Yet for the most part, technicians are no more qualified to respond to this type of question than fortune tellers. Few technical analysts will claim to be able to forecast stock prices far into the future. Oh, they can make a projection based on past history or cycles… but more often than not, it’s just an educated guess. Yet technical analysis is an invaluable tool to the average investor who understands the true objectives of this inexact science – as well as its limitations.

InvesTech’s Objectives…

There is no Holy Grail or single indicator that can always forecast the market – and there never will be. However, by developing and following several time-proven indicators, a market technician can address a number of vital questions with a surprising degree of accuracy:

Are we in a long-term bull market, and what is the probability it will continue for at least 6 to 9 months?

What is today’s relative level of market risk as compared to past history?

Is the monetary environment favorable or unfavorable for investors?

How will pressures on the Federal Reserve change the outlook for stocks in the coming months?

What historic warning signals will indicate this market is headed for major trouble?

The so-called “tools” of a technician can range all the way from the esoteric (i.e., astrology) to the more valuable and dependable monetary indicators which monitor the actions of the Federal Reserve banking system. And while most top analysts have developed their own market forecasting models, these indicators can generally be classified into eight categories. Following is a brief synopsis of the various forms of technical analysis and how they relate to InvesTech’s approach to risk allocation.

The Technical Menagerie…

❋❋ Closely followed by InvesTech ❋ Monitored by InvesTech

Esoteric: Astrology Bullish Years ending in “5” Super Bowl Indicator

There are a number of Wall Street pundits who place substantial faith in using astrology to forecast market prices, or in the old Super Bowl Index – where a win by an original NFL team supposedly points to higher prices throughout the year, while a win by an old AFC team is bearish. We consider these approaches entertaining, but of little value in managing your hard-earned investment dollars.

Cycles: Elliott Wave 6-week cycle, 16-week cycle, etc. ❋ Santa Claus Rally ❋❋ Presidential Cycle

While R. N. Elliott developed the Elliott Wave during the 1930s, Bob Prechter has combined this complex theory with analysis of investor psychology to yield numerous successful forecasts of intermediate market cycles in the 1980s. However, outside of the Elliott Wave, we consider the remaining cyclical studies


overpublicized and unreliable. It’s easy to draw apparent cycles on charts of past data; but using these cycles to project stock prices into the future is of questionable value.

The cycles that display the most promise are those that result from a definitive force. Historically, year-end tax selling will depress stock prices by early December, after which there is a 75% probability of a rising market for the next 4 weeks… the so-called Santa Claus or Year-End Rally. And the fact that both fiscal and monetary policies are often more stimulative in the year preceding a Presidential Election explains why bear markets seldom occur in the 12 months leading up to the election.

Sentiment: —— CONTRARY —— Public Short-Selling ❋❋ Margin Debt ❋ Mutual Funds Cash ❋❋ Advisory Sentiment ❋❋ Consumer Confidence — NON-CONTRARY — Specialist Short-Selling Insider Buy/Sell Ratio

By definition, a bull market peaks when optimism has reached a maximum – and the market runs out of buyers. In other words, a major top doesn’t occur until everyone who wants to buy stock has bought stock. So a number of technical tools are commonly used to gauge when this investor sentiment has reached an extreme and a contrary stance is warranted. These include measuring the sentiment of advisory services, option buyers, short-sellers, the cash levels of mutual funds, and the funds borrowed to purchase stocks on margin.

Conversely, there are also several non-contrary indicators which attempt to assess what the “smart” money is doing (such as the specialists and corporate insiders). In this case, it’s usually most profitable being on the same side of the market as these individuals.

In general, the Sentiment Indicators are the most widely followed… receive the most publicity… and, unfortunately, are the least precise! Those that do work often peak up to 12 months before the market, and it’s impossible to find a consistent level to use as a buy or sell signal.

Momentum: Volume ❋ Moving Averages ❋❋ Coppock GuidePerhaps the crudest form of technical analysis involves

the use of moving averages in stock market timing. While a moving average can be extremely useful in smoothing data or a volatile indicator, it has several serious defects if used for timing. First, moving averages by definition are always late. That means an investor can easily miss the most profitable portion of a market’s move.

The second flaw relates to the increased volatility in today’s markets and the fact that investors can be relentlessly whipsawed as the market gyrates wildly above and below the moving average.

A final danger arises if the stock market makes an extended move as it did in the first half of 1987. The moving average can be so slow to adjust, that the market could crash 20% or more before signaling trouble… as it did in October 1987.

Other more reliable momentum indicators often utilize volume, leadership, breadth, or a combination of moving averages in determining market direction. But these are usually complex mathematical models, such as the Coppock Guide (described later), which have been developed over years of historical research.

Charting: Trendlines Speed-Resistance Lines ❋ Support/Resistance Levels

Also quite primitive, the art of charting has expanded to include trendlines, speed-resistance lines, and innumerable patterns that will supposedly provide insight into the market’s next move. And while we must admit that many of these patterns are indeed unique (i.e., triangles, wedges, saucers, inverted head-and-shoulders), their usefulness as technical tools is somewhat mixed.

One major exception would be the true support or resistance levels that a particular stock (or the market in general) has repeatedly bumped against. Each time that the market or a stock fails to break through a particular price level, an increasing number of investors will recognize that zone as an important price barrier. For example, when the DJIA has been trading within a narrow 600 point trading range for six months, any breakout from that range will likely trigger a stampede as investors scramble to “get on the right side” of the market.

Leadership: Quantity and Quality ❋❋ Leadership Index ❋❋ Negative Leadership Composite ❋❋ Bellwether IndexA bull market with solid, broad-based leadership is


destined to continue climbing. And a market with narrow, low-quality leadership is usually skating on thin ice. Once again, measuring the quantity and quality of leadership has proven an elusive task in the past. But InvesTech’s Leadership Index, Negative Leadership Composite, and Bellwether Index, eliminate the subjective aspect of tracking leadership.

These indices (explained later in this manual) are fairly simple to understand and follow, yet their simplicity is outshone by their reliability and usefulness as tools for staying on the correct side of the market.

Breadth: ❋❋ Advance-Decline Line ❋❋ A/D Divergence Index

For the novice investor, “market breadth” is sometimes a difficult concept to fathom. In simple terms, it measures the quantity of stocks taking part in a major market move. A healthy bull market requires widespread participation by both blue chips and small stocks alike. And, historically, trouble is looming when investors become more selective… the stock market climbs higher and higher with fewer and fewer stocks taking part.

Technicians have always plotted and watched the Advance-Decline Line for gauging this “breadth” (the A-D Line is merely a continuous sum of daily advancing stocks minus declining stocks).

Yet in the early 1980s, InvesTech developed several breadth gauges to remove the ambiguity surrounding market breadth. These indexes played a key role in InvesTech’s warnings of the the 1987 Crash, the 1990 Recession and High Tech Bubble which popped in early 2000. A detailed discussion of two of these models, the A/D Divergence Index and A-D Line, is provided later in this manual.

Monetary: ❋❋ Interest Rates ❋ Banking Liquidity ❋ Credit Demand ❋ Money Supply Growth

❋❋ Bond Timing Models ❋❋ Inflation Forecasting Models ❋❋ Monetary Exposure Profile

The monetary picture is one of the most important and the least appreciated by the average investor. A favorable monetary climate, with falling interest rates and rapid money supply growth, goes hand-in-hand with runaway bull markets. So if an analyst could accurately gauge the pressures on the Federal Reserve –and know where to watch for signs of the Fed’s next move– then odds would dramatically improve for staying on the right side of the stock market most of the time.

While it’s not feasible to anticipate every gyration in interest rates or inflation statistics, InvesTech tracks a number of indicators which have a remarkable track record in determining the outlook for inflation and Federal Reserve policy. For example, our MEP monetary model, which is explained later, remained bullish throughout the 1984-87 record advance and triggered a major sell signal just 90 days before the market peaked at DJIA 2722 and began sliding toward the ’87 Crash.

And when stocks are locked in the throes of a bear market, InvesTech tracks major bond models to signal when an “alternative” investment opportunity might appear in bonds. That way, we are always looking for the safest profits available – anywhere.

Summary…

In reality, there is no magic formula… no dark, hidden secrets… just hard work. Technical analysis is the blending of a scientific approach with a careful understanding of the strengths and weaknesses inherent in each of the indicators.

Yet technical analysis can be a powerful tool in today’s stock market. By using InvesTech’s computer capabilities and extensive data banks, we’ve developed an arsenal of time-proven technical indicators. These form the basis for a “safety-first” strategy that keeps us abreast of today’s markets – in a manner which is easy for subscribers to understand and utilize.


The Monetary Exposure Profile (MEP)

…measuring monetary conditions and Federal Reserve policy

In a study conducted over 25 years ago, the Institute for Econometric Research found that between early 1964 and the end of 1984, a stock market investor could have earned seven times the profits – just by avoiding the three major bear markets!

As one example of how quickly things can change, the top-rated 20th Century Ultra mutual fund gained an impressive 189% from August 1982 through mid-1983, but quickly lost two-thirds of that gain after monetary conditions turned sour. So how can an investor know when to take profits… let alone recognize a full-fledged bear market?

This requires a combination of indicators to gauge the “technical health” of the market, as well as the “monetary climate” for the economy. From the technical side, InvesTech’s Negative Leadership Composite measures leadership, while the A/D Divergence Index monitors market breadth. Respectively, these two gauges help determine whether Wall Street is in a long-term bull market, and yet provide an early warning of its imminent end.

