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Appraisal of methods used for timing investment decisions in the stock market Rousseau, Alfred Sim 1968

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AIT APPRAISAL OF METHODS USED FOR TIMING IS TESTMENT DECISIONS IN THE STOCK MARKET by ALFRED S. ROUSSEAU A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE RBQUIREIiENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION i n the Department of FINANCE We accept t h i s t h e s i s as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA A p r i l , 1968 In p r e s e n t i n g t h i s t h e s i s i n p a r t i a l f u l f i l m e n t of the requirements f o r an advanced degree at the U n i v e r s i t y of B r i t i s h Columbia, I agree t h a t the L i b r a r y s h a l l make i t f r e e l y a v a i l a b l e f o r r e f e r e n c e and Study. I f u r t h e r agree t h a t p e r m i s s i o n f o r e x t e n s i v e copying of t h i s t h e s i s f o r s c h o l a r l y purposes may be granted by the Head of my Department or by hits r e p r e s e n t a t i v e s . It i s understood t h a t c o p y i n g or p u b l i c a t i o n of t h i s t h e s i s f o r f i n a n c i a l g a i n s h a l l not be a l l o w e d w i t h o u t my w r i t t e n p e r m i s s i o n . Department of The U n i v e r s i t y of B r i t i s h Columbia ABSTRACT AN APPRAISAL OP METHODS USED FOR TIMING INVEST!' LEST DECISIONS IN TEE STOCK MARKET by A l f r e d S. Rousseau The main purpose of t h i s study was to t e s t the worth o f u s i n g methods of t i m i n g Investment d e c i s i o n s i n the stock market. The w r i t e r i n v e s t i g a t e d the use of economic and t e c h n i c a l i n d i c a t o r s i n f o r e c a s t i n g the most advantageous times f o r i n v e s t i n g and d i s i n v e s t i n g ' i n the stock market. R e c o g n i t i o n was g iven to the importance of fundamental a n a l y s i s i n the choice o f s t o c k s , and the "balance of the a p p r a i s a l v/as devoted to the t i m i n g d e c i s i on, o r , "Y/hen to "buy?". A n u l l hypothesis was formed to provide the b a s i s f o r a t e s t on the t i m i n g d e c i s i o n . The hypothesis v/as tes ted by the use o f a model, c o n s i s t i n g of economic and t e c h n i c a l i n d i c a t o r s , and c r i t e r i a that are deve loped ' for the performance of the model. The s t a t i s t i c a l method i n t h i s a p p r a i s a l comprises of the formation o f indexes f o r f o r e c a s t i n g the investment d e c i s i o n s . Some o f the l e a d i n g economic i n d i c a t o r s that were developed "by the N a t i o n a l Bureau of Economic Research, and the Index of Consumer Sentiment of the U n i v e r s i t y of Michigan were formed i n t o a d i f f u s i o n index , which v/as tes ted f o r the purpose -of a s s i g n i n g a weight to i t s performance. A group of e ight c u r r e n t l y used t e c h n i c a l i n d i c a t o r s were then i n d i v i d u a l l y tes ted f o r t h e i r e f f e c t i v e n e s s i n a market f o r e c a s t . Of these, s i x were found s u i t a b l e , and were then incorporated i n t o a composite index . The composite index was then tes ted f o r the purpose o f a s s i g n i n g a weight to i t s performance. On the bas is of t h e i r weight ing , the d i f f u s i o n index and the composite index were then incorporated i n t o the model. By means of t e s t s , s u i t a b l e c r i t e r i a were A l f r e d S. Rousseau developed f o r the performance of the model. The model was then used to t e s t the nulj. hypothesis" that was formed f o r t h i s a p p r a i s a l . The r e s u l t s i n d i c a t e d that there was a s i g n i f i c a n t d i f f e r e n c e between a buy and hold investment d e c i s i o n , and one that was timed to the i n d i c a t i o n s of the chosen economic and t e c h n i c a l i n d i c a t o r s . i i i TABLE OF CONTESTS PAGE ACKHOYJLEDGBivlENTS i i LIST OP TABLES v i LIST OF CHARTS v i i i LIST OF APPENDICES i x CHAPTER I INTRODUCTION , 1 Future Importance of Timing . 3 Approaches to the Timing Issue 6 Purposes and Hypothesis 7 I I THEORY OF BUSINESS CYCLE INDICATORS 11 The Business Cycle 11 Business Cycle Forecasting . . . . 14 What Indicators Are Used 15 HOY; Are They Used 22 Merits and L i m i t a t i o n s of the Use of Indicators 24 Consumer Sentiment 27 Monetary Indicators . . . . 29 I I I A DIFFUSION INDEX 34 D e s c r i p t i o n 34 Methodology 35 Method of Analysis . . . . . 39 A Currency Problem • . . 40 C r i t e r i a f o r Buy and S e l l Indicators 40 Testing f o r Indicator Levels 41 i v CHAPTER ' PAfiE I I I 'cont) Testing the D i f f u s i o n Index 45 I n t e r p r e t a t i o n of Results 51 Summary of C r i t e r i a f o r the D i f f u s i o n Index 55 17 TECHNICAL INDICATORS 64 Theory of the Technical Study and P o s i t i o n of the Market . 64 Dow Theory 68 What Are Technical I n d i c a t o r s and What Are Used 71 Logic of Use and Method of A p p l i c a t i o n of the I n d i v i d u a l Indicators 72 Advance-Decline I n d i c a t o r 73 New Highs and New Lows 77 Credit Balances i n Brokerage Accounts . . • - 79 Quality of Market Leadership 81 Volume of Trading 82 Odd Lot Purchases and. Sales 85 V COMPOSITE INDEX 89 D e s c r i p t i o n 89 Methodology 91 Test I: The Advance-Decline Line 94 Test I I : The New Highs and New Lows Index 102 •Test I I I : Credit Balances i n Brokerage Accounts 106 Test IV: Quality of Market Leadership 114 Test V: Volume of Trading 133 Test VI: Odd Lot Sales to'Odd Lot Purchases 142 Test V I I : Net Purchases and Net Sales on Odd Lots 150 V CHAPTER P A C £ V ( c o n t ) T e s t V I I I : The Odd L o t S h o r t S a l e s Index 158 F o r m a t i o n o f the Composite Index - 166 T e s t i n g the Composite Index 166 V I TESTING THE HYPOTHESIS AND THE CONCLUSION 177 D e s c r i p t i o n o f the Model C o n s t r u c t i o n 178 T e s t i n g the Model Index 179 T e s t i n g the H y p o t h e s i s 188 C o n c l u s i o n 189 BIBLIOGRAPHY . 190 v i LIST OP TABLES TABLE ' ' PAGE I I I n d i c a t o r Q u a l i t i e s 19 I I I Timing at peaks 19 IV Timing at troughs . . 1 9 V In d i c a t o r S e l e c t i o n 21 VI In d i c a t o r #1 - Average Hours Worked/week Ind i c a t o r #30 - Non. A g r i c . Placements 57 V I I I n d i c a t o r #6 - New Orders f o r Durables B i l l i o n $ Indi c a t o r #"29 - Housing Permits 1957/1959 = 100 58 V I I I Indicator #23 - I n d u s t r i a l M a t e r i a l P r i c e s 1957/59 .= 100 . . . 59 I n d i c a t o r #17 - P r i c e / u n i t Lab. Output Index 1957/59 .= 100 IX I n d i c a t o r #14 - Business F a i l u r e s & L i a b i l i t i e s (inverted) I n d i c a t o r - Index of Consumer Sentiment - By Smoothing the Curve of Quarter Data 60 X Indi c a t o r #85 - Change i n Money Supply Ind i c a t o r #112 - Change i n Bus. Loans B i l l i o n $ 61 XI Five Question Index of Consumer Sentiment . 62 X I I Standard and Poor 500 Index 1941-3 = 100 . 63 X I I I I n d u s t r i a l Bond Y i e l d 92 XIV Standard and Poor Quarterly Dividend Y i e l d s 95 XV Cumulative Advances and Declines 101 XVI Cumulative New Highs and New Lows 105 XVII Credit Balances i n Brokers Accounts . . . . . 113 XVIII Average Monthly P r i c e of the Ten Most A c t i v e Stocks on the New York Stock Exchange (Five month moving average) . . . . 122 XIX Average Monthly P r i c e of the Ten Most A c t i v e Stocks on the New York Stock Exchange . . . 123 XX Ratio of the Volume of the Ten Most A c t i v e Stocks to the Da i l y Volume of Shares Traded on the New York Stock Exchange (5 month moving average) . . . 131 v i i TABLE . PAGE XXI Ratio of the Volume of the 'Ten Most A c t i v e Stocks to the D a i l y Volume of Shares Traded on the Kev; York Stock Exchange (monthly averages) 132 XXII Average D a i l y Volume on the 11 err York Stock Exchange (5 month moving average) 140 XXIII Average D a i l y Volume on the Hew York Stock Exchange ±*1 XXIV Odd Lot Sales to Purchase Ratio 149 XXV Odd Lot Net Purchases and Net Sales 157 XXVI Odd Lot Shorts to Volume Ratio I65 v i i i LIST OF CHARTS C H A R T P A G I I Index of Consumer Sentiment 38 I I & I I I D i f f u s i o n Indexes 42 43 IV & V The Advance-Decline Line 99 100 VI & V I I Cumulative New Highs and New Lows 103 104 V I I I & IX Stock P r i c e s and Cr e d i t Balances i n Brokerage Accounts . I l l 112 X & XI Average Monthly P r i c e of the Ten Most A c t i v e Stocks . . 120 121 X I I & X I I I Ratio of the Ten Most A c t i v e Stocks to the Volume 129 of the Market 130 XIV & XV Stock P r i c e s and Volume of Trading . . 138 139 XVI & XVII Odd Let Sales to Odd Lot Purchases 147 148 XVIII & XIX Odd Lot Net Purchases and Net Sales 155 156 XX & XXI The Odd Lot - Short Sales Index I63 164 XXII & XXIII A Composite Index of Technical Indicators 172 173 XXIV & XXV The Model Index 184 185 Ix LIST OF APPENDICES APPENDIX PAGE I Diffusion Index Data - Moving- Average and Diffusion -Index Monthly 54 I I Weighting the Indicators 174 I I I A Composite Index 175 176 IV The Model Index •' 186 187 I would l i k e to express my app r e c i a t i o n f o r assistance i n t h i s study to the Chairmen of my t h e s i s committee, Br. Vf. Y'iniata and Dr. L . Wong, and also to Dr. H. Purdy who a s s i s t e d them i n t h e i r e f f o r t s . Dr. Wong's patience and guidance, i n my search for, and i s o l a t i o n of, the top i c f o r t h i s study, were of s i g n i f i c a n t a s sistance. P a r t i c u l a r g r a t i t u d e i s expressed to Dr. W. Winiata who spent many hours of h i s valuable time i n co u n s e l l i n g and guiding. His enthusiasm and i n t e r e s t i n t h i s study were so contagious that the e f f o r t expended by the w r i t e r was a very pleasant experience. Dr. Purdy's knowledge of t h e s i s s t r u c t u r e and wealth of experience i n research reports were of p a r t i c u l a r assistance and are g r a t e f u l l y acknowledged. My appreciation i s also expressed to the Fac u l t y of the Department of Business A d m i n i s t r a t i o n and the U n i v e r s i t y of B r i t i s h Columbia i n making my academic t r a i n i n g p o s s i b l e . Last and not l e a s t , a bouquet to my wife and fa m i l y , whose patience and understanding made the past few years a rewarding experience. CHAPTER I INTRODUCTION This study investigates methods currently used to predict the turning point of prices in the stock market. It i s an attempt to test the validity of a contention-made by some stock market analysts that, i t is not possible to make predictions about turning points of prices in the stock market averages with a better than chance probability of being accurate. (1) In a subsequent effort to test this statement, the writer has made two assumptions: that chance probability refers to a .50 probability; and that accurate refers to an improvement in the investment performance by the use of timing over a buy and hold policy, which completely negates timing. Cohen and Zinbarg identify a classification of investment decisions under two main headings: selection and timing.