Cybernetic Trading Strategies: Developing a Profitable Trading System with State-of-the-Art Technologies

3

Long-Term Patterns and Market Timing for Interest Rates and Stocks

This chapter will show you how to use fundamental data to predict longterm trends in both interest rates and stock prices.

This type of long-term analysis is very important for people who switch mutual funds, as well as anyone with a variable rate loan. It is also important for short-term traders because many systems are based on buying pullbacks in the long-term uptrends of both stocks and bonds, which started during the early 1980s. When these bull markets end, these systems will stop working—with disastrous results.

INFLATION AND INTEREST RATES

It is commonly known that interest rates are positively correlated to inflation. As inflation rises, so do interest rates. In general, this relationship is true, but it is not constant. We will examine this relationship using 3-month T-Bill yields and yields on the longest government bond. We will compare these yields to the 1-year inflation rate, calculated by taking a 12-month percentage change in the Consumer Price Index (CPI). These data, as well as the other fundamental data used in this chapter, were supplied by Pinnacle Data Corporation and are part of their index database.

To study the relationship between T-Bill yields and inflation, we researched monthly data going back to 1943. Most major increases in shortterm rates occur when the inflation rate is a negative ...