However, one KEY driving force behind the economy and, therefore, the stock market is monetary policy. Prior to 1987, the Federal Reserve –with its control over interest rates and the money supply– was virtually the only force determining the monetary environment. In recent years, however, monetary policy has been strongly influenced by international money flows and currency exchanges. In both cases, an investor who is able to track the changing monetary environment has a tremendous advantage over those who don’t.

The Monetary Exposure Profile (MEP) was developed over 25 years ago to fill this void, and has become the primary monetary model used by InvesTech. The MEP (Figure 1 ) provides the means of determining whether the monetary environment is favorable or unfavorable for the stock market. As the MEP climbs above the

Monetary Exposure Profile - (MEP)

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neutral axis (0), it indicates an ideal environment for investing in stocks or a stock mutual fund… a reading above +25 is often a precursor of an “explosive” new bull market. Conversely, a reading below 0 means that monetary conditions warrant a more cautious stance… while a reading below -25 indicates the potential for a serious bear market.

The MEP tracks Federal Reserve policy by measuring banking liquidity, credit demand, and the trend and momentum of key interest rates. And to account for monetary forces that sometimes override Federal Reserve policy, the MEP also started including global money flows in 1995.

Notable from this graphic ( 1 ) is the fact that most bear markets (including the 1987 Crash) began after the MEP had dropped into the negative region – signaling a deteriorating or hostile monetary climate. Consequently, it is a valuable tool in telling you when to be more cautious… or concerned about a probable bear market.

In addition, you’ll notice that during most bear markets, the MEP remained negative throughout much of the decline. A subsequent return to the positive region signaled a shift in Federal Reserve policy and –in most cases– created the foundation from which a new bull market could be launched.

Two important exceptions to this rule were the 2000-2002 and 2007-2009 bear markets, in which the stock market declined in spite of frantic easing by the Federal Reserve. The Fed’s attempt to avert a recession and cushion these bear markets failed. But it would be incorrect in saying that our MEP failed… as it was merely reflecting Fed policy, which under normal conditions would have been bullish. In retrospect, the popping of the “high tech bubble” of the late 1990s and the "housing bubble" of 2005-2007 created deflationary forces that rendered Fed policy ineffective. However, when the economy achieves a more stable footing, and deflationary forces recede, Fed policy will become more normalized and this will once again be reflected by movements in the MEP. Nonetheless, these examples show the value of having an “arsenal” of technical and monetary tools at our disposal, and the importance of not hanging your hat entirely on any one model at any time.

From a long-term perspective, the MEP can make a significant difference in your ability to manage stock market risk and improve portfolio returns. As shown in the graph at right, over a 40-year period from 1962 through 2001, an investor who placed his portfolio in an S&P 500 Index Fund only when the MEP was positive (and moved it to the safety of a money market fund when the MEP was negative) would have outperformed a buy-and-hold investor by almost a 5-to-1 margin. The MEP investor would have grown his original $10,000 investment into $3,332,028, while the buy-and-hold investor in the S&P Index Fund would have only $719,592 – a sizable nest egg, but far less than could have been earned by simply managing risk with a good monetary tool like our MEP.

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The InvesTech Bellwether Index

…measuring bellwether leadership

Historically, there are certain bellwether stocks, and even full sectors, that have characteristically led the broad market averages at major market tops. At different times over recent decades, these have included stocks like General Motors, IBM, JP Morgan and GE. Yet it is primarily three economically and monetarily sensitive sectors –Consumer Discretionary, Financials and Utilities– that have earned the right to be called true bellwethers.

In the later stages of a bull market, the Federal Reserve will tighten monetary policy as the economy starts to overheat, with the result that the interest-rate sensitive Financial and Utilities sectors begin to weaken. At the same time, higher interest rates curb borrowing and investment spending. And as the economy slows, consumers cut back on purchases of Consumer Discretionary items such as cars, restaurants and entertainment. Hence, these three economically sensitive sectors will often signal an early warning flag prior to the start of a bear market.

The InvesTech Bellwether Index is designed to forewarn investors that they should start battening down the hatches in anticipation of a market turning point. To compile this Index, we pulled some of the longest-trading and most leading stocks from these three economically and monetarily sensitive sectors. Selection emphasis was given to companies that were well capitalized and which displayed a cyclical price pattern that peaked well before previous bull market tops.

As shown in this long-term graph of our InvesTech Bellwether Index (below), for each bull market since 1987, weakness in this Index foreshadowed the subsequent bear market at least several months in advance.

The InvesTech Bellwether Index is a proprietary composite of stocks which are in the most sensitive economic sectors of the market. The key prerequisite for each component stock was that it have adequate market capitalization and over 20+ years of established track record. Selection emphasis was given to companies that displayed a cyclical price pattern and peaked prior to bull market tops.

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The 1987 CrashAs the stock market rose sharply in the summer of 1987, the S&P 500 Index (bottom graph at left) gained over 10% in just 4 months. In contrast, the InvesTech Bellwether Index struggled just to stay even – thereby sending an important warning that these bellwether stocks were signaling trouble.

The 1990 Bear MarketBy the summer of 1990, the economy was on the verge of recession [actual starting date was July 1990]. Investors focused on the DJIA and S&P 500 Index which were enjoying new all-time highs. But the component stocks in this InvesTech Bellwether Index were already in a steep decline – warning of the imminent bear market ahead.

The 2000-02 Bear MarketAll of the major stock market averages peaked in the first three months of 2000 at all-time record highs. However, the InvesTech Bellwether Index had already hit its peak over 12 months earlier and had declined by almost 20%!

NOTE: Although these bellwether stocks did not continue declining in 2000-01, they had nonetheless already given their all-important warning signal. And with interest-rate sensitive stocks making up part of this Bellwether Index, it’s one reason why it should not be used during bear markets or at market bottoms. It’s exclusive purpose is to help identify market tops.

Stepping back in history to the four most important market peaks since the mid-1980s, we see how this Index would have warned of imminent trouble…

The 2007-09 Bear MarketAlmost 8 months of advance deterioration in this InvesTech Bellwether Index during the summer of 2007 was yet another ominous warning flag of a potential bear market ahead. Instead of looking at corporate earnings, media headlines, and “no recession” reassurances from economists, this is where investors should have been watching!

Used alongside other technical and monetary indicators, the InvesTech Bellwether Index definitely deserves close attention when it peaks and begins tumbling well in advance of the popular market indexes.

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…measuring the real quality of internal leadership

Why should one pay attention to leadership? Two reasons. First, leadership is easily measured. And second, broad leadership is a prerequisite for a bull OR a bear market. The biggest, multi-year bull markets have the most bullish leadership. Conversely, the big bear markets must have very negative leadership. Many other indicators, such as valuation and sentiment gauges, are more subjective and imprecise. That is, they never peak at the same level twice. In addition, both sentiment and valuation are “counter-trend” – meaning that once a market top is in place and stock prices start falling in a bear market, these indicators immediately begin to improve by moving toward more favorable readings. In other words, if you’re not already defensive, these counter-trend indicators will keep you invested all the way down.

In researching various leadership indicators, we found little value in attempting to quantify leadership in blue chip stocks versus secondary stocks, or in NYSE versus Nasdaq stocks. In addition, we also discovered that tracking upside leadership (the number of stocks hitting new yearly highs) failed to differentiate between a temporary correction and a full-fledged bear market. The real quality of leadership analysis lay somewhere else…

QUESTION: What is the most difficult decision that an investor must make? If you answered “when to sell a stock,” you’re at least partially correct. Every investor inevitably learns that the most difficult decision is actually “when to sell a stock at a loss.” Emotions can easily overwhelm judgment. And there isn’t a seasoned investor alive who hasn’t held at least one stock all the way down, as he waited and hoped for that one chance to get out even.

The Negative Leadership Composite

① SELLING VACUUM [-BULLISH-]: This confirms the absence of negative or downside leadership. It is normally a very bullish signal since a stock market without any downside leadership is destined to move much higher.

② DISTRIBUTION [-BEARISH-]: This signals that investors are anxious to sell stocks regardless of whether their position is at a loss, or the stock market is tumbling to new lows. It carries bearish implications as it suggests investors will use any rallies to get out of the market.

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With time, logic replaces emotion. So selling a stock at a loss becomes a little more mechanical (if not less painful) for the experienced investor. Nonetheless, it often requires a pretty grim market outlook for the majority of investors to “bite the bullet” and dump a stock that is tumbling to new 12-month lows. Therein lies one of the most valuable technical tools in the stock market: downside leadership – or the number of stocks hitting new yearly lows. Shown in the graph on the previous page are over 45 years of the S&P 500, plus the two components of our Negative Leadership Composite or NLC. Both parts of our NLC are based purely on downside leadership. Together, they’re designed to signal the onset of a new major bull market, which is often when investor gloom is most widespread. And perhaps more importantly, they reveal when the probability of a full-scale, portfolio-slaughtering bear market is highest.

The top half of our NLC ( ① ) monitors the absence of selling pressure or what we call a "Selling Vacuum." No new bull market springs to life without seeing downside leadership dry up – with the appearance of this Selling Vacuum. More often than not, the height and duration of this Selling Vacuum help indicate how strong a new bull market is – and how long it will last. For example, look at the times this Index climbed to a very strong +60 to +70 reading. Almost invariably, they confirmed the onset of a new multi-year bull market.

The bottom (shaded) half of our NLC ( ② ) measures "Distribution" by looking at the rate of acceleration in downside leadership. Quite simply, when the shaded region appears, it means that investors have reached that “bite-the-bullet” stage and are anxious to dump their stocks – even if at a big loss. This is the most vulnerable, dangerous region for the stock market… it is when bear markets can strike.