(2) Selection deals with the question: Yfliat do we buy? Timing deals with the question: When do we buy? They recognize the importance of selecting the right stock or bond on a value basis, but stress that possibly not enough importance is placed on the timing function. However, the value analyst expresses his doubt- about the Importance and feasibility of the timing approach for the following reasons: 1. It is not possible to make predictions about turning points of prices with a better than chance probability of being accurate. (1) Cohen, J.B. and Zinbarg, E.D. Investment Analysis and Portfolio Management, p. 455• ( 2) lbid., p. 455. 2 2. Inves tors confront a market o f s t o c k s , r a t h e r than a stock market . 3. Recent swings i n the market htve amounted to only 10 to 20 per cent and have there fore not been great enough to warrant the e f f o r t . These arguments are to be found i n Cohen and Z i n b a r g ' s book, Investment A n a l y s i s and P o r t f o l i o Management. • I t i s a p o s i t i o n , however, w i t h which the authors d i s a g r e e . As p r e v i o u s l y s t a t e d , t h i s study chal lenges the f i r s t reason. The v a l i d i t y o f the second and t h i r d statements i s tes ted by the evidence i n F i g u r e 1. Industry Group Price Changes during Bull and Bear Markets Bear Market Datel Peak Month 6/48 1/53 7/56 7/59 12/6/ Trough Month 6/49 9/53 12/57 10/60 6/62 % Change S & P 500 - 1 7 - 1 1 - 1 7 - 1 0 - 2 3 % Change S & P 425 - 1 8 - 1 2 - 1 7 - 1 1 - 2 3 No. of groups with price changes ofi + 10.1% and over 2 1 8 18 0 + .1 to +10.0% 4 6 9 13 0 0 to -10.0 20 37 13 12 8 -10.1 to -20.0 18 29 24 12 23 — 20.1 and over 39 10 31 33 57 i j Bull Market Dotel I Trough Month 6/49 9/53 12/57 10/60 6/62 t i foak Month 1/53 7/56 7/59 I2/6J 1/66 | % Change S & P 500 + 87 + 110 + 48 + 34 + 68 i % Change S & P 425 +93 + 125 + 48 + 33 + 70 No. of groups with price changes ofi + 100.1% ond over 21 29 11 4 24 + 50.1 to +100.0% 26 20 38 21 29 + 25.1 to + 50.0 20 21 29 32 19 0 fo + 25.0 14 12 8 V 12 - .1 to - 10.0 2 1 1 4 0 - 10.1 to - 20.0 0 . 1 0 0 1 — 20.0 and over 0 0 0 0 2 Source: Investment A n a l y s i s and P o r t f o l i o Management, Cohen and Zinbarg It is recognized by Cohen and Zinbarg, that while'there appears to be a degree of selectivity of stocks in the market, there is also an. overall rone that is related to the upward and downward swings of the averages. Y/hen the averages f a l l , stocks in most industries f a l l also, and likewise when averages rise, the majority of groups rise also. The third statement might be questioned in view of the severity of the downswings and upswings of some stock groups as related to the averages. Of the 88 stocks in Figure 1, during bear markets, the stocks f e l l by more than 10 per cent on 289 out of 440 occasions or 65.7 per cent of the time, and during bull markets the stocks rose by more than 25 per cent on 355 out of 440 occasions, or 80.7 per cent of the time. One would conclude that these swings are of sufficient magnitude to contradict the argument that swings in the market averages have not been great enough to warrant making efforts to identify them. FUTURE IMPORTANCE OF TIMING The rate of return from buying and holding stocks, has, in recent years (1957-1967)> been from 8 - 9 P e r cent as compared to 12 - 15 per cent in much of the post?/ar period (1945-1957)• Tbe higher return in the postwar period as a whole was due to the growth of stock prices in the early 50's. These have been the result of growth in earnings and dividends, and higher prices that the public has been prepared to pay for each dollar of earnings. The latter point is exemplified by the present P/E ratios of 15 to 20 as compared to 10'to 15 in the early 1950's.(3) (-^ Cohen and Zinbarg, op.cit. p. 458 Continued growth of earnings and dividends can be expected, but can one expect a, continued growth i n P / E r a t i o s ? Cohen and Zinbarg think that the growth i n P / E r a t i o s w i l l slacken and P / E norms of 15 to 20 w i l l be acceptable. As the prognosis f o r stock investments on a buy and hold basis i s f o r a lower r a t e of r e t u r n , than that of the 50's, a method to increase the rate or maintain i t should be welcomed. One method would be to time buying and s e l l i n g decisions at low and high p o i n t s , r e s p e c t i v e l y , by a n t i c i p a t i n g the turning points i n market p r i c e s . I f decisions can be made at turning p o i n t s , the f o l l o w i n g simple i l l u s t r a t i o n i n d i c a t e s the su b s t a n t i a l b e n e f i t s to be forthcoming. The data from Figure 1 are used, and the time period studied i s from October 10th, i960 to January 1st, 1966. A $1,000 stock purchase of the S . & P . averages i s made i n each (4) case. Case I : Buy and hold - $1,000 of the averages bought at the trough of October/1960 and held to the peak of January I966 and then s o l d . Case I I : $1,000 of S . & P . averages bought at the trough of October/ i960—sold at the peak December 3'lst, I96I—bought again at the trough of June 30th, 1962 and sold at the peak January Jlst, I 9 6 6 . v 'A' comparison of return on p r i c e appreciation only i s made; dividends are excluded. The loss of dividends i n Case I I f o r the period from December 31st, I 9 6 I to June 30th, I962, would have been o f f s e t , to some extent, by i n t e r e s t earnings from short term instruments. Trough Peak Trough Peak 10/60 12/61 6/62 1/66 s. & Poor 500 fo change + y4 - 23^ + 68fo Case I P r i c e $1,000 $1,340 $1,032 S I , 7 3 4 Case I I P r i c e 11,000 S I , 3 4 0 $1,648 $2,769 Time T o t a l 62 months A p p r e c i a t i o n Case I Case I I 5 year r e t u r n on investment $734 $1,769 Average Annual Rate of Return x i x 100 = 10.7/0 1884 X "5 X 1 0 0 = 1 8 ' ^ The r e t u r n i n Case I I .was 241 per cent that of Case I where no buy and s e l l d e c i s i o n s 'were made. I t can be seen, t h a t , i f on the average the buy and s e l l d e c i s i o n s were c o r r e c t 50 per cent of the t ime, the e f f o r t to time d e c i s i o n s would be j u s t i f i e d provided the costs of making the t iming d e c i s i o n s d i d not exceed the p r o f i t s they generated. Other costs to be considered would be the oppor tuni ty cost of the c a p i t a l when i t i s not i n v e s t e d , and a lso the costs of brokerage i n buying and s e l l i n g . In our a n a l y s i s , oppor tuni ty costs w i l l be considered by r e c o g n i z i n g earnings on the funds when they are not i n v e s t e d i n the market, as they would be capable of earning short term i n t e r e s t . A l s o , the dividends that are earned by the investments v/hen they are i n the market w i l l be considered i n the c a l c u l a t i o n s of the r e t u r n , but f o r s i m p l i c i t y sake, i t w i l l be assumed that they are not r e i n v e s t e d , but taken as income. Brokerage costs w i l l a l so be cons idered, by making an allowance of lfo f o r e i t h e r a buy or s e l l i s made i n a l l the investment t r a n s a c t i o n s . The Commission was deemed adequate, as i t approximated the round l o t commission f o r a #100 stock purchase or sa le on the New York Stock Commission. 6 APPROACHES TO THE TIMING ISSUE Edwards and Magee (5) i n t h e i r study of market i n d i c a t o r s have c l a s s i f i e d the schools of market study i n t o three methods of a r r i v i n g at the problem of what? and when? These methods are: 1. Fundamental 2. Technical J . C y c l i c a l The d e s c r i p t i o n of the fundamentalist's method i s the f a m i l i a r , "He evaluates h i s stock as to i n t r i n s i c value; i f i t was s e l l i n g below i t s a p p r a i s a l , he regarded i t as a buy. -.(6) No f u r t h e r d e c i s i o n regarding timing i s contemplated. The t e c h n i c a l and c y c l i c a l approach are regarded by Edwards and Magee as methods of timing the movements of the averages to forecast the turning points of p r i c e s . They defined the t e c h n i c a l approach as the study of the a c t i o n of the market i t s e l f as opposed to the study of the goods i n which the market deals. Cohen and Zinbarg express e s s e n t i a l l y the same idea by saying that the business cycle approach deals with f a c t o r s outside the market i t s e l f , •such as i n d u s t r i a l production and i n t e r e s t r a t e s ; whereas the t e c h n i c a l approach i s concerned only with market phenomena such as p r i c e s and volume of trading.^^^ The approach of the t e c h n i c a l analyst i s to search f o r r e c u r r i n g patterns of p r i c e movements and other market data, and attempt to e s t a b l i s h c r i t e r i a f o r judging future p r i c e movements. The underlying 5th Ed., p. 3 (6) ( 5 ) , W / E d w a r d s , R.D. and Magee, J . 'Technical Analysis of Stock Trends, I b i d . , p. 3. (7) v 'Cohen and Zinbarg, o p . c i t . p. 503. 