Page 351 - How to Make Money in Stocks Trilogy

M = Market Direction: How You Can Determine It 227

virtues bullishly or bearishly, they probably haven’t done their homework.
No secondary measurements can be as accurate as the major market
indexes, so you don’t want to get confused and overemphasize the vast
array of other technical measures that most people use, usually with lack-
luster or damaging results.

Watch Federal Reserve Board Rate Changes
Among fundamental general market indicators, changes in the Federal
Reserve Board’s discount rate (the interest rate the FRB charges member
banks for loans), the fed funds rate (the interest rate banks with fund
reserves charge for loans to banks without fund reserves), and occasionally
stock margin levels are valuable indicators to watch.
As a rule, interest rates provide the best confirmation of basic economic
conditions, and changes in the discount rate and the fed funds rate are by far
the most reliable. In the past, three successive significant hikes in Fed inter-
est rates have generally marked the beginning of bear markets and impend-
ing recessions.
Bear markets have usually, but not always, ended when the rate was
finally lowered. On the downside, the discount rate increase to 6% in Sep-
tember 1987, just after Alan Greenspan became chairman, led to the severe
market break that October.
Money market indicators mirror general economic activity. At times I
have followed selected government and Federal Reserve Board measure-
ments, including 10 indicators of the supply and demand for money and
indicators of interest-rate levels. History proves that the direction of the
general market, and also that of several industry groups, is often affected by
changes in interest rates because the level of interest rates is usually tied to
tight or easy Fed monetary policy.
For the investor, the simplest and most relevant monetary indicators to fol-
low and understand are the changes in the discount rate and fed funds rate.
With the advent of program trading and various hedging devices, some
funds now hedge portions of their portfolio in an attempt to provide some
downside protection during risky markets. The degree to which these
hedges are successful again depends greatly on skill and timing, but one
possible effect for some managers may be to lessen the pressure to dump
portfolio securities on the market.
Most funds operate with a policy of being widely diversified and fully or
nearly fully invested at all times. This is because most fund managers, given
the great size of today’s funds (billions of dollars), have difficulty getting out
of the market and into cash at the right time and, most importantly, then
getting back into the market fast enough to participate in the initial power-