Obviously, this Negative Leadership Composite doesn’t provide a major signal very often. When Distribution (shaded region) is present, it’s time to be more cautious and carry a higher cash reserve. But when a Selling Vacuum appears (especially after 6 or more months of Distribution), it’s time to take notice and get ready to jump on a charging new bull market in stocks. Of course, the decision to aggressively buy at that time should be confirmed by other technical and monetary indicators tracked by InvesTech.


The Leadership Index

…measuring the short-term trend of leadership

“Leadership” has always been an ambiguous and somewhat elusive element for market watchers to measure. From a long-term standpoint, InvesTech’s Negative Leadership Composite (previous pages) has proven invaluable in identifying the start of a new bull market, or warning when an outright bear market appears imminent. Yet even from an intermediate viewpoint, a good leadership indicator can often help an investor know:

1) If a new rally has dependable leadership and is likely to be profitable for at least several months or 2) If a rally attempt is doomed to fail from the lack of broad, solid leadership

A number of esoteric methods of weighing leadership involve looking at the “quality” of the most active stocks, or volume flowing into blue chips versus low-priced secondary stocks. But the most popular measurement involves viewing the number of stocks hitting new yearly highs and new yearly lows on a daily basis. The more stocks hitting new highs, the stronger the leadership, and the more bullish the market outlook. Conversely, when a large number of stocks are falling to new yearly lows, leadership is absent or lacking and the stock market is usually headed lower.

However, several perplexing problems arise in tracking the new “highs” and “lows.” First, it is a lagging indicator. During the last half of a big bear market, the number of stocks hitting new yearly highs is always very low (<25). And even after a new bull market springs to life, these new highs will remain anemic until stocks recover enough of their bear market losses to permit an increasing number of them to qualify for “new yearly high” status. This means that someone watching only the new highs would sit out a major portion of the advance. Later, after the bull market has drawn to a close, investors often have to wait months for the number of new lows to reach troublesome levels – and by that time, their portfolio losses are already quite severe.

A second problem with any “high/low” indicator lies in attempting to quantify the amount of bullishness or bearishness. Is 100 new highs only half as bullish as 200 new highs? And how do you adjust these numbers for market action during the past year? For example, if the market itself is at a new yearly high, there are obviously going to be many times the new highs than in the first stages of the bull market.

Our objectives in developing an intermediate index based on leadership were threefold. First, it had to possess good predictive value, and serve as a guide to keep us in gear with the primary trend of the market. Secondly, whipsaws should be kept to a minimum. And thirdly, it had to be simple to follow.

Our in-depth research eventually led us to a striking conclusion: Contrary leadership is far more important than leadership in the direction of the primary trend. For example, in a bull market, instead of focusing on the number of stocks hitting new yearly highs (which gyrated quite wildly), 1967 1968 1969 1970 1971 1972 1973 19751974 1976

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a more valuable reading or warning signal came from stocks heading to new lows. And, of course, the opposite was found to be true in a bear market.

InvesTech’s Leadership Index (shown in the accompanying graphs) successfully weights new highs and lows to allow for previous market action, and removes many of the whipsaws that leadership often experiences. Of course, it’s impossible to eliminate all gyrations from the indicator, because fluctuations are inherent in the markets themselves – bull and bear alike. But when used in conjunction with our MEP monetary model, Negative Leadership Composite, and A/D Divergence Index, this Leadership Index helps decipher the major trend of the market and increase profits from extended moves.

Here are two guidelines to use in tracking our Leadership Index:

1) For longer-term investors, a move above 0 is favorable, while a level over +50 normally warrants a heavily invested position (if other key indicators confirm the bullish reading). On the opposite hand, a drop under 0 in the Leadership Index is unfavorable, while -50 or below means that extreme caution is necessary.

2) The index is also valuable to investors and traders in confirming trouble as the market approaches a new peak. The arrows ( ) in the graphs mark just a few of the warnings where the market was hitting (or nearing) new highs, yet our Leadership Index was diverging with much weaker readings.

NOTE: There are actually two independent Leadership Indexes –one for the NYSE and one for the OTC market– to help indicate when the secondary issues are expected to outperform the larger capitalization stocks. Both of these indexes are updated daily on the InvesTech Daily Data Report posted on our website (www.investech.com).

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The A/D Divergence Index

…measuring long-term breadth divergence

Stock market “breadth” or participation has always been a most valuable tool at market tops. As stocks reach overpriced levels (and inflation fears appear or interest rates begin to rise), it’s common to see investors become more selective in their stock purchases.

The A-D Line (cumulative total of daily advancing issues minus declining issues) is the most prevalent tool in monitoring breadth. To use this tool, one must visually compare the line’s divergence with the graph of a market index such as the S&P 500, and accurate measurement can be difficult. Additionally, the A-D Line can display a long-term downward bias.

In developing InvesTech’s A/D Divergence Index, we tried to expand on previous research done by others in the area of market breadth. Yet our goals for the model were very specific:

● It should provide confirmation of a probable bull market when underlying breadth is broad and strong.● It should reveal when breadth divergence is reaching a critical point at which past bear markets

have normally begun.● It should not be distorted by “temporary” weakness or strength in the A/D Line.

In technical terms, first we adjusted the 75 years of A-D Line data for the increasing number of stocks traded over time. Next, we normalized the S&P 500 Index so current price changes are comparable to historical price changes. And finally, through linear regression, we found the correlation that was most consistent in past bull markets. The end result is a model that reveals the percent difference between the actual S&P 500 Index in a bull market… and the “expected” S&P 500 Index based on historical breadth. That difference or divergence, when it reached a certain level, was an excellent precursor warning of an impending bear market.

Technical jargon aside, here are the results – shown by example. Figure 1 above shows the S&P 500 Index as the “Go-Go Fund” era of the late 1960s gave way to the 1969-70 Bear Market. Also displayed is our “Theoretical S&P 500 Index” (or where the S&P 500 should have been based on market breadth). You’ll notice that by the time the bear market started, a substantial gap existed between these two lines or indexes. As the bear market progressed, this spread opened even wider… increasing the downside risk. Quite simply, that gap measured how much the market’s breadth was leading prices down.

To display this divergence in a more understandable form, we’ve shown it (as percent difference) in our A/D Divergence Index – Figure 2 at left. As with a surprising majority of bear markets, the “danger zone” of this Index turned out to be between 8-12%. The more that breadth weakened in the bear market, the faster this Index declined, and the faster the market fell.

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In Figure 3 at right, we’ve shown our A/D Divergence Index for the 1982-87 Bull Market (and subsequent crash). From mid-1983 until mid-’84, deteriorating breadth caused problems for the market as the Nasdaq dropped over 30% during a high tech washout. But note that this A/D Divergence Index then moved higher (strengthened) for several years… until 1987. The warning before the ’87 Crash was a classic!

How has this gauge performed in other benchmark periods? Remarkably, it did work in 1929… with one of the greatest breadth divergences in history. And entering the 1950s, this A/D Divergence actually showed the S&P 500 Index as 20% underpriced by 1951. That bullish condition remained throughout most of the decade… with the A/D Divergence rising as stocks marched profitably higher.

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The Coppock Guide

…identifying the safest buying opportunities

The Coppock Guide or Curve was originally developed over 50 years ago by Edwin S. Coppock. It’s been modified and adapted by a few analysts since then, but the only notable publicity it receives is an occasional mention in a timely Barron’s article or from independent, technically-oriented newsletters. Yet this indicator has a remarkable 85-year track record when it comes to signaling the start of a new bull market for stocks. And it is one of the few technical tools that would have kept anxious investors from stepping prematurely into the middle of the 1929-32 record stock market decline.

The Coppock Guide has been described as a “barometer of the market’s emotional state.” As such, it moves very slowly and methodically from one emotional extreme to another. Its historical value lies in signaling or confirming the best, low risk buying opportunities in history. All of these are noted by the dashed lines to the S&P 500 Index in the graph below.

By calculation, this Index is actually the 10-month weighted moving total of a 14-month rate of change plus an 11-month rate of change of a market index. In other words, it’s really just a momentum oscillator. Because of this, it reverses direction when the momentum or rate of change in the market peaks. And since market bottoms are usually sudden or “spiked” reversals, the Coppock Guide works amazingly well in triggering buy signals.

After dropping to 0 or below, a mere 1-point upturn in this Index can usually be treated as an excellent buying opportunity. And often, the more negative the Coppock Guide is when it turns upward, the more impressive the profits ahead. The only two false signals under this guideline were in 1941 and November 2001.

NOTE: S&P 500 estimated prior to 1928 by correlation with a similar index

NOTE: Double Tops or "Killer Waves" have preceded 1929, 1969, 1973, and 2000 - four of the biggest bear markets of the past 100 years.

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COPPOCK GUIDE 2nd Peak in Start of Bear “Killer Wave” S&P 500 Bear Market Loss

❶ Oct 1929 Sept 7, 1929 -86.2%❷ May 1946 May 29, 1946 -28.8%❸ Feb 1969 Nov 29, 1968 -36.1%❹ Jan 1973 Jan 11, 1973 -48.2%❺ Sept 1987 Aug 25, 1987 -33.5%❻ Apr 1998 Mar 24, 2000 -49.1%❼ Jul 2007 Oct 9, 2007 -56.8%

Yet this Coppock Guide has never been noted for timely sell signals. The reason is that market tops are usually slow, rounding formations in which momentum (and the Coppock) peak up to a year or more ahead of the market. So other technical or monetary tools must be used to gauge when to reduce exposure and shift to a higher cash reserve. Except, that is, in a few cases. And that’s where the carnage comes in, as explained below…

In the late 1960s, a technician named Don Hahn observed another phenomenon about the Coppock Guide. When a double-top occurs without the Coppock falling to 0, it identifies a bull market that hasn’t experienced any normal, healthy washouts or corrections. That’s a runaway bull market usually headed for disaster. This double-top has occurred only 7 times in over 87 years – with 4 of them accompanying the start of the most notorious bear markets of the 20th Century: 1929, 1969, 1973 and 2000.