7 r e l a t i o n s h i p s are not explained and the strength of the a n a l y s i s i s supported only "by the r e c u r r i n g interrelationships.^®^ Sorae of the t y p i c a l measures used are: Short S e l l i n g , Volume of Trading, Odd Lot Indexes, Breadth of Market. I t might be argued that the c y c l i c a l approach i s s i m i l a r In that past patterns are used to make statements about the future without strong explanations, about the fundamental economic processes that are at work. The i n d i c a t o r s , however, are quite d i f f e r e n t from those l i s t e d above, and one must concede that they seemingly do possess some economic r a t i o n a l e . The i n d i c a t o r s which include Average Hours Worked, New Orders f o r Durables, Index of Consumer Sentiment, Change i n Money Supply, are divi d e d i n t o three groups; leading, coincident and lagging. The main r e l a t i o n s h i p with v/hich we are concerned, i n the business cycle approach, i s that of the leading i n d i c a t o r s to the stock market averages, v/hich are themselves a leading i n d i c a t o r to the business c y c l e . PURPOSE AND HYPOTHESIS As stated e a r l i e r , t h i s study i n v e s t i g a t e s methods c u r r e n t l y used to pre d i c t the turning point of p r i c e s i n the stock market. The two methods that are being c u r r e n t l y used are the Business Cycle Approach, and the Technical Approach. To e s t a b l i s h an objective to t h i s study, a n u l l hypothesis has been formed, and w i l l be tested. The n u l l hypothesis i s , " I t i s not possible to make pr e d i c t i o n s about turning points of p r i c e s i n the stock market averages I b i d . , p. 503. 8 with a b e t t e r than . 50 p r o b a b i l i t y that would improve investment performance over what you would have achieved by a buy and hold d e c i s i o n of the averages." The method of t e s t i n g the hypothesis w i l l be as f o l l o w s ; A model to for e c a s t the t u r n i n g points of p r i c e s i n the stock market averages w i l l be formed. This model con s i s t s of the following} 1. A d i f f u s i o n index of Business Cycle Indicators with c r i t e r i a f o r p r e d i c t i o n . 2. A composite index of Technical Indicators with c r i t e r i a f o r p r e d i c t i o n . J . C r i t e r i a combining the judgement c r i t e r i a of the d i f f u s i o n and composite indexes to e s t a b l i s h whether the n u l l hypothesis should be accepted or r e j e c t e d . I f we accept the n u l l hypothesis we substantiate the observation of the value analysts. (9) I f ve r e j e c t the n u l l hypothesis, we uphold our b e l i e f that the t u r n i n g points of p r i c e s i n the stock market averages can be p r e d i c t e d w i t h a b e t t e r than chance p r o b a b i l i t y of being accurate, and state that the Business Cycle and the Technical methods of approach are e f f e c t i v e beyond, the p r o b a b i l i t y of chance, i n t h e i r p r e d i c t i o n . Components of the Model: 1. The d i f f u s i o n index i s e s s e n t i a l l y a summarizing device of the consensus of opinion given by the i n d i v i d u a l business cycle and o t h e r • i n d i c a t o r s i n i t s s t r u c t u r e . The nature of i t s a c t i o n i s to provide a forecast of the movement of stock indexes by v i r t u e of w y T h a t i t i s not possible to p r e d i c t the turning points of stock market p r i c e s . 9 i t s l e a d on the stock indexes and the business c y c l e . Judgement c r i t e r i a are e s t a b l i s h e d to make buy and s e l l d e c i s i o n s on a h y p o t h e t i c a l investment i n the stock p r i c e averages. The performance of vhe forecas t dec i s ions f o r investment t iming i s judged by the c a p i t a l a p p r e c i a t i o n of the investment i n the stock averages. 2. The composite index i s a device s l i g h t l y d i s s i m i l a r to the d i f f u s i o n index . One d i f f e r e n c e being that i t s components are t e c h n i c a l i n d i c a t o r s r a t h e r than business c y c l e , another i s t h a t , f o r c o n s t r u c t i n g the index , a system of weights i s used to vary the i n f l u e n c e of the i n d i v i d u a l components. The system of weight ing i s based on the performance of the buy and s e l l d e c i s i o n s of the i n d i v i d u a l i n d i c a t o r s as r e l a t e d to a d e c i s i o n of p e r f e c t t i m i n g on a buy and s e l l d e c i s i o n of the stock averages. C r i t e r i a are a l so developed f o r i n v e s t i n g and d i s i n v e s t i n g , on the b a s i s of four market breaks i n the ten year time span from 1956 to 1966. 5. The n u l l hypothesis v / i l l be e i t h e r accepted or r e j e c t e d by the use of judgement c r i t e r i a developed f o r the d e c i s i o n making process of the two indexes and t h e i r i n d i v i d u a l c r i t e r i a . The judgement c r i t e r i a c o n s i s t s of a system of weight ing the dec i s ions of the two indexes on the bas i s of t h e i r past performances r e l a t i n g to investment dec i s ions of buying the averages under per fec t t i m i n g . Separate c r i t e r i a f o r weight ing the indexes are s i m i l a r l y formed f o r s e l l i n g d e c i s i o n s of an investment i n the stock averages. F i n a l l y , judgement c r i t e r i a s ta tes that i f the investment performance of the model does not exceed that of a buy and ho ld d e c i s i o n of the stock market averages we accept the n u l l hypothesis and s ta te that i t i s not p o s s i b l e to make p r e d i c t i o n s about t u r n i n g po in ts of p r i c e s i n the 10 stock market averages with a b e t t e r than .50 p r o b a b i l i t y tnat t h i s would improve investment performance over what you would hav^ achieved by a buy and hold d e c i s i o n of the averages; a l s o , i f the performance of the model does exceed that of a buy and hold p o s i t i o n , we r e j e c t the n u l l hypothesis and state the converse. CHAPTER I I THEORY OP BUSINESS CYCLE INDICATORS In t h i s chapter we w i l l d iscuss vhat the business cyc le i s and i t s use i n f o r e c a s t i n g . The i n d i c a t o r s that are used i n f o r e c a s t i n g , t h e i r nature of use , and t h e i r mer i t s and l i m i t a t i o n s , w i l l then he examined. Three other i n d i c a t o r s ; consumer sentiment, change i n money supply and change i n bank loans are used i n con junct ion wi th the business cyc le i n d i c a t o r s , and the theory and l o g i c of t h e i r use i s then eva luated . THE BUSINESS CYCLE In order that one may b e t t e r understand the techniques that are used f o r measuring economic f l u c t u a t i o n s and i d e n t i f y i n g major t u r n i n g p o i n t s of o v e r a l l economic a c t i v i t y , an explanat ion of the theory of the business c y c l e i s undertaken. J u l i u s S h i s k i n g ives a general explanat ion of the concept of a business c y c l e . ( " ^ "The business cyc le concept has been developed from the sequence of events d iscerned i n the h i s t o r i c a l study of movements of economic a c t i v i t y . Though there are many crosscurrents and v a r i a t i o n s i n the pace of business a c t i v i t y , per iods of business expansion appear to cumulate to peaks. As they cumulate, contrary forces tend to gain s t rength , b r i n g i n g about a r e v e r s a l i n business a c t i v i t y and the onset of a r e c e s s i o n . As a recess ion cont inues , forces making f o r expansion g r a d u a l l y emerge u n t i l ^ " ^ S h i s k i n , J u l i u s - "The Known and the Unknown", paper presented on Aug. 24) 1963> publ i shed i n Business Cycle Developments, Sept. I963. they become dominant and a recovery b e g i n s . " The mechanics of the movements i n the cyc le are expla ined by S h i s k i n i n t h i s d e s c r i p t i o n , but he does not attempt to develop a theory to e x p l a i n the movements of economic a c t i v i t y i n the c y c l e . Some w r i t e r s l ay primary s t r e s s oh the r o l e of investments i n inventory and f i x e d c a p i t a l ; others g ive the c e n t r a l r o l e to the supply of money and c r e d i t and the i n t e r e s t r a t e ; s t i l l others look f o r c lues i n the r e l a t i o n s among p r i c e s , costs and p r o f i t s . I t has been s a i d that many of these f a c t o r s i n f l u e n c e the course of business a c t i v i t y , and some are more important at times than o t h e r s , but there i s no general agreement as to which are more c r u c i a l to the process . A f a i r l y standard explanat ion of the business c y c l e r e s t s on i n t e r a c t i o n s of c a p i t a l investment and consumption. I t provides p o s s i b l e i n s i g h t s of the a c t i o n of economic processes In the cyc le and r a t i o n a l e f o r the use of c e r t a i n i n d i c a t o r s f o r p r e d i c t i v e purposes. Pro fessor A l v i n Hansen has i l l u s t r a t e d the i n t e r a c t i o n of c a p i t a l investment and consumption wi th a simple model, (3) We are g iven that K^I _= AY, where K i s - t h e investment m u l t i p l i e r , & I and A Y are r e s p e c t i v e l y a change i n investment and a change i n income a n d ^ i l + A C =^Y, where A. C i s a change i n consumption. The process i s s a i d to go something l i k e t h i s . An increase i n investment r a i s e s incomes i n the c a p i t a l goods i n d u s t r i e s and t h i s induces an increase of consumption expendi tures . Thus an increment of investment induces s e v e r a l , though d i m i n i s h i n g rounds of increments of consumption. F i n a l l y , a one shot increase i n investment w i l l l ead to an increase i n income equal to K / i l . But the induced r i s e i n income may i n turn lead to a f u r t h e r r i s e ( 2 ) I b i d . (3) w ' H a n s e n , A . H . Business Cycles and Na t iona l Income, p . l ? ! . i n investment—the m u l t i p l i e r e f f e c t — a n d so o n . However, an upward s h i f t i n the consumption f u n c t i o n can a lso r a i s e income by a magni f ied amount, p r e c i s e l y i n the same manner as i n the case o f an increase i n investment . I t may a lso be seen that a change i n the marg ina l propens i ty to consume can a l s o have an e f f e c t on the consumption f u n c t i o n . But these upswings have always reversed themselves, and P r o f e s s o r Hansen s t a t e s tv/o reasons why t h i s cumulative process comes to an end:(4) 1. The marginal p r o p e n s i t y to save c a l l s a h a l t to the expansion. 2. The autonomous volume of investment runs out by reason of the d e c l i n i n g marginal e f f i c i e n c y of investment . STOCK OF CAPITAL GOODS NET INVESTMENT DISINVESTMENT Figure 1 In F igure 2, we assume that a change i n the stock of c a p i t a l goods i s induced by a movement i n f i n a l demand. The a c t i o n of net investment i s at a peak when the ra te of growth of c a p i t a l goods i s g r e a t e s t , and i s at (4) I b i d . , p . 179, i t s peak of disinvestment when the rate of c o n t r a c t i o n of c a p i t a l goods i s greatest. The a c t i o n of c o n t r a c t i n g and expanding waves can thus he seen between such items as c a p i t a l goods, net investment and f i n a l demand. I f t h i s i s a r e l i a b l e statement of the underlying processes, and i f the t.'tock market moves with the business c y c l e , then f o r our purpose, we would want to have i n d i c a t o r s that would forecast the business c y c l e . BUSINESS .CYCLE FORECASTING The basic concept underlying the business cycle i n d i c a t o r s approach, i s that various economic processes tend to move through the course of the business cycle i n consistent but d i f f e r e n t time sequences. Measures of the v a r i a b l e s involved i n these economic processes are r e f e r r e d to as i n d i c a t o r s . I n d i c a t o r s are used as s i g n a l s or e a r l y warning, or confirmation of a change i n an economic process i n the c y c l e . The National Bureau of Economic Research (N.B.E.R.) i s the body that has conducted the major research on Business Cycle I n d i c a t o r s . I t has compiled a l i s t of i n d i c a t o r s of economic a c t i v i t y , and has c l a s s i f i e d these i n d i c a t o r s according to whether they u s u a l l y lead, roughly coincide, or l a g behind the c y c l i c a l movements of aggregate a c t i v i t y . Roughly Coincident These time s e r i e s r e l a t e p r i m a r i l y to the aggregate economic a c t i v i t y . These a c t i v i t i e s tend to coincide with, and i n a sense define, the business c y c l e . This group includes such measures as G.N.P., i n d u s t r i a l production, employment, income, bank debits, r e t a i l s a l e s , and wholesale p r i c e s . 15 Leading I n d i c a t o r s These s e r i e s u s u a l l y reach peaks or troughs before those i n aggregate economic a c t i v i t y . They are generally measures of a c t i v i t i e s v/hich r e f l e c t future production and employment. In a manner they are s i g n a l s of things to come. They include such s e r i e s as average work-week i n manufacturing, n o n - a g r i c u l t u r a l placements, Index of net business formation, New Orders f o r Durables, Contracts and orders f o r plant and equipment, I n d u s t r i a l materials p r i c e s , Stock P r i c e s and Corporate p r o f i t s a f t e r taxes. Lagging Indicators These s e r i e s such as new plant and equipment expenditures, and manufacturer's i n v e n t o r i e s u s u a l l y reach turning points a f t e r they are reached i n aggregate economic a c t i v i t y . WHAT INDICATORS ARE USED? In a recent paper published by the N.B.E.R. a I966 l i s t of i n d i c a t o r s was released along with a scoring plan to a s c e r t a i n the q u a l i t y of performance of an i n d i c a t o r . (5) The scoring plan stresses s i x factors that contribute to accepting a s t a t i s t i c a l s e r i e s as an i n d i c a t o r . 1. Economic s i g n i f i c a n c e 2 . S t a t i s t i c a l adequacy 3. Conformity to major swings i n business 4. Consistency of timing at turning points i n business w'Moore, G.H. - S h i s k i n , J . N.B.E.R. Occasional Paper 7V/-103 Dr. G.H. ivloore i s a d i r e c t o r of the National Bureau of Economic Research. He has c a r r i e d on the e a r l i e r work of V/.C. M i t c h e l l on business i n d i c a t o r s . Dr. Moore rev i s e d the N.B.E.R. 1938 l i s t of business i n d i c a t o r s , with the r e v i s i o n appearing i n 1950. His subsequent r e v i s i o n s were i n i960 and 1967• He has been r e c e n t l y recognized as one of the foremost a u t h o r i t i e s i n h i s f i e l d . 16 5. Smoothness 6. Currency An exp lanat ion of these f a c t o r s was made hy L . H . Lempert i n a recent a r t i c l e , ar.d i t i s summarized by the w r i t e r as f o l l o w s : ^ ) 1. Economic s i g n i f i c a n c e This i m p l i e s that the behaviour of a p a r t i c u l a r a c t i v i t y i s understood, and important i n the theory of business c y c l e s , or that the i n d i c a t o r ' s performance has a r a t i o n a l e x p l a n a t i o n . 2. S t a t i s t i c a l adequacy This i s concerned w i t h the adequacy of the economic process as a measure i n future business c y c l e s . Such cons iderat ions are mentioned: (a) The r e p o r t i n g system based on d i r e c t in format ion ra ther than estimates i s idea.l (b) The coverage o f a sample should be s t a t i s t i c a l l y adequate (c) The frequency and magnitude of r e v i s i o n s i n data should not be such as to a l t e r the v a l i d i t y of i t s use. J . Conformity The conformity of an i n d i c a t o r as regarded by the N . B . E . R . i s subject to the f o l l o w i n g c r i t e r i a : (a) During the i n t e r v e n i n g months between the peak and trough of a major business t u r n , an i n d i c a t o r may have v 'Lempert, L . H . "Do the l e a d i n g business i n d i c a t o r s lead?" The F i n a n c i a l Ana lys ts J o u r n a l Hov/Dec I967, p . 22. 17 experienced one or minor upturns of i t s .own. At the time, any one of the i n t e r i m upturns might have been considered the beginning of a major business upswing. This reduces the performance score of the i n d i c a t o r , (b) A s e r i e s which reveals a cycle c l e a r l y and d e c i s i v e l y Is more u s e f u l , other things being equal, than one whose - c y c l i c a l movements are mild and d i f f i c u l t to d i s t i n g u i s h from other types of f l u c t u a t i o n . 4. Timing A leader i s an i n d i c a t o r whose timing comparisons show that I t turns by an average lead of two months or more before the economy as a whole; a dagger turns by an average of two months or more a f t e r the o v e r a l l economy; a roughly coincident i n d i c a t o r coincides with the movement of the economy. The timing at peaks and troughs i s u s u a l l y a measure of y/hether the i n d i c a t o r i s more r e l i a b l e i n detecting downswings or upswings i n the c y c l e . An example i s the index of i n d u s t r i a l materials p r i c e s , which has an average lead of s i x months at the peak, and no average lead at a l l at troughs. I t therefore has a lead at peaks, and i s roughly coincident at troughs. I t s score would therefore not r a t e too high as a leading i n d i c a t o r , as i t leads only at the peaks. 5. Smoothness Indicators unfortunately do not move smoothly up or down during a business upswing or downswing. The challenge to i n t e r  p r e t a t i o n i s whether the movement i s merely e r r a t i c or whether i t i s s i g n i f i c a n t . The smoother the s e r i e s from month to month, the more weight one may g ive to a change i n d i r e c t i o n . 6. Currency I n d i c a t o r s w i th cons i s tent leads o f , say, three months, are not equa l ly va luab le i f in format ion f o r one i s a v a i l a b l e weeks or even months before the o ther . For t h i s reason, some i n d i c a t o r s are ra ted more h i g h l y , as they are more va luab le In a f o r e c a s t than o ther s . From the 1966 l i s t of choice i n d i c a t o r s , the N . B . E . R . has f u r t h e r der ived a short l i s t of 25 i n d i c a t o r s which they consider to have best met the var ious t e s t s to which they were sub jec ted . This short l i s t inc luded 12 l e a d i n g , 7 c o i n c i d e n t , and 6 l agg ing i n d i c a t o r s . In the N . B . E . R . occas iona l paper a c l a s s i f i c a t i o n was made of these i n d i c a t o r s by the s c o r i n g p l a n , and a l so by a mea.sure of t h e i r t i m i n g at peaks and troughs.(7) This i s i n d i c a t e d i n Tables I I , I I I & IV which are der ived from data i n the N . B . E . R . paper. In t h i s a p p r a i s a l , the t u r n i n g po in t of the stock market indexes , i s the dependent v a r i a b l e that was to have been f o r e c a s t . The business cyc le approach i n t h i s case , i s to u t i l i z e the l e a d i n g economic i n d i c a t o r s to s i g n a l a l ead on the stock indexes . The stock indexes themselves are a l ead i n d i c a t o r , so l ead i n d i c a t o r s to a l ead ing i n d i c a t o r are r e q u i r e d . The model used i n the f o r e c a s t would therefore u t i l i z e lead i n d i c a t o r s to the stock indexes as Independent v a r i a b l e s . Moore, G . H . - S h i s k i n , J . , o p . c i t . 19 TABLE I I TABLE I I I Indicator Econ. Sionif . Stat . Adequ. Conform ity Timing Smooth ness Cur rency Final Score Employment & Un employment Avg. workweek in mfg. Nonagri. placements 50 75 65 63 81 63 66 58 60 80 80 80 66 - 68 Fixed Capital investment Net business formation New orders, dur. goods Contracts & orders 75 75 58 72 81 88 67 84 80 60 40 80 68 73 plant & equipment Housing permits 75 50 63 60 92 76 50 80 40 60 40 80 64 67 Inventories & inv. Invest. Mfg. & trade inv. change 75 67 77 78 20 40 65 Prices, Costs & Profits Indust. materials prices Common-stock prices Corporate profits, net Price/unit labor cost 50 75 75 50 72 74 70 67 79 77 79 84 44 87 76 72 80 80 60 60 100 100 25 80 6 7 " 81 68 69 Money & Credit Consumer debt change 50 79 77 60 60 40 63 TABLE IV Timing at Peaks leading Indicator Peaks Covered Leads Rouoh Coin.