So one historical aspect of this double-top: They can result in nasty bears! Looking at the 7 "Killer Waves" of the past century, the table at right shows the month of the second peak, along with the timing of the start of the S&P 500 bear market. And a glance at those resulting bear markets reveals why the double-top in the Coppock Guide has been nicknamed a “Killer Wave.” The average decline (excluding the -86% loss in 1929) was almost -48%!

In summary, there are two critical lessons in this model. First is the inherent danger that accompanies a double-top in the Coppock Guide. Such a formation often precedes the biggest and most devastating bear markets. The second lesson, and perhaps most important, is the knowledge that the safest and most profitable buying opportunities appear after this Guide declines to (or below) 0 and then turns upward.

With its remarkable track record, the Coppock Guide should be a key tool in any investment strategy. When used with our other indicators, it can provide the discipline and patience to avoid treacherous bear market rallies and wait for the best buying opportunities that occur only a couple times each decade.


Short–Term Indicators

The Pressure Factor

Market psychology tends to roll in waves… a wave of euphoria followed by a wave of pessimism… overconfidence followed by fear. As a result, markets advance (or decline) in a volatile manner as they bounce between “overbought” and “oversold” levels. Both investors and traders are easily swept along in these buying panics or selling panics, only to find themselves jumping in near a short-term peak or selling right at a short-term bottom.

An “overbought” market condition can be defined as stock prices having climbed too far, too fast, with too much volume flowing into too few stocks. In simple terms, the more overbought a market becomes, the higher the probability that it will level off to digest its recent rise, or even correct downward – giving back a portion of its gain. The opposite is true for an oversold market. Obviously, an investor could increase his profit potential by determining when these sentiment swings reach an excessive level. For example, someone desiring to buy stocks (or exit a short position) can likely buy at a lower, more favorable price if the market is not overbought… or better yet, waiting until the market is oversold. Over the years, a number of methods have been used to measure the degree that a market becomes overbought or oversold. One of the most common is the Short-Term Trading Index or TRIN – defined as the Advance/Decline Ratio divided by the Advancing/Declining Volume Ratio.

InvesTech's proprietary Pressure Factor (PF) is an overbought/oversold index which utilizes three individual oscillators: an inverse variation of the TRIN, a volume oscillator, and a price oscillator. It has been mathematically modified so as to range between -100 (oversold) and +100 (overbought). It is due to this oscillation about a neutral 0-axis that the indicator is termed an oscillator. (For a detailed description on the development of the PF, call to order a copy of our technical report – The Development and Debiasing of a Relational Oscillator.)

Under NORMAL market conditions, as the Pressure Factor climbs above a certain level, the market becomes overbought; the higher the PF, the more overbought and the higher the probability that the market is about to stall or correct downward. As the PF drops below a certain level, the market becomes oversold; the lower the PF, the more oversold.

Shown at right is a graph of this Pressure Factor versus the S&P 500 during the protracted 1973-74 Bear Market. Notice that traders were presented the best opportunities for adding to short positions as the PF fell out of the overbought region – marked by ❶ .

The infamous bull market of 1982-83 was exactly the opposite, as the oversold region provided the optimum entry points for purchasing stocks [ ❷ next page]. In addition, whenever the PF jumped to an overbought level, investors were normally better off waiting to add to long positions (purchase stocks) until after the PF dipped to neutral or into the oversold area.

Since markets can often reach an extreme overbought/oversold level, the PF should be used as a trigger when it exits these regions. In other words… the time to purchase stocks is not when the PF enters the oversold region, but rather after it bottoms and exits the oversold region. Conversely, the time to sell a stock is when the PF exits the overbought region.

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You will also notice the overbought/oversold regions have been shifted downward in a bear market (such as 1973-74), and shifted upward in a bull market (1982-83). This leaves the obvious question: “How do we determine when to shift the levels?” Actually, the shifting can be based on monetary policy – upward if the Federal Reserve is accommodative, downward if they are tightening. An alternative to shifting the shaded levels would be to mathematically adjust the Pressure Factor itself. This is now done by InvesTech with the shaded overbought/oversold thresholds now fixed at +30 and -30.

The CBOE Call/Put Ratio

A variety of forms of the call/put ratio (or inverse put/call) have been popular tools of traders in recent years. However, in our research and testing we’ve found the volume ratio from the Chicago Board Options Exchange (CBOE) to be of great value in gauging excessive swings in trader sentiment. That’s probably due to its insulation from the institutional arbitrage and buy/sell programs.

This ratio measures the relative trading volume in call options versus put options to reveal when traders are too optimistic with a dominance of call volume over put volume. As shown in Figure 1 below, a high Call/Put Ratio often indicates that the market is about to consolidate or correct downward in coming weeks, while an abnormally low Call/Put Ratio (shown by arrows) confirms the lower-risk buying opportunities.

As put options became more popular over the past decade, this trading tool began to show a downward bias, making it difficult to determine true bullish and bearish levels. Because of this, the index was modified to plot the deviation of the Call/Put Ratio from its long-term trend, thereby removing any bias. The resulting model (shown here) has proven much more valuable to traders as it oscillates between fixed bullish (+100) and bearish (-100) levels.

In summary, these short-term trading indicators have proven their worth in improving individual stock purchases or sales. They often permit one to get the extra benefit of a slightly lower purchase price or a higher sale price. And for traders, it’s even more invaluable in timing entry/exit points for options or stock index futures, while avoiding the wild emotional swings which have become a part of today’s volatility.

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Too Much Pessimism - Bullish

Too Much Optimism - Bearish

CBOE CALLS/PUTS RATIO

S&P 500

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InvesTech Research

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Bond Market Indicators

Bonds may seem boring, but don’t underestimate the profits that can appear from the depths of a bond bear market – in many cases, they can rival those of a healthy bull market in stocks. Here’s how we objectively identify the best buying opportunities in bonds…

In theory, bond prices are merely a measurement of long-term interest rates. If interest rates rise, or are expected to rise, then bonds fall in value. If interest rates decline, bonds rise in value. So fundamental to any bond analysis is the premise that interest rates are a gauge of supply versus demand for money. This demand is generally a function of consumer, corporate, or government borrowing. Money supply, however, is regulated by the Federal Reserve, whose only concern is maintaining economic growth with a minimum of inflation.

With this understanding, it’s easy to see that a charging bull market in bonds requires one or more of the following: 1) easing inflationary pressures; 2) falling credit demand; 3) rising money supply growth; 4) a positive yield curve (short-term rates lower than long-term rates). The first two developments usually occur in an economy that is slowing. The second two signal that the Federal Reserve is in the process of easing or pushing interest rates downward. In the end, any timing model for the bond market must measure at least one of the above trends or pressures.

InvesTech tracks inflation pressures through several time-proven models, like the U.S. Future Inflation Gauge from Economic Cycle Research Institute (ECRI). However, our primary basis for deciding when to invest in bonds comes from four different bond market indicators… two of our own design, and two from Ned Davis Research (NDR). Together, these tools help identify and confirm the best buying opportunity in bonds, and then confirm the right time to buy. Here are the criteria to watch for, in chronological order:1) InvesTech’s Bond Advanced Risk

Index (Figure 1 ) drops deep into the high-risk zone below -1.0.

2) This same InvesTech Bond Advanced Risk Index signals a reversal in underlying “risk” by climbing 0.1 pt.

3) At least two of the three remaining models (Figures 2 – 4 ) trigger a “BUY” signal by moving into the bullish region.

Important Note: During extended periods of low inflation, the InvesTech Bond Advanced Risk Index may not drop below -1.0 before other bond models turn bullish. If this occurs, a buying opportunity is still indicated if two of the three confirming bond models shown in Figures 2-4 trigger “Buy” signals in the absence of a signal from the Bond Advanced Risk Index.

unfavorable

+1.5+2.0

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R = start of recessionSL = soft landing

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R R R R R SLSL R R

Note that "Best Buy" opportunitiesusually accompany the startof recession (R) or soft landing (SL)

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* Prior to April 2002 based on DJ20/40 Bond Indices

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BOND ADVANCED RISK INDEX

INVESTECH BOND BAROMETER

NDR LONG-TERM BOND MOMENTUM COMPOSITE MODEL

NDR BOND BENCHMARK MODEL

DJ CORPORATE BOND INDEX*

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High Risk Zone

InvesTech Research

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Conversely, the end of a bond bull market is indicated when the InvesTech Bond Advanced Risk Index drops into the “High Risk Zone,” confirmed by any of the other models. That’s the time to start shifting…

The InvesTech Bond Advanced Risk Index 1 should be treated independently. This model is based primarily on inflation pressures and usually provides the earliest signal of future bond market trends. As noted earlier, however, it is less reliable or may not signal during a long-term deflationary environment. As an advanced warning system, it alerts investors to a tiring bull market in bonds. But even more importantly, a sudden, sharp upward reversal of this gauge from the extreme bearish region (less than -1.0) is usually the earliest indication of an approaching “best buy” opportunity in bonds. This is the signal to start watching the other bond models for confirmation.