* Peaks Laas Skipped Extra Median Peaks Lead Timing at Troughs Employment & Un employment Avg. workweek in mfg. 9 Nonagri. placements 5 Fixed Capital Investment Net business formation 5 New orders, dur. goods 10 Contracts £. orders plant & equipment 4 Housing permits 11 Inventories & Inv. Invest. Mfg. & trade inv. change 5 Prices, Costs & Profits Indust. materials prices 10 Common-stock prices 22 Corporate profits, net 10 Price/unit labor cost 10 Money & Credit Leadinn Indicator Employment & Un employment Irounns Covered Consumer debt change 7 Totals 108 7 1(0) 1 1 1 6 - 4 0(0) 0 1 2 11 4 0(0) 0 1 0 20 8 1(0) 0 2 1 8 4 0(0) 0 0 0 8 - 8 1(0) 1 2 4 13 5 0(0) 0 0 2 14 8 3(0) 1 1 2 6 17 9(1) 2 2 4 4 7 4(2) 0 1 2 6 9 4(0) 1 0 1 11 6 1(0) 0 1 2 12 87 24(3) 6 12 21 l O t Avg. workv/eek in mfg. 10 Nonagri. placements 5 Fixed Capital Investment Net business formation New orders, dur. goods Contracts & oulers, plant & equipment Housing permits Inventories & Inv. Invest. 5 10 4 11 Mfg. & trade inv. change Prices, Costs & Profits Routju Com.* 3(2) 4(0) 2(1) 6(1) 2(0) 4(1) 2(1) Laus Trouiihs Extra Median Skipped Troughs Lead Indust. materials prices 11 5 6(4) 1 1 2 0 Common-stock prices 22 16 5(1) 3 2 4 4 - Corporate profits, net 10 6 7(2) 2 0 2 2 Price/unit labor cost 11 8 6(1) 2 0 1 3 Money & Credit Consumer debt change 7 5 3(0) 1 1 2 4 Totals 111 78 50(14) 12 7 21 3t •The number of exact coincidences arc shown in parentheses. The other number represents rough coincidences, which means a lead or lag of 3 months or less. For example, a lead of 1 month at a turn is counted as both a lead and as a rough coincidence. T = mean. Source; F i n a n c i a l Analysts' Journal Nov/Dec 19^7, page 19 20 On the bas i s of data from tab les I I , I I I and I Y , bas ic c r i t e r i a e s t a b l i s h e d by the N . B . E . R . , and other c r i t e r i a se lec ted by the w r i t e r , a s e l e c t i o n of business c y c l e i n d i c a t o r s to be used i n t h i s a p p r a i s a l was made. The c r i t e r i a f o r the choice of business cyc le i n d i c a t o r s i s i n d i c a t e d as f o l l o w s : 1. The data should be r e a d i l y a v a i l a b l e . They should be i n the s c o r i n g range of between 80 to 100 po in ts . (®) 2 . The t iming at peaks and troughs had to l ead the stock index . (This c r i t e r i o n was e s t a b l i s h e d by the w r i t e r f o r t h i s appra i sa l . ) (9) J . An expla inab le economic r e l a t i o n s h i p should e x i s t between the i n d i c a t o r s and the business c y c l e . 4- The s c o r i n g of the i n d i c a t o r s f o r smoothness and t iming should be reasonably h i g h . (8) 5. The i n d i c a t o r should conform to pat terns that i d e n t i f y major changes i n the c y c l e . The s e r i e s should a lso r e v e a l the cyc le c l e a r l y and d e c i s i v e l y , such that i n d i c a t i o n s may be r e f e r r e d from i t s movement. The i n d i c a t o r s are #1, 30> 6, 29, 23, 17« Another i n d i c a t o r #14, Business F a i l u r e s from the i960 l i s t of the N . B . E . R . l e a d i n g i n d i c a t o r s was a lso chosen. The past performance of l e a d s , that exempl i f i ed a 3 month lead on the stock indexes at peaks and troughs, as w e l l as conformity to the other c r i t e r i a , were the bas i s f o r i t s s e l e c t i o n . v ' S c o r i n g system developed by G . H . Moore i n N . B . E . R . Occasional Paper #103. The highest score , being 100 p o i n t s , i s assigned to data that Is i d e a l f o r the c h a r a c t e r i s t i c being t e s t e d . (9)'i'he i n d i c a t o r should lead the stock market Indexes i f i t i s to have forecas t v a l u e . 21 Three other i n d i c a t o r s ; Change i n Honey Supply, Change i n Bank Loans, and the Index of Consumer Sentiment, were also added to more adequately cover the processes that are r e l a t e d to the forecast i n t h i s model. The economic r a t i o n a l e of these In d i c a t o r s are Money and C r e d i t , and Consumption. The l o g i c of use of these three i n d i c a t o r s i n the for e c a s t , and t h e i r r e l a t i o n s h i p to the processes associated with the stock market are reviewed i n the l a t t e r part of t h i s Chapter. The i n d i c a t o r s that have been selected are arranged, i n table V, on the basis of t h e i r economic r a t i o n a l e . TABLE V Economic Rationale N.B.E.R. # Indi c a t o r Employment and Unemployment Fixed C a p i t a l Investment P r i c e s , Costs and P r o f i t s Money and Cred i t 1 30 6 29 23 Lead (-) Lag (+) i n months Period of Moving Peaks Troughs Average Average hours worked per week i n mfg. Non A g r i c u l t u r a l placements New Orders f o r Durables Housing Permits I n d u s t r i a l M a t e r i a l s U. - 7 l l - 8 13 4 1 2 5 P r i c e s 3 - 6 0 17 P r i c e / U n i t Labour Cost 4 - 11 - 3 14 Business F a i l u r e s 6 - 7 - 7 85 Change i n Money Supply 6 - 20 - 10 112 Change i n Bank Loans 5 - 22 0 of Mich. Index of Consumer Sentiment - 9 - 3 Mean of Lead & Lags (Medians) as r e l a t e d to Business Cycle - 12 - 3. Stock Index Median Lead & Lag - 4 - 4 22 As seen i n Table V , the stock index has a median l ead and l a g on the business c y c l e of 4 .months at peaks and troughs. The average leads and average l e g s of a l l the i n d i c a t o r s have a l ead on the c y c l e of 12 months at peaks and 3,6 months at t roughs. There i s thus an average lead advantage of 8 months at peaks, and an average l a g disadvantage of 4 months at troughs f o r the i n d i c a t o r s as a group. One might assume that t h i s c r i t e r i o n of leads and lags should be the only important bas i s f o r s e l e c t i o n , but the w r i t e r chose to s a t i s f y the general c r i t e r i a as evenly as p o s s i b l e by making s a c r i f i c e s on c e r t a i n i s s u e s . On t h i s b a s i s , the average performance of the group at troughs i s almost co inc ident w i t h the stock indexes . Thus a weakness of a fo recas t w i t h t h i s group of i n d i c a t o r s can be detected at the trough of the stock index . HOW ARE THEY USED Having chosen ten i n d i c a t o r s to l ead the stock index , the problem a r i s e s ; HOT/ to u t i l i z e them i n the forecas t? The c o n d i t i o n of v a r i a b i l i t y amongst indexes has created d i f f i c u l t y i n i n t e r p r e t i n g t h e i r s i g n i f i c a n c e . G .H . Moore i n e a r l i e r s tudies u t i l i z e d a summarizing device to consider broad groups ra ther than the i n d i v i d u a l index . (10) His thoughts were based on the observat ion that the i n d i v i d u a l i s more v a r i a b l e than the group. This device i s r e f e r r e d to as a d i f f u s i o n index . I t c o n s i s t s of a measure of the percentage of indexes that are expanding i n a group, and t h i s measure produces a consensus among the movements of a group. The percentage i s computed by r e l a t i n g how many ser i es rose t h i s month to the t o t a l ? The v 'Moore, G.H. "Ana lyz ing Business C y c l e s " , p . 15 The American S t a t i s t i c i a n , A p r i l - M a y 1954-c o n s t r u c t i o n of a d i f f u s i o n index w i t h the chosen i n d i c a t o r s i s shown i n Chapter I I I , hence, only a b r i e f o u t l i n e of the mechanics of the index i s made here . The nature o f d i f f u s i o n Indexes i s not smooth due to the e r r a t i c movements of the component s e r i e s . The more e r r a t i c the components, u s u a l l y the more e r r a t i c the combined s e r i e s . To smoothen out the e r r a t i c swings i n a d i f f u s i o n index , Moore recommended the use o f moving averages. He had experimented w i t h the var ious s e r i e s of l e a d i n g i n d i c a t o r s and found c e r t a i n per iods of moving averages more I d e a l f o r some s e r i e s than o t h e r s . ( n ) U t i l i z i n g moving averages, he smoothed the s e r i e s i n d i v i d u a l l y , then formed the r e s u l t i n g monthly data i n t o 'a d i f f u s i o n index of moving averages. A d i f f u s i o n index of the unadjusted data was a lso formed, and i t s movements v/ere p l o t t e d a longside that of the adjusted data . The unadjusted index he regarded as the u n d e r l y i n g t r e n d , and a bas i s f o r e x t r a p o l a t i n g the data of the moving average d i f f u s i o n index . (12) Moore e s t a b l i s h e d c e r t a i n c r i t e r i a f o r the p a r t i c u l a r index he constructed , and the w r i t e r used t h i s as a bas i s f o r the c r i t e r i a formed f o r the d i f f u s i o n index i n Chapter I I I . (13) The c r i t e r i a that v/as used by Moore, f o r an index of l e a d i n g i n d i c a t o r s i s summarized as f o l l o w s : 1. The average l e v e l of the l e a d i n g curve has been where 50 per cent of the i n d i c a t o r s are expanding. (14) ( " ^ I b i d . , p . 15. C ^ i b i d . (I4)]) r > Moore i n h i s experience wi th a p a r t i c u l a r d i f f u s i o n s e r i e s , found that the 5O70 l e v e l of the index was i n d i c a t i v e of a change. Moore, G.H. A n a l y z i n g Business Cycles - American S t a t i s t i c i a n Apr i l -May 1954-2. The l e a d i n g curve u s u a l l y reaches t h i s p o i n t a few months e a r l i e r than the peak or trough of the business c y c l e . 3. G?nuiness i s i n d i c a t e d by the depth or he ight of the curves . 