The other three models are designed to trigger a buy signal when they move into positive or “bullish” territory. The InvesTech Bond Barometer 2 , a composite of indicators that measure external forces on bonds, is a long-term, low volatility gauge. NDR’s Long-Term Bond Momentum Composite Model 3 is a compilation of over 70 monetary and economic indicators, and the NDR Bond Benchmark Model 4 is comprised of 50% external and 50% internal (or bond price related) indicators. Since these gauges measure a variety of factors, a “buy” signal from any two should confirm a safe entry point for bonds (even in the absence of an initial signal from the InvesTech Bond Advanced Risk Index).

How did these criteria do in the big bond bull markets of the past 44 years? The table below shows the start of the bond bull markets that correspond with buying opportunities shown in graph 5 on the previous page. Note that the big bond bull markets [❶ – ❽] invariably came at the onset of a recession or soft landing. In the table, the lead time for each of the models at the start of each bull market is indicated with a positive (+) sign. A lagging or late signal is shown in negative (-) figures. The final column shows what portion of the total gain in the bond market (from the low to the high) would have been captured by following the criteria outlined above. In other words, it represents the portion of profits available to someone who bought when two confirming bond models turned positive (assuming, of course, that positions were held until the peak).

For recession-induced bond bull markets (❶ – ❸ and ❽), our Bond Advanced Risk Index signaled an approaching “buy” opportunity well in advance of the bull market. This was not the case in the 1990 recession (❺) as the Advanced Risk Index turned upward right after two of the confirming models turned bullish. The bond bull market in 2000 (❼) actually began 10 months before the 2001 recession, without triggering any warning signal. These models also accurately signaled the great bond opportunity that began with 1984's soft landing (❹). The soft landing in 1994 (❻) was less predictable, as the Bond Advanced Risk Index never reached the -1.0 threshold that would mark a true “best buy” in 1994. Based on performance over these 7 major bond bull markets, our simple 3-step criteria takes the guesswork –and risk– out of bond investing.

Bond Bull % Potential Market Bond Adv IT Bond NDR LT Bond NDR Bond Gain Start Risk Barometer Momentum Benchmark Captured

8/22/70 +28.0 mo 0.0 mo +1.0 mo +1.0 mo 89.3% 10/5/74 +9.5 mo -5.5 mo -12.5 mo -1.5 mo 66.5% 2/13/82 +26.0 mo +4.0 mo +4.0 mo +3.0 mo 95.1% 5/26/84 +2.0 mo -6.5 mo -1.5 mo -5.0 mo 78.9% 9/29/90 -2.5 mo -6.5 mo +1.5 mo -1.5 mo 93.5% 12/31/94 no signal* -7.5 mo -7.5 mo -5.0 mo 36.7% 5/20/00 no signal* -5.0 mo -4.0 mo -2.5 mo 88.8% 10/18/08 +9.0 mo +20.0 mo +20.0 mo +2.0 mo ?

Bond Model “Buy” SignalsConfirming Triggers

❶❷❸❹❺❻❼ ❽

+ = lead– = lag

* Bond Advanced Risk did not reach -1


Profit Potential in a Bond Bull Market…Finally, we want to emphasize the profits that are available when the blocks drop into place for a bull market in bonds. The graph below shows the performance of bond funds with varying maturities during the three year bull market that began with the 1990 recession. The Treasury money market fund, which has an average maturity of 90 days or less, approximates the performance of T-bills. For the short-term bond group the average effective maturity was 2.3 years, and for the long-term group it was 14.5 years.

By taking advantage of long-term bonds, investors could have quadrupled the 3-year total return of a Treasury money market fund to 54.8%. And with the leverage provided by zero-coupon bonds, that return would double again to +125%, outstripping even the return on blue chip stocks over that period.

Yes, bonds may be boring – even painful if you jump in early and get caught in a bear market. However, when the right blocks drop into place, the profits from bonds can be downright spectacular. The critical lessons to remember are: 1) don’t be impatient in the early stages of a bond bear market; and 2) have a well-planned strategy and criteria for determining the right time to step in.

Short-Term Bonds +28.4%

Long-Term Bonds +54.8%

25 yr Zero-Coupon Bonds +125.0%

Performance: Maturity vs. Zero-Coupon Bonds9/28/1990 - 10/15/1993

1991 1992 1993

Treasury Money Market +13.9%

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Glossary of General Market Terms

ADR (American Depository Receipt): A negotiable certificate issued by a U.S. bank in place of one or more shares of foreign corporations held in trust by the bank. ADRs are traded on U.S. exchanges and facilitate the trading of foreign stocks by domestic investors.

A/D Divergence Index: A proprietary indicator developed by InvesTech showing the percent difference between the actual S&P 500 Index and the “expected” S&P 500 Index based on historical breadth. Unlike other breadth gauges, this model is not distorted by temporary weakness or strength in the Advance-Decline Line. InvesTech monitors the A/D Divergence Index to reveal when breadth or participation is deteriorating to the level at which a bear market normally begins. (See Advance-Decline Line.)

Advance-Decline Line: A cumulative sum of the difference between advancing stocks and declining stocks on a given day. A graph of the Advance-Decline Line is often compared with the DJIA or S&P 500 to determine if “breadth” is improving or worsening. (See A/D Divergence Index.)

Advance/Decline Ratio: Calculated by dividing the number of advancing stocks by the number of declining stocks on a given day, normally using a moving average.

Advancing or declining volume: Advancing volume is the total number of shares traded in only the stocks which advanced during the day; conversely for declining volume. Used primarily in momentum indicators.

Advisory Sentiment Index: Compares the percentage of investment advisors who are bearish to those who are bullish. A contrarian indicator, since the market is most likely to reverse direction upward when the greatest number of advisors are bearish; and market tops typically occur when bullishness is widespread.

Arbitrage: Simultaneous purchase and sale of stock, stock options, and/or stock index futures in order to profit from price discrepancies or interest income. This activity has become so widespread among specialists and institutions that some of the common sentiment indicators have likely lost their validity.

Banker’s acceptances: Short-term notes (promises) to pay a specified amount to “accepting” banks. Banker’s acceptances are generally drawn (made) by importers and exporters and used to finance international trade. These negotiable instruments are often bought and held by money market funds who consider them a very safe investment because they’re backed by the accepting bank (which is obligated to make payment at maturity), as well as the originator of the draft.

Bellwether Index: A proprietary composite of stocks, developed by InvesTech, which are in the most sensitive economic sectors of the market. Bellwether stocks are generally more sensitive to interest rates and economic conditions so, therefore, tend to display a cyclical price pattern that peaks well before bull market tops.

Bellwether stocks: Stocks or industries that purportedly have the capability of predicting broad market action by the movement in their own prices.

Beta: A measurement of a stock’s volatility relative to the market in general. A beta of 1.00 means that a stock has traditionally matched the market’s swings. A high beta indicates greater profitability from a stock in a bull market, but higher risk in a bear market.

Bid/asked price: In the over-the-counter market, the bid price is what a dealer or potential purchaser is willing to pay for at least 100 shares of stock, while the asked or offer price is the price “asked for” by a current holder of the stock.

Block or block trade: A large trade consisting of over 10,000 shares of stock.

Blue chip: A stock of high investment quality that has been issued by a large, well-established company and enjoys public confidence in its worth and stability.

Bond Advanced Risk Index: A proprietary indicator developed by InvesTech to evaluate the long-term investment climate for bonds. One of the major components of this Index is based on inflationary pressures, which have historically proven the most common trigger of higher interest rates and tumbling bond prices.

Bond Barometer: A composite timing model developed by InvesTech which reveals whether the climate is favorable or unfavorable for holding bonds or bond income funds. Ranges between +100 and -100.

Bond market: Similar to the stock market, an exchange where corporations (and the Federal government) can raise capital by selling interest-bearing notes. Bond prices are extremely sensitive to interest rates and inflationary fears. Thus, falling bond prices are perceived to lead stocks downward.

Bond Momentum Composite Model (Long-Term): A bond timing index formulated by Ned Davis Research for determining the bullish or bearish nature of the bond market. It is comprised of over 70 monetary and economic indicators.

Book value: The total shareholder equity (assets less liabilities) of a corporation. The value of a company's assets after all liabilities have been paid off, as reported on the balance sheet.

Breadth: Relates to the number of stocks taking part in a market move. A market advance with a large number of stocks participating is healthier (and more likely to continue) than an advance in which few stocks are taking part. Breadth indicators are usually the earliest indicator of market weakness; but often lag at market bottoms. (See A/D Divergence Index and Advance-Decline Line.)

Bull/Bear market: Indicating that the market is in a long-term uptrend (Bull) or long-term downtrend (Bear).

Buying volume: Used by InvesTech to refer to the general desire of investors to purchase additional stock.

Call option: See put/call option.

Capacity Utilization: The current operating rate at the nation’s factories, expressed as a percentage of their maximum capacity under ideal conditions. Rising capacity utilization is closely watched by the Federal Reserve as an advance warning of impending inflation, since companies must increase prices to cover the expense of bringing new manufacturing facilities on line.

CBOE Call/Put Ratio: The ratio of the daily volume of calls to puts on the Chicago Board Options Exchange. A contrarian indicator based on the concept that options traders are usually wrong near critical turning points. High readings are bearish, and low readings are bullish.


CD rate, 90-day: The interest rate paid by banks on 90-day certificates of deposit. (See Federal Funds rate.)

Closed-end fund: An investment fund which specializes in stocks or bonds, but whose price is not solely dependent upon the true assets of the fund. Because the fund has a fixed capitalization (number of shares which are traded on a stock exchange), share price is determined by supply and demand and will often trade at a premium or discount to the value of the stocks owned by the fund.