4 . The percentage expanding curves are mechanical summaries o f economic a c t u a l i t i e s represented by the s e r i e s upon v/hich they are based. This i s one of the s t rong p o i n t s , but i t i s a l so a weakness. These curves are intended as a ids to and not s u b s t i t u t e s f o r c a r e f u l study and a n a l y s i s of the u n d e r l y i n g data . MERITS AND LIMITATIONS OP THE USE OP INDICATORS S h i s k i n i n an e a r l i e r paper f e l t that short term forecasts from 6 to 12 months v/ere p o s s i b l e w i t h business cyc le i n d i c a t o r s .(^5) The knowledge of past c y c l e s , w i t h due allowance f o r governmental f i s c a l and monetary p o l i c i e s and other r e l a t e d economic, p o l i t i c a l and i n t e r n a t i o n a l events, he thought v/ere s u f f i c i e n t to form a short term f o r e c a s t . An observat ion he a lso made was that a f t e r m i l d reces s i o n , the f i r s t year of expansion was a lso m i l d . Severe c o n t r a c t i o n s are l i k e l y to be fo l lowed by more vigorous upsurges. The h i s t o r i c a l p a t t e r n of a n a l y s i s fo l lowed by S h i s k i n might be summarized i n three stages:(-^) 1. Downturn The s i g n a l s f o r such are u s u a l l y detected by the l e a d i n g i n d i c a t o r s and d i f f u s i o n index of l e a d e r s . V e r i f i c a t i o n i s sought from a downturn of the c o i n c i d e n t i n d i c a t o r s or d i f f u s i o n index, which would occur about 4 to 6 months l a t e r . (IS) v y / S h i s k i n , J u l i u s - o p . c i t . p . 77- ( l 6 ) l b i d . 2. S e v e r i t y of Decline I f a f t e r 4 or 3 months of recession, the rate of decline i n the leading s e r i e s i s severe compared with the rate of decline In previous recessions, there i s reason to believe that the ultimate decline vri.ll be r e l a t i v e l y l arge, i n the absence of measures to combat recession. 3. Upturn This u s u a l l y i s s i g n a l l e d by an upturn i n the leading series and d i f f u s i o n indexes and i s confirmed by a downturn i n the lagging s e r i e s . The cycle i s now completed and a new one begins. L i m i t a t i o n s of the i n d i c a t o r s are recognized by S h i s k i n , and he stresses that a mechanical forecast with these i n d i c a t o r s should be avoided. (17) Some of the l i m i t a t i o n s are l i s t e d : 1. Some of the i n d i c a t o r s give s i g n a l s that lead to mi s i n t e r  p r e t a t i o n , and the reason should be r a t i o n a l i z e d f o r v a l i d i t y , e.g. When the expansion of a c t i v i t y i n defense i n d u s t r i e s o f f s e t declines i n others. 2. The v a r i a b i l i t y of leads among se r i e s during a cycle i s a source of d i f f i c u l t y . 3. There are periods of hesitancy i n the middle of stages of expansion which are d i f f i c u l t to i n t e r p r e t . This can produce double peaks i n the expansion. 4 . I n a b i l i t y to incorporate c e r t a i n p o l i t i c a l , i n t e r n a t i o n a l and f i n a n c i a l developments i n t o a s t a t i s t i c a l f o r e c a s t i n g system. 5. D i f f i c u l t y of applying moving averages to data at the c r u c i a l t urning points that should be forecast by the • l a t e s t f i g u r e s . Data f o r several months beyond i s required f o r a completely adjusted s t a t i s t i c and t h i s creates a weakness when the greatest accuracy i s required. S h i s k i n f u l l y recognized the merits and l i m i t a t i o n s of the business cycle approach when he stated^®) "For purposes of f o r e c a s t i n g future short term trends i t cannot be stressed too much that the business cycle i n d i c a t o r s must be used with other data, such as the n a t i o n a l income a c c o u n t s — f i n d i n g s from contemporary studies, industry, consumer and government trends." S h i s k i n has thus stressed the use of other data to increase the number of independent v a r i a b l e s used i n the forecast and to use data that has an underlying r e l a t i o n s h i p to the business c y c l e . For t h i s reason", the w r i t e r desired to incorporate consumer and monetary trends to provide a wider, economic coverage. I t can thus be seen i n Table V that our economic r a t i o n a l e covers measures of employment, f i x e d c a p i t a l investment, p r i c e s , costs and p r o f i t s , consumer trends and money and c r e d i t . An index of consumer sentiment was used as a measure of consumer trends, and two index s e r i e s , changes i n t o t a l U.S. money supply and the rate of change of business loans by banks In the Federal Reserve System were used f o r measuring monetary trends. ( " ^ I b i d . , p. 78. CONSUMER SMTIMENT Professor A l v i n Hansen fur t h e r strengthens the r a t i o n a l e f o r i n c l u s i o n of consumer influence i n a business cycle forecast when he a.rgues that consumer goods resemble producers equipment or c a p i t a l investment i n t h e i r i n f l u e n c e on the c y c l e . T h u s consumption, p a r t i c u l a r l y that of durables, might have p r e d i c t i v e q u a l i t i e s . To provide what one might c a l l a lead, on a leading i n d i c a t o r , the author used a measure of consumer sentiment as a leading i n d i c a t o r on consumption and p o s s i b l y other processes i n the c y c l e . The Index of Consumer Sentiment of the Survey Centre of the U n i v e r s i t y of Michigan was used to provide the leading s e r i e s . The author of the theory and uses of t h i s index i s Professor G. Katona of the Survey Centre, U n i v e r s i t y of Michigan. Professor Katona i n h i s studies, r e l a t e d the importance of consumer wants and the psychological motivation of these wants to the study of the business c y c l e . He recognized that an increase i n consumption was not only a function of a change i n income, but also a f u n c t i o n of increased optimism or confidence i n the economy. This he substantiated by means of n a t i o n a l consumer surveys. He c l a s s i f i e d a High degree of uncertainty and a lack of confidence i n the outlook of the economy as adverse, whereas, a high degree of optimism was favourable to personal consumption. He devised questionnaires to detect the degree of sentiment amongst consumers, and produced an Index of Consumer Sentiment. ("^Hansen, A.H. o p . c i t . p. 78. H i l l - 1964 K a t° n a' G* M a S S C o n s u , n P t i o n Society, p. 76 Publ. McGraw The performance and p r e d i c t i v e value of t h i s index was tested by a companion researcher, Eva Mueller.(21) A c o r r e l a t i o n v/as done betveen f l u c t u a t i o n i n consumer durables expenditures and. personal income taken from a period 6 months e a r l i e r . D = F l u c t u a t i o n s i n Expenses on Consumer Durables Y ^ = Disposable Personal Income D = 0.13 Y_± + 3.7 y*2 = .29 This shows that Disposable Personal Income of p r i o r periods accounts f o r only 29 per cent of the f l u c t u a t i o n . However, a second c o r r e l a t i o n was done using the Index of Consumer Sentiment as an a d d i t i o n a l independent v a r i a b l e . S = Index of period of Y_]_ D = 0.I8 Y_X + 0.405s - 48 = .76 This i n d i c a t e d that by combining the use of Consumer Sentiment 76 per cent of the f l u c t u a t i o n i n durable goods expenditures are explained. The past performance of the index as i n d i c a t e d by the Research Centre i s that i t leads expenditures on consumer durables by s i x to nine months. I t also has predicted the trough of the 1954, the 1958 and I96I recessions i n the economy with leads of'about 6 months.( 2 2^ The p r e d i c t i v e value i s decreased by extraneous events that occur a f t e r the measurements have been taken. Such events as the outbreak of war, or new l e g i s l a t i o n , or Government c o r r e c t i v e f i s c a l or monetary act i o n have been l i s t e d as d i s r u p t i n g occurrences. The importance of consumers a t t i t u d e s to the changing l e v e l of business a c t i v i t y i s f o r t i f i e d by Katona's study on consumers and the (21) 'Mueller, Eva "Ten Years of Consumer A t t i t u d e Surveys" Journal of the American S t a t i s t i c a l Assoc. 1963, p. (22). A . 'Katona, G. o p . c i t . p. 80. economy. The growth of d i s c r e t i o n a r y income s ince World War I I i s one of the measures he g ives to emphasize the growing importance of the consumer s e c t o r , f o r convenience, he has descr ibed d i s c r e t i o n a r y income as that p o r t i o n of Jncome that i s a v a i l a b l e f o r purchases beyond the u s u a l needs. To measure i t s growth, he formulated a representa t ive Income group as being one w i t h pretax earnings from 6,000 to 15,000, and the group head being i n the maximum earning age range from 55 to 54 y e a r s . The growth of t h i s group from 1951 to 1961 had almost doubled, whereas n a t i o n a l income had grown by 60 per cent . He concluded that we are faced w i t h a growing mass consumption s o c i e t y that i s capable of making purchases as sentiment d i c t a t e s , and i s thus an important i n f l u e n c e on the behaviour of the (23) economy.^ ^v The Index of Consumer Sentiment may therefore be summarized as a measure, of the o p t i m i s t i c or p e s s i m i s t i c views of personal f i n a n c i a l prospects and of the general business out look , which contr ibute to Y / i l l i n g - ness to embark on a d i s c r e t i o n a r y purchase.(^4) Having e s t a b l i s h e d the r e l a t i o n s h i p , of consumption to the processes of the business c y c l e , the l e a d q u a l i t i e s of the Index of Consumer Sentiment, and i t s p r e d i c t a b i l i t y of consumption, the w r i t e r incorporated the Index of Consumer Sentiment i n t o the d i f f u s i o n index . MONETARY INDICATORS In S h i s k i n 1 s explanat ion of the business c y c l e , he r e l a t e d the nature of the causat ive f a c t o r s to a v a r i e t y of theor ies expounded by economists. I b i d . , p . 13. I b i d . , p . 88. One o f the causat ive f a c t o r s he mentioned was "Money and C r e d i t . ' • (25) Money Supply: Hamil ton B o l t o n i n h i s recent p u b l i c a t i o n , made a concise statement which seemed to summarize the importance o f money and c r e d i t ; " I f money and c r e d i t are not the only causes of the business c y c l e , i t i s s t i l l c l e a r tnat movements i n business must be t r a n s m i t t e d through the medium of exchange, which i s money i n one form or other—money i s the l i n k between a l l economic a c t i v i t i e s . "(26) B o l t o n a s s o c i a t e d the r a t e o f change o f money supply to an e x p l a n a t i o n of movement w i t h i n the business c y c l e . At the peak o f r a t e o f expansion, the p o i n t o f i n f l e c t i o n i n money supply o c c u r r e d , and i t s q u a n t i t y l e v e l l e d o f f , as the r a t e of growth d i m i n i s h e d . B i l l i o n s $ F igure 5 -- Money Supply P o i n t of I n f l e c t i o n Rate o f Growth Time S h i s k i n , J u l i u s Business Cycle Developments, September I963 (26) B o l t o n , A . Hamil ton "Money and Investments", P u b l . I r w i n 1967 p . 57. ' An explanation of t h i s movement as r e l a t e d to the quantity theory of money i s given by S p r i n k e l . ( 2 7 ) He takes a more r e f i n e d view of the theory that MV = PT, where M = t o t a l money supply, V = v e l o c i t y of turnover, P _= average p r i c e l e v e l , T = r e a l n a t i o n a l product, and contends that V shows r e l a t i v e l y l i t t l e r e a c t i o n to M, other than at turning points i n the rate of Monetary growth. The regular formula for a l l p r a c t i c a l purposes considers V constant and assumes that M i s an independent v a r i a b l e . Hence, PT = f(M) , where PT i s the average p r i c e l e v e l X volume of transactions, or assumed as being G.N.P. He contends that changes i n M, a f f e c t t o t a l spending. S p r i n k e l also shows long term evidence that the average annual rat e of r i s e i n money supply ( 5 » 9 ^ ) n a s c l o s e l y approximated that of spending (5.jfo) i n the 50 year period I9O9 - 1958- He points out two things: 1. A l l business cycle declines since 1909 were preceded by a reduction i n the r a t e of monetary growth, or a decline i n the rate of change of money supply. 2. A l l recoveries since 1909 were c o n s i s t e n t l y preceded by a r i s e i n the r a t e of monetary growth. However, as a weakness to t h i s method of forecast, he in d i c a t e s that the degree of l i q u i d i t y that i s e x i s t i n g at points of change i n rate of growth of money supply can have a misleading e f f e c t . For example, i n the d e c l i n i n g post War II period, a period of high l i q u i d i t y , a d e c l i n i n g rate of money supply Increase may not herald a recession. A. Hamilton Bolton has recognized the value and the weaknesses of t h i s f o r e c a s t i n g t o o l , but i s rather d e f i n i t e when he states that v/hen the increase i n rate of monetary supply i s zero or negative, then i t i s no time ( 2 7 ) ^ 'Spr i n k e l , Beryl V/. Money and Stock P r i c e s , Publ. Irwin I964, to be i n the stock market.( 2 8) He c i t e d 5 periods that had occurred since 1909. 1. F i r s t and Second quarter of 1921 2. Last h a l f of 1931 3. Last h a l f of 1937 •4. F i r s t quarter of I949 5. F i r s t h a l f of i960 Conversely he mentioned that the moment the downward trend of these rates was broken on the upside, a major buying opportunity f o r common stocks appeared. As a measure of the rate of change of money supply, the w r i t e r chose the N.B.E.R. lead i n g i n d i c a t o r #85 change i n t o t a l U.S. money supply. This measure consists of changes i n demand deposits and currency. The raw data are derived from the Federal Reserve system. On the N.B.E.R. scoring plan, the median lead to the peak of the business cycle i s 20 months and 10 months to the trough. I t i s c u r r e n t l y a v a i l a b l e , and has missed only about 9 P e r cent i n the l a s t eleven cycles covered. Business Loans: As an adjunct to an increase i n money supply as measured by demand deposits, Hamilton recommended a breakdown w i t h i n to a s c e r t a i n which p o r t i o n i s demand oriented i n the form of loans, and which i s supply, i n the form of increased bank investments due to monetary expansion. ( 2 9) These Bank investments are a r e s i d u a l that tend to move up and down with the supply of loanable funds. As the demand f o r loans, which a,re s t i m u l a t i n g to the ^ 2 8 ^ B o l t o n , A. Hamilton o p . c i t . , p. 144. (29) Bolton, A. Hamilton o p . c i t . , p. 145. economy, increases, banks tend to run down t h e i r supply of funds which have been i n the form of investments as Government arid Municipal Bonds. As a measure of bank loans to businesses, tne author has chosen the N.B.E.R. se r i e s of #112 which i s the rate of change of Business loans by banks i n the Federal Reserve System. This s e r i e s was sta r t e d i n 1959 and was incorporated i n t o the model from that period on. I t i s recognized as one of the le a d i n g s e r i e s by the N.B.E.R. and has missed only 20 per cent of the l a s t 5 cycle turns measured. Summary of Indicators Moore and S h i s k i n l i s t e d s i x major economic process groupings that are d i r e c t l y responsible f o r c y c l i c a l f l u c t u a t i o n s i n the business c y c l e . (30) The author has summarized these processes along with the i n d i c a t o r s that have been chosen f o r use in.the model. Economic Rationale Indicators Chosen 1. Employment and unemployment #1 Average Hours Worked #50 Non A g r i c u l t u r a l Placements 2. Production, Income, Index of Consumer Sentiment - Consumption and Trade U. of Mich. J. Fixed C a p i t a l Investment #6 New orders f o r durables #29 Housing Permits 4 . P r i c e s , Costs and P r o f i t s #23 I n d u s t r i a l M a t e r i a l s P r i c e s 5. Money and Cred i t #14 Business F a i l u r e s #85 Change i n Money Supply #112 Change i n Business Loans Lempert, L.H. o p . c i t . , p. 26. CHAPTER I I I A DIFFUSION INDEX In t h i s chapter we w i l l discuss the d e s c r i p t i o n and methodology of a d i f f u s i o n index constructed from the component i n d i c a t o r s that were described i n Table V of Chapter I I . The establishment of c r i t e r i a f o r p r e d i c t i o n s from the Index w i l l next be considered. The index i s then tested with the Standard and Poor 500 Index and a judgement i s made on i t s performance. The r e s u l t s are then i n t e r p r e t e d to e s t a b l i s h a basis f o r weighting the forecast of the d i f f u s i o n index i n the model to be tested. DESCRIPTION A d i f f u s i o n index i s a summarizing device used to accumulate a con sensus of opinion that i s expressed by a group of i n d i c a t o r s . I t consists of a measure by percentage of the s e r i e s that are undergoing expansion. When the value i s over 50 per cent more se r i e s are expanding than contracting, conversely, when the value i s under 50 per cent more se r i e s are contracting than expanding. For our purpose, the d i f f u s i o n index we u t i l i z e , v / i l l c o n s i s t of the f o l l o w i n g i n d i c a t o r s : N.B.E.R. T ,. , Period of Moving . In d i c a t o r , Number Averages •//l Average hours worked per week i n mfg. 4 #30 Non A g r i c u l t u r a l placements #6 New Orders f o r durables 6 #29 Housing permits 6 #23 I n d u s t r i a l materials p r i c e s 3 #17 P r i c e / u n i t labour cost 4 #14 Business f a i l u r e s . 6 #85 Change i n money supply 6 #112 Change i n bank loans 5 Index of consumer sentiment 35 METHODOLOGY Source o f Data: The data used f o r the d i f f u s i o n index i s der ived from Business Cycle Developments wi th the except ion o f the Index of Consumer Sentiment which i s compiled by the U n i v e r s i t y of M i c h i g a n . Business Cycle Developments i s a monthly p u b l i c a t i o n of the N a t i o n a l Bureau of Economic Research i n a s s o c i a t i o n w i t h the U . S . Bureau o f the Census. The data required f o r our d i f f u s i o n index are p u b l i s h e d monthly i n t h i s j o u r n a l . The index i s constructed by measuring the number o f the s e r i e s that has r i s e n i n each month, and express ing i t as a percentage of the t o t a l . These monthly values are formed i n t o an index , that represents the d i r e c t i o n of movement o f the m a j o r i t y of i n d i c a t o r s i n the s e r i e s . Two indexes were c a l c u l a t e d f o r our a p p r a i s a l ; one that i s not smoothed, (moving averages not taken) . We w i l l r e f e r to t h i s as the D i f f u s i o n Index (unaveraged). The other i s smoothed (moving averages are taken) and we w i l l r e f e r to t h i s as the D i f f u s i o n Index. As s ta ted e a r l i e r , the unaveraged index w i l l serve as the u n d e r l y i n g trend from which data can be ex t rapo la ted to b r i n g the D i f f u s i o n Index up to date. Moving Averages: The s e r i e s c a l c u l a t e d i n t h i s method i s choppy, and produces a very e r r a t i c p a t t e r n . I t can be smoothed by the use of moving averages. The w r i t e r used a method which G.H. Moore recommended f o r smoothing economic s e r i e s used i n d i f f u s i o n indexes, and i t i s described as f o l l o w s . ^ ) A s t a t i s t i c a l c a l c u l a t i o n of a moving average requires that the average be centred , sxid therefore the c e n t r a l p o i n t i s i n t e r p o l a t e d when even years are ^ M o o r e , G .H. "Analyz ing Business C y c l e s " , p . 1 6 , The American S t a t i s t i c i a n A p r i l , I964. 