Commercial paper: Short-term negotiable debt instruments sold by corporations to the public. Reported weekly, it is a good indication of business credit demand.

Consumer Confidence Index: An index based on a representative sampling of 5,000 households, compiled monthly by The Conference Board and used to predict the future health of the U.S. economy. The index is a weighted average of two separate components: 40% current expectations and 60% future expectations.

Consumer Credit: A monthly release indicating short-term loan demand by the public.

Consumer Price Index (CPI): Measures the change in the cost of goods and services (housing, food/beverage, transportation, apparel, medical care, and entertainment) purchased by a typical wage earner. Reported monthly by the Labor Department and often referred to as the “consumer inflation rate.” Consumer Sentiment Index: Compiled from a nationwide survey of consumers by Thomson Reuters/University of Michigan, this Index measures consumers’ current and future expectations for financial and business conditions and is designed to detect changes in consumer psychology and, by extension, the economy.

Coppock Guide: Originally developed by Edwin S. Coppock in the 1950s as a “barometer of the market’s emotional state.” Recognized for its accurate historical track record in signaling the best, low-risk buying opportunities – although it is not noted for timely sell signals. Monitored regularly by InvesTech as one of the key confirmations of a new bull market.

Coupon pass: A permanent purchase of government securities by the Federal Reserve for its own account. This injection of funds into the banking system to reduce (or hold down) the Federal Funds rate, is normally considered bullish. (See repurchase agreement.)

Credit demand: This, along with banking liquidity and the Federal Reserve’s willingness to supply funds to the banking system (money supply growth), controls the course of interest rates.

Customer repo: See repurchase agreement.

Cycle – business/economic/investment: Cycles of alternating growth and contraction exist in the economy and in the financial markets. A number of theories abound for predicting investment cycles (including the Kondratieff Wave, Gann Theory, and the Elliott Wave Theory based on Fibonacci numbers); but their value in forecasting future price levels is statistically questionable.

Date of declaration/payment/record: In stock splits and dividend or capital gains payments, the date of declaration is the date that the impending action is announced by the company. The date of record determines which stockholders will take part in the transaction, while the payment date is the actual distribution date.

DAX: The major market average traded on the German Frankfurt Stock Exchange.

Debt-to-Equity Ratio: The ratio of a corporation’s total debt to shareholder equity (number of shares times value per share). This

figure is one means of evaluating a company’s underlying value or long-term liquidity.

Deferred sales charge: See redemption fee.

Derivatives: Any of a number of investment instruments which derive value from an underlying security. Examples include options, futures, stripped bonds, and different types of structured notes. Derivatives are widely used by institutions to manage risk, but actually increase risk if used inappropriately.

Discount rate: The interest rate which member banks must pay to borrow funds directly from the Federal Reserve (as opposed to the Federal Funds rate).

Disparity: The degree of nonconfirmation by an indicator with respect to the market’s movement; i.e., the failure of the Advance-Decline Line to reach a new high while the DJIA hits a new high.

Dividends: Corporate earnings which are distributed to individual stockholders.

Dividend Yield: Calculated by dividing the most recent 12-month dividends per share by the price of the stock. Dividend Yield can be thought of as an investor's cash return on investment.

Dow Jones Corporate Bond Index: An equally weighted basket of 96 recently issued investment-grade corporate bonds with laddered maturities. The object of the index is to capture the return of readily tradable, high-grade U.S. corporate bonds.

Dow Jones Industrial Average (DJIA): A price-weighted market index composed of 30 major, primarily NYSE-listed corporations. Often criticized for containing too few issues.

Dow Jones U.S. Total Stock Market Index (formerly the Wilshire 5000 Index): A broad-based index representing the dollar market value of all publicly traded stocks in the United States. The index is capitalization-weighted.

Dow Jones Transportation Average (DJTA): A stock market index composed of 20 major, primarily NYSE-listed transportation stocks.

Dow Jones Utility Average (DJUA): A market index composed of 15 major NYSE-listed utility stocks.

Downside volume: See advancing or declining volume.

Dow Theory: A set of criteria developed around 1900 by Charles H. Dow which utilizes the DJIA and DJTA to identify the current major trend of the market.

Durable Goods Orders: Monthly statistic released by the Commerce Department reporting new orders received by manufacturers for goods having a useful life exceeding three years (appliances, autos, etc.). Econometric model: An economic/stock market forecasting model developed by applying mathematics and statistics to economic and financial trends.

Emerging Markets: Generally thought of as Second or Third World countries whose stock markets possess greater profit potential due to higher economic growth rates. Emerging markets are accompanied by correspondingly greater market and currency risk.

Eurocurrencies: Deposits of a currency held in banks outside the country which originally issued it, yet paid interest based on prevailing rates in the home country.

Eurodollars: U.S. currency deposits held in banks outside the


United States. (See Eurocurrencies.)

Ex-dividend: A stock is listed as ex-dividend when new purchasers are not eligible for a dividend which has been announced but not yet paid.

Expense ratio: The yearly percentage of a mutual fund’s total assets which are used to pay administrative, management, and distribution (12b-1) expenses. Industry average is approximately 1.5% for domestic equity mutual funds.

Exponential moving average: A simplified (yet quite accurate) method of calcu lating a moving average using only the current day’s value and the previous day’s moving average.

Federal Funds rate: The interest rate which banks must pay to borrow from other member banks of the Federal Reserve system. The Federal Funds rate and the 90-day T-bill rate are the best indication of the direction of short-term interest rates and usually lead the more commonly followed “prime rate.”

Federal Reserve System: Established by the Federal Reserve Act of 1913 as the national banking system independent of government control. Composed of a seven member Board of Governors and 12 Reserve Banks. The Federal Reserve has the responsibility of controlling monetary policy with the power to supply (print) money or drain funds from the banking system.

Financial futures: That portion of the commodities market which refers to the trading of T-bill, T-bond, and GNMA (Government National Mortgage Association or Ginnie Mae) contracts… all of which are extremely sensitive to interest rates.

Flat: See long/short/flat.

F.O.M.C. (Federal Open Market Committee): The decision-making arm of the Federal Reserve, consisting of seven Federal Reserve Board members (Presidentially appointed), the president of the Federal Reserve Bank of New York, and four other Reserve bank presidents (selected in rotation from the remaining 11 district banks).

FTSE 100 Shares: A major market average of 100 stocks traded on the London Stock Exchange.

Fundamental analysis: Analysis of the stock market (or individual stocks) through the evaluation of current or past economic and business statistics.

Gross Domestic Product (GDP): The dollar value of the final output of all goods and services produced in the U.S. in one year. GDP is expressed in current dollars and includes the effects of inflation; while real (or constant dollar) GDP is adjusted to exclude the impact of inflation.

Hang Seng Index: The primary index representing stock market performance in Hong Kong.

Hedging: Protecting against a possible investment loss by a counterbalancing transaction. For example, an investor who owns stock which he does not wish to sell (because of tax considerations or impending dividend, etc.), can protect against a temporary drop in that stock by purchasing a corresponding put option which would increase in value as the stock price fell.

Hidden load (12b-1): An annual fee charged by mutual funds for marketing expenses to attract new investors that is often hidden in the fine print of a fund's prospectus.

Highs/lows: “New highs” refers to the total number of stocks which have traded up to hit a new 52-week high on a given day; vice versa for “new lows.” High/low figures can be used as an

indication of market leadership.

Initial Claims for Unemployment: A weekly report of new unemployment claims compiled by the Labor Department from data collected from each of the states and Washington, DC.

Initial Public Offering (IPO): See New Issue.

Insider Trading (Buying/Selling): Buying or selling of corporate stock by the officers of a company must be reported to the SEC; and is often referred to as an excellent indication of future earnings by those "in the know." However, in reality, it is the epitome of the worst imaginable investment tool.

Institutions: A generic term referring to trading that is conducted by large portfolio managers (i.e., mutual funds, pension funds, etc.).

Intermediate-term: See short/intermediate/long-term.

International Monetary Fund (IMF): An international organization to which all nations may contribute, and from which any nation may borrow to support the value of its currency or encourage development within its country. The IMF was created in 1944 to stabilize the international currency market, lower trade barriers, and induce postwar recovery.

ISM Purchasing Managers Index: Based on a monthly survey of the Institute for Supply Management. Members (major corporations) often reflect early economic trends in employment, production, and prices. A reading above 50% confirms a growing manufacturing sector.

January Barometer: A Wall Street phenomenon (approximately 68% accurate over 80 years) in which the stock market’s performance during January is a precursor of the market’s performance for the remainder of the year. (See Seasonality.)

Junk bonds: High-yield corporate bonds which are considered high-risk due to the increased probability of a default by the issuer, and are rated BB or lower by Moody’s Rating Service.

Leadership: Leadership is indicated by the quantity and quality of stocks leading the market in a particular direction – usually a prerequi site for a trend to continue (see highs/lows).

Leadership Index: An indicator that InvesTech uses to gauge bullish versus bearish leadership, it serves as a strong confirmation of the primary market trend and ranges between a very favorable +100 and a bearish -100.

Leading Economic Indicators (U.S.): Consists of select statistics which are used to hypothetically forecast the nation’s future economic health. They are:

Consumers ......................... Index of expectationsEmployment ....................... Average weekly initial unemploy-

ment claimsHousing .............................. Building permits, new privately-

owned housing unitsIndustrial Production ....... Percentage of companies reporting

slower deliveriesInterest Rate Spread ......... 10-year Treasury bonds less federal

fundsLabor Usage ....................... A v e r a g e w e e k l y h o u r s ,

manufacturingMoney Supply .................... M2New Orders (consumer) .... New orders of manufactured

consumer goods and materialsNew Orders ........................ New orders of manufactured non-

defense capital goodsStock Prices ....................... S&P 500 Stock Price Index


Leverage: Assuming a greater risk/reward potential by controlling a larger investment with a minimum of investment capital; i.e., stock options or stock index futures.

Liquidity: A term used to describe a security which trades with high volume on a daily basis, such that a large sale of the security would not affect the price significantly. This term is also used to describe the ability to meet debt obligations with current assets and income.

Load/no-load: A “load” is a fee which is charged by some mutual funds to investors who purchase shares. Loads may consist of sales fees, redemption fees, or both. Even some no-load funds may have hidden fees in the form of 12b-1 charges, but these must be listed in the fund’s prospectus.

Logarithms (log scale or log plot): A graph with its vertical axis and plot constructed using the logarithmic function, and easily identified by uneven divisions on the vertical axis. A log plot permits data to be viewed in terms of percentage gains – where a 10% change appears equal near the upper OR lower portion of the graph.

Long/short/flat: Used to describe a position in the market or in a particular stock/option, etc. “Long” pertains to the purchase of a stock with the expectation that it will rise in price and later be sold at a profit. “Short” or “selling short” describes the opposite strategy – selling a stock with the expectation that it will drop in value, later yielding a profit when repurchased at a lower price (see short-selling). “Flat” means having no position.

Long-term: See short/intermediate/long-term.

Management fee: A fee charged to compensate the manager of a mutual fund (load or no-load) or other managed account. Usually a fixed annual percentage (between .5% and 2.0%) of assets under management.

Margin: Investment capital which is borrowed from a brokerage firm to purchase additional stock or mutual funds. Up to 50% of an investor’s account equity may be used as collateral, and interest is charged by the broker on these borrowed funds.

Margin call: A notice sent to clients who have purchased stock “on margin,” when their account balance drops below the minimum margin requirements due to falling stock prices. The investor must either “meet” the margin call by supplying additional funds, or sell the stock which was purchased on margin.

Margin Debt: The sum total owed to NYSE member firms by customers who have borrowed money in margin accounts to finance stock purchases.

Merchandise Trade Balance: The net difference between U.S. exports and imports of goods, leaving either a surplus (when exports exceed imports) or a deficit (when imports exceed exports).

Momentum: Refers to the strength or acceleration of a trend – the stronger the trend, the greater its likelihood of continuing.

Monetary: Variables such as interest rates, credit demand, or liquidity which the Federal Reserve attempts to control through its regulation of the banking system. Monetary factors are usually a precursor of future stock prices and economic conditions.

Monetary base: The total “money” (credit, gold stock, etc.) made available to the banking system by the Federal Reserve to finance consumer and business borrowing.

Monetary Exposure Profile (MEP): An indicator developed by InvesTech which determines whether the monetary environment (as controlled by the Federal Reserve) is favorable or unfavorable

for the stock market. Ranges between +100 and -100.

Money market fund: An investment fund which provides a relatively secure interest income by investing only in high-grade money market instruments (T-bills, banker’s acceptances, certificates of deposit, or commercial paper). Often used by investors for excess capital not currently invested in the stock or bond market.

Money supply: Total stock of money in the economy consisting primarily of currency in circulation or held as short-term investments: M1: Currency + demand deposits (i.e., checking accounts) M2: M1 + savings accounts + time deposits under $100,000 + money market funds

Money velocity: Measurement of the rate of turnover of “money” within the economy. Often expressed as the ratio of GNP growth to money supply, it indicates the desire of consumers or business to hold money rather than spend it.

Morosani Index: Created by economist John Morosani and tracked by InvesTech as an predictor of inflation, the Morosani Index is a ratio of capacity utilization to the trade-weighted U.S. dollar.

Moving average: Calculated by averaging an indicator’s values for a given number of days in order to smooth out minor fluctuations and obtain a more reliable value.

Municipal bonds: Bonds issued by state or local governments. Interest on municipal bonds is exempt from federal income tax, as well as state/local taxes if the bond owner lives in the issuing state.

Mutual fund: A professionally managed investment pool with the primary objective of investing in common stock, preferred stock, or debt securities for capital gain and/or interest income. Fund shares may be purchased by the investor, thereby eliminating the need for the investor to select individual stocks.

Mutual Funds Cash/Assets Ratio: The ratio of cash (and cash equivalents) to total assets of mutual funds as compiled by the Investment Company Institute. Normally above 11% near market bottoms and under 5% at market peaks, this indicator can sometimes prove quite misleading.

NASDAQ National Market System: NASDAQ (National Association of Securities Dealers Automated Quotation System) is a computerized pricing system which determines bid and asked prices for actively traded stocks in the over-the-counter market.

NASDAQ Composite Index: A capitalization-weighted market index composed of all domestic companies listed on the National over-the-counter (OTC) market.

NAV (net asset value): Pertaining to mutual fund quotes, the NAV represents the total net assets of the fund divided by the number of shares outstanding. This is usually the fund’s purchase price (except in the case of a “load fund” which adds a sales or redemption fee to the NAV).

Negative Leadership Composite: A proprietary indicator developed by InvesTech to track internal market leadership. A "SELLING VACUUM" (without any downside or negative leadership) is always triggered in the early stages of a long-term market advance. Conversely, when an increasing number of stocks are dropping to new yearly lows, this Index enters the "DISTRIBUTION" zone where the stock market is most vulnerable.

Net free reserves: A measure of banking liquidity calculated by subtracting the banking system’s legally required reserves


and borrowings (through the Federal Reserve system) from their total cash reserves.

New issue: The initial offering of stock to the public by a corporation or its founders to raise capital for growth.

New York Stock Exchange Composite (NYSE): A capitalization-weighted market index composed of all corporations traded on the New York Stock Exchange. Often preferred by analysts over the DJIA for its broader base.

Nikkei 225 Index: The major market average traded on the Japanese Tokyo Stock Exchange.

No-load mutual fund: A mutual fund which charges no commissions or sales/redemption fees to execute transactions. As with load funds, an internal management fee (and often a 12b-1 distribution fee) is charged directly to the fund.

NYMEX: New York Mercantile Exchange – where commodity futures and options are traded for energy, metals and other commodities.

Odd lot: Purchase or sale of a block of stock consisting of fewer than 100 shares.

Odd lot shorts: Short sales of fewer than 100 shares made by small (supposedly unsophisticated) investors.

OEX: An index option on the capitalization-weighted S&P 100 Index, referred to by its ticker symbol OEX.

Option: See put/call option.

Oscillator: A short-term timing indicator that fluctuates about a neutral axis – between an oversold (bullish) condition and an overbought (bearish) condition.

OTC (over-the-counter) Market: Unlike other exchanges, where trading is conducted in one physical location, the OTC market trades via telephone and computerized negotiations between buyers and sellers. A new issue is usually listed first on one of the regional OTC markets. Then, as the corporation grows and its trading volume expands, the stock moves to the National OTC market before advancing to the NYSE.

Overbought: A market condition in which stock prices have risen too rapidly, with too much volume flowing into too few stocks. The more overbought a market becomes, the higher the probability that it will level off to digest its recent rise, or experience a temporary correction.

Oversold: A market condition in which stock prices have declined too quickly, with too much volume flowing into too few stocks. The more oversold a market becomes, the greater the probability that it will temporarily level off or bounce upward.

Perpetual futures contract: A hypothetical commodity futures contract with a floating expiration date, which permits a comparison of long-term commodity trends. For example, today’s value of a 3-month perpetual contract would be calculated by prorating the premium on a nearby futures contract with the premium on a contract that expires in four or more months.

Preferred stock: Stock given priority over common stock in the payment of dividends (often fixed) and/or distribution of assets.

Premium: In the case of stock index futures or options, the difference between the current futures or options price and the actual cash value at expiration if the underlying commodity or stock doesn't change in value. The premium is usually considered

the “expense” for controlling a leveraged investment with a limited amount of capital.

Pressure Factor (PF): A short-term timing model developed by InvesTech which utilizes three individual oscillators: an inverse variation of TRIN, a volume ratio oscillator, and a price oscillator.

Price/Book Value Ratio: A fundamental measure of stock valuation that is calculated by dividing the price of a stock by the book value per share.

Price/Earnings Ratio (P/E): A fundamental measure of stock valuation that is calculated by dividing the price of a stock or index by its latest 12-month earnings per share.

Prime rate: The interest rate that banks charge their most credit-worthy customers. A poor monetary indicator, as it usually lags other key rates (see Federal Funds or T-bill rate).

Producer Price Index (PPI): Measures the cost of goods and resources (food, capital equipment, energy, etc.) purchased by a typical manufacturer. Reported monthly by the Labor Department, it is considered a leading indicator of the Consumer Price Index (CPI) or inflation rate.

Program buying/selling: Refers to the numerous arbitrage-related programs which institutions trade with the use of extensive computer analysis. Often blamed for the increased day-to-day volatility in the stock market.

Protective stop: A means of limiting potential losses or locking-in profits by pre-selecting a price at which a stock position will be exited if it falls. In the case of over-the-counter stocks and mutual funds where an actual stop cannot be placed as an order, a “mental stop” should be used. When the stock nears its mental stop, it must be monitored closely for a possible exit.

Public (or Non-Member)/Specialist Short Ratio: An indicator which supposedly measures the amount of short-selling by “ill-informed” investors (the public) with respect to short-selling performed by sophisticated specialists. Distorted by today’s arbitrage trading.

Put/call option: An option to buy (or sell) common stock at a specified price (“strike” price) within a given amount of time (expiration date). Put options are purchased in antici pation of the price of the stock falling, while call options are purchased in expectation of higher prices.

Put/Call Premium Ratio: Developed by Bob Nurock (The Astute Investor) as a sentiment gauge to measure excessive optimism (< 40) or widespread pessimism (> 125). Compares the average premium on all listed put options to the average premium on all listed call options.

Put/Call Volume Ratio: Developed by Perry Wysong (Consensus of Insiders) as a sentiment gauge to measure excessive optimism (< 10) or widespread pessimism (> 100). A ratio of 40 means that $.40 is changing hands in puts for every $1.00 traded in calls.

Random walk theory: The assumption that a stock’s future price is totally unrelated to past price movements.

Redemption fee: A charge of up to 2% levied by some mutual funds, and collected only when you sell the fund. This fee is often contingent on the length of time the investment is held and is not charged by true no-load funds.

REIT (Real Estate Investment Trust): An investment group, closed-end fund, or security which pools funds for the purpose of investing in real estate related areas.


Relative strength: Measures a stock (or stock group’s) current performance relative to other stocks (or groups). Often indicative of potential future performance.

Repurchase agreement (repo): An increasingly popular transaction whereby securities of the U.S. government or a federal agency are sold with a simultaneous agreement (by the seller) to repurchase the securities at a later date (usually 2-4 days). Used by the Federal Reserve to inject funds into the banking system to temporarily reduce (or hold down) the Federal Funds rate, a “system repo” is carried out with several banks, while a “customer repo” involves a single bank. Repurchase agreements are also used as short-term investments by money market funds.

Reserve requirements: The minimum cash reserve level which all Federal Reserve member banks must carry as “insurance” against nonperforming loans or defaults. Estab lished by the Federal Open Market Committee (F.O.M.C.) of the Federal Reserve.

Resistance level: See support/resistance level.

Risk Adjusted Return: A return measurement that is adjusted to represent the amount of risk taken to earn the return. A component such as volatility is used to gauge how much risk is involved in producing a security return. Common risk-adjusted return measures include Alpha, Information Ration, and Sharpe Ratio.

Risk Allocation Strategy: The strategy employed by InvesTech Research in its Model Portfolio, whereby the recommended investment allocation is gradually increased or decreased based on market risk as measured by key indicators. Money market funds or T-bills are used as a temporary parking place for investment capital when the market environment is unfavorable.

S&P 500 (Standard & Poor’s 500 Index): A capitalization-weighted index composed of 500 leading companies in leading industries of the U.S. economy, the S&P 500 represents approximately 75% of the U.S. equities market. Based on 200 issues at inception in 1917, the index was expanded to 500 issues in 1957, and is included as one of the Conference Boards’s 10 Leading Economic Indicators.

S&P CNX Nifty Index (Nifty 50): A free float capitalization weighted index of 50 large companies that trade on the National Stock Exchange of India. The stocks in the Nifty 50 cover a broad base of 22 sectors within the Indian economy. The index started on November 3, 1995.

Seasonality: The tendency of stock prices to react favorably during certain times of the year. Most notable are the two days prior to each major holiday and the period between mid-December and mid-January.

Secondary stocks: Small high-growth companies which are usually listed on the various OTC exchanges, they are often considered higher risk investments due to the lack of an established sales/earnings record.

Sentiment: Sentiment indicators attempt to measure the extremes in investors’ emotions or confidence. Used as a contrary indicator, since optimism is greatest near market tops and pessimism is widespread near market bottoms. (See Short Interest Ratio, Advisory Sentiment Index, and Public/Specialist Ratio.)

Short Interest Ratio: A sentiment indicator calculated by dividing the total number of shares that have been sold short by the average daily trading volume. A high SIR (above 1.75) is normally considered bullish and a low SIR (under 1.00), bearish. Severely distorted during recent years by institutional arbitrage activity.

Short/intermediate/long-term: Referring to the relative length

of time an investor normally holds or maintains a stock position. Short – within the next 4 weeks; intermediate – from 1 to 6 months; long – greater than 6 months.

Short-selling: Selling borrowed stock with the objective of repurchasing it at a profit, after its price has declined.

Singapore Straits Times Index: The index for Singapore’s stock market. The Straits Times and Hang Seng Indexes are considered to be two of the primary markets of the Far East.

Soft Landing: A term used by the financial media to describe a cooling of the economy sufficient to quell inflation and interest rates without triggering a recession.

Specialist: A professional investor on the floor of the New York Stock Exchange whose role is to balance incoming buy and sell orders and maintain liquidity to create fair prices in the stocks in which he specializes.

Speculation: A trader’s willingness to assume above average “risk of loss” in return for above average “potential for profit.”

Split: A stock split increases the number of shares outstanding for a particular company, while decreasing the stock’s price by an equal amount. Stock splits DO NOT affect an investor’s profit or loss in the stock, but make the stock more affordable to the general investing public.

Spot Price Index (Spot Raw Materials Prices): A daily index comprised of 13 commodities (excluding food and energy), compiled by the Commodity Research Bureau. This Index is a good measure of inflation at the earliest stages of production.

Spread: The price difference between the bid and asked price in OTC quotes. It may also refer to an option-hedging strategy in which an investor has taken contrary positions in the same underlying stock simultaneously but with different strike prices or expiration dates.

Standard Deviation: A statistical measure which gauges variation in a stock price series. The wider the range of variation, the higher the risk.

Stock index futures: A very speculative means of investing in the stock market using a highly leveraged contract which is traded on the commodities exchanges (not for the faint-of-heart).

Stopped out: A term used to describe the completion (exiting) of a trade or stock position when a “protective stop” has been hit.

Summer Rally: A popular Wall Street truism which contends that the summer months provide a seasonal advantage for stock market gains over other months of the year. Research conducted by InvesTech has disproved the existence of a summer rally.

Support/resistance level: A “support” level is established under a stock’s price as it advances upward; and con versely, a “resistance” level is established above the stock’s price when it bounces lower in a downtrend. In either case, these levels represent important price barriers which the stock has been unable to penetrate after a number of consecutive attempts.

T-bill rate, 90-day: The interest rate paid by the Federal government on 90-day Treasury bills to help finance the short-term portion of the Federal deficit (see Federal Funds rate).

Technical analysis: The science (and art) of predicting future market trends and stock price movements through analysis of market statis tics, monetary conditions, price patterns, as well as sentiment indicators.


TICK: The net number of stocks on the NYSE whose latest change was up or down. For example, a TICK of +500 means that out of the total NYSE stocks traded, 500 more traded on an uptick (moved higher) than traded down. Sometimes thought of as an instantaneous reading of “advances minus declines,” the TICK can be a strong indication of market direction during the next few hours.

Trade-weighted dollar: A comparison of the U.S. dollar against a basket of foreign currencies, with the weight of each of those currencies depending on the amount of trade which that country transacts with the United States.

Trend-line (200-day): A 200-day moving average of a stock’s price or market index is often compared with its current price to indicate the long-term trend. It may act as a resistance level for a declining stock, or a support level for an advancing stock.

TRIN: Calculated by dividing the ratio of advancing to declining stocks by the ratio of advancing to declining volume: (A/D)/(+V/-V). Available through most brokerage firms, TRIN readings are considered to be bullish if under 1.0 and bearish if above 1.0. Also known as the Short-Term Trading Index or the Arms Index (after its inventor, Richard Arms). A 10-day moving average is often used for smoothing.

Unweighted Indexes: Market indexes which give equal weight to all the stocks on an exchange. Unweighted indexes are believed to do a better job of reflecting the price fluctuations of the majority of stocks traded on an exchange than price or capitalization-weighted indexes. Some examples are the Value Line Index and the S&P Equal Weight Index.

Upside volume: See advancing volume. Value Line Index: An unweighted index of all the approximately

1700 stocks covered in the Value Line Investment Survey.

Volatility: The increased tendency of a market (or stock) to change price very rapidly. A more volatile stock will usually rise faster in an advancing market while falling further in a declining market (see Beta).

Volume flow: A term used to describe the degree to which net advancing volume (advancing volume minus declining volume) is “flowing” into net advancing stocks.

Warrant: A certificate entitling the holder the right to purchase securities within a specific time period at a specific price. A warrant is similar to an option, but generally has a longer life and is often sold upon the new issue of a stock.

Year-end Rally (Santa Claus Rally): A historic phenomenon (approximately 75% accurate) whereby the market usually moves higher during the weeks before and after Christmas. (See Seasonality.)

Yield: The dividends or interest paid by an investment such as a stock, mutual fund, or T-bond. In the case of stocks, the yield is expressed as a percentage of its current price.

Yield curve: A graphic comparison between the yields on short-term and long-term deposits or money market instruments. A positive yield curve is one where long-term rates are higher than short-term rates, and indicates a normal relationship which is healthy for economic growth. A flat or inverted yield curve is indicative of tight money – and is usually a precursor of a slowing economy.

Zero-coupon bond: A particular type of bond which is sold at a steep discount from face value, then appreciates until maturity (in lieu of periodic interest payments). The gain is taxable as accrued, even though there are no actual interest disbursements.

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© InvesTech ResearchReproduction of this manual, in whole or part by photocopying or any other means, is strictly forbidden.

Excerpts may be quoted with the written permission of InvesTech Research.

IMPORTANT DISCLOSURE INFORMATION: Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategy recommended and/or undertaken by InvesTech) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Please see additional IMPORTANT DISCLOSURE INFORMATION at http://www.investech.com.

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