36 used, and i s LIC a s i l y located with odd years. However, Moore stated that i n p r a c v i c e , none of the moving averages need be computed since the only Information required i s t h e i r d i r e c t i o n of change, and t h i s may be i n f e r r e d by comparing appropriate months of o r i g i n a l data, as shown i n the f o l l o w i n g scheme. Period of Mov. Average Months 1 2 3 4 5 6 Months Compared 1st & 2nd 1st & 3rd 1st & 4th 1st & 5th 1st & 6th 1st & 7th Month i n Which D i r e c t i o n of Change i s Entered 2nd 2nd 3rd 3rd 4 th 4th The choice of period of moving averages was another d e c i s i o n that was made, based on G.H. Moore's experience with leading i n d i c a t o r s . I n a d i f f u s i o n index of leading i n d i c a t o r s covering from 1946 to 1953, he found that the f o l l o w i n g periods of moving averages were appropriate; a s i x month period f o r business f a i l u r e s , new orders, r e s i d e n t i a l contracts, commercial contracts and incorporations; a four month period f o r stock p r i c e s and work week; a three month period f o r basic p r i c e s . By the use of t h i s data, periods were assigned to a l l of the leading i n d i c a t o r s with the exception of change i n money supply, change i n bank loans, Index of Consumer Sentiment and non a g r i c u l t u r a l placements. The s t a t i s t i c s f o r the Index of Consumer Sentiment v/ere smoothed by the use of a graph. The index has been a v a i l a b l e on a quarterly and somewhat i r r e g u l a r basis, p a r t i c u l a r l y i n i t s e a r l i e r years. The w r i t e r required monthly data f o r the d i f f u s i o n index, so ( 2 ) l b i d . , p. 16 a method of p l o t t i n g the a v a i l a b l e data on a graph and j o i n i n g the points by a smooth curve was u t i l i z e d . ( I n t h i s maimer, monthly data were a v a i l a b l e from a s e r i e s that d i d not require smoothing by the use of moving averages. The d i r e c t i o n of change v/as the measure desired, so t h i s method was considered as being accurate. Non a g l i c u l t u r a l placements as presented i n index form i n Business Cycle Developments i s a smooth s e r i e s , and i t v/as the w r i t e r ' s judgement that no adjustments be made to the data as presented i n the j o u r n a l . Change i n money supply and change i n bank loans were subjected to s i x month and f i v e month moving averages r e s p e c t i v e l y by the Bureau of the Census, i n t h e i r construction of i n d i v i d u a l indexes of these i n d i c a t o r s , so the w r i t e r chose to use the same periods of averages i n h i s data. Continuity of Data: The data f o r a l l of the indexes were not a v a i l a b l e from 1956 on. The Index of Consumer Sentiment data were a v a i l a b l e from June 1956 thereafter. The s e r i e s , change i n business loans, commenced i n September 1959 a n (3. has been a v a i l a b l e since. A l s o , the s e r i e s , change i n money supply, v/as r e v i s e d back to January i960 by the Bureau of the Census, so i t s i n c e p t i o n was taken as of January 1st, i960. Therefore, as w i l l be noted i n Appendix I , the D i f f u s i o n Index data consists of the f u l l s l a t e of ten i n d i c a t o r s from i960 on. The period from 1956 to i960 c o n s i s t s of the consensus of opinion of from s i x to ten i n d i c a t o r s . I t could be therefore considered that the e a r l i e r periods d i d not r e f l e c t the same scope of coverage as that period from I960 9bU on. (3)_. Monthly data f o r Consumer Sentiment i s presented i n Table IX and the graph i s on Chart I . (^Business Cycle Developments - Bureau of the Census 39 The data f o r the i n d i c a t o r s used i n the construction of the d i f f u s i o n indexes are loc a t e d i n Tables VI to XI i n c l u s i v e , with the Standard and Poor 500 Index data i n Table X I I . The construction and handling of data of the D i f f u s i o n Index are i n d i c a t e d i n Appendix I , parts (a) and (b), and f o r the D i f f u s i o n Index (non averaged), part (c) of Appendix I contains the relevant m a t e r i a l . METHOD OP ANALYSIS The dependent v a r i a b l e i n t h i s a p p r a i s a l i s the stock market index. For t h i s purpose we selected the Standard and Poor Composite of 500 stocks, as i t represents one of the broader and. popular measures of the stock market, and Is also a s e l e c t l e a d i n g i n d i c a t o r of the N . B . E . P L . The period covered i s from 1956 to 19^7. I t was considered adequate f o r a p p r a i s a l purposes, as i n t h i s span, there have been four s i g n i f i c a n t market breaks, two of which j u s t preceded, periods that were c l a s s i f i e d as recessions by the N . B . E.R. The purpose f o r t e s t i n g t h i s index i s to a s c e r t a i n i t s p r e d i c t a b i l i t y f o r timing investment decisions i n order that a standard of weights may be established f o r i t s use i n our model to be appraised. This w i l l be done by comparing the movement of the d i f f u s i o n index with that of the Standard and Poor 500 Index, and by so doing e s t a b l i s h dates on which buying and s e l l i n g decisions should be made. We w i l l thus have to e s t a b l i s h c r i t e r i a as to when the d i f f u s i o n index i n d i c a t e s buy, and when i t i n d i c a t e s s e l l , keeping i n mind that the perfect d e c i s i o n would be, to s e l l at the peak and buy at the trough of the averages f o r the greatest return on investment. A CURRENCY PROBLKJ The currency of the D i f f u s i o n Index appeared to create a problem when attempting' to f o r e c a s t the stock averages. The l e a d time of the index was d imin i sned , by the l o s s of about two months due to the c a l c u l a t i o n of the moving average, and a lso by about a month due to the currency of d a t a , making a t o t a l l o s s o f about three months o f l e a d t ime. This d i f f i c u l t y was p a r t l y overcome by e x t r a p o l a t i n g the moving averages, u s i n g the l a s t month of data a v a i l a b l e , to cover the same p e r i o d as that of the monthly d i f f u s i o n index . The remaining one month l a g was accounted f o r by l agg ing the i n d i c a t o r one month on the p e r i o d s i g n a l g iven by the i n d i c a t o r s . These p o i n t s are designated as buy and s e l l on Charts I I and I I I . CRITERIA FOR BUY AND SELL INDICATIONS This c r i t e r i o n i s developed f o r the moving average d i f f u s i o n index o n l y , which i s r e f e r r e d to as the D i f f u s i o n Index. A b r i e f reminder- i s made at t h i s p o i n t , o f the c r i t e r i a Moore developed f o r h i s d i f f u s i o n index of l e a d i n g i n d i c a t o r s , i n order that our own c r i t e r i a may be so d i r e c t e d . (5) 1. The index u s u a l l y reaches the 50 per cent po int a few months e a r l i e r than a general r e v e r s a l of business t i d e . 2. The percentage expanding curves designate the number only of i n d i c a t o r s that are expanding, and are a ids t o , not s u b s t i  t u t e s f o r c a r e f u l study. The f i r s t c r i t e r i o n for performance can be stated from the evidence under, A Currency Problem, descr ibed e a r l i e r . Moore, G .H. o p . c i t . , p . 1 6 . 1. Extrapolate the D i f f u s i o n Index data to the current month, and deduct one month from the l e t d time at the point of i n d i c a t i o n given. C r i t e r i o n number 2 i s stated from G.H. L'oore's c r i t e r i a and also common senses 2. The per f e c t d e c i s i o n would be to s e l l at the peak and buy at the trough of the averages f o r the greatest return on invest ment . On the basis of these c r i t e r i a , points are examined on the D i f f u s i o n Index f o r both the downside and upside to as c e r t a i n i f the 50 per cent l e v e l used by Moore i s the c e n t r a l point f o r i n d i c a t i o n on the D i f f u s i o n Index. The D i f f u s i o n Index and Standard and Poor 500 Index are p l o t t e d on Charts I I and I I I . TESTING FOR INDICATOR LEVELS The D i f f u s i o n Index i s subjected to a series of test s to measure i t s a b i l i t y to give buy and s e l l s i g n a l s close to the i d e a l buy and s e l l s i g n a l s . The method used i n t h i s t e s t w i l l be used i n other parts of t h i s study, where t e c h n i c a l i n d i c a t o r s are tested f o r t h e i r a b i l i t y to give buy and s e l l s i g n a l s which approach the i d e a l . The te s t i s described as follows: A c o n t r o l measure i s selected as a standard f o r the experiment. Hypothetical buy and s e l l investment decisions are then formulated on c e r t a i n i n d i c a t i o n s from the index being tested. The r e s u l t s of each of these decisions i s then measured against the standard, to gauge the effectiveness of the index performance under the s p e c i f i e d conditions. The time period covered i s eleven years, from January 1st, I956 to December 31st, 1966. DIFFUSION I N D E X - i n o v i n g average-DIFFUSION INDEX— ''monthly_ STANDARD & POOR COMPOSITE 500 s p f 110--H 100 ... T DIFFUSION INDEX- moving average-DIFFUSIOK INDE X_ m o n t h l y - Mojnthly: rf|-; p: STANDARD & POOR COMPOSITE 500 Chart H I 75! Da, 60 50 ta ! P; - D i f f u s i o n ( m o v i n g a v e r a g e ^ ••• 1 I n d e x - — - 1 1 - ? • ' • 1 <• t- ; .4- •t-i l-f f-rft T T D T ] FT 0 | r | >uy! ! i I s e l l TT"! i T T T TTT I i r r 1 ! ' ' -j-i--- r4 -;- H ! r i i f r; -IT i r 111 iol 81 Ui-j~ IX - |_L. i_ j - . I i" 6 5 4| 10' : "T" a rr r i rp 1967 1968 1969 1970 1971 Dividends d u r i n g the p e r i o d i n which our "buy and s e l l " i n v e s t o r would be out of the stock market pose a problem. There are two mevhods of h a n d l i n g t h i s problem, and i n both of these methods we observe the f o l i o w i n c o n d i t i o n s : 1. I n the p e r i o d that an investment i s i n the market, dividends are t r e a t e d as a g a i n , and are not r e i n v e s t e d . The g a i n i s c a l c u l a t e d from the average, of the d iv idend y i e l d s of the Standard and Poor 500, f o r the p e r i o d under c o n s i d e r a t i o n . 2. When an investment i s not i n the stock market, i t w i l l be i n v e s t e d i n h i g h grade i n d u s t r i a l bonds, the y i e l d s of which are quoted i n the Federa l Reserve B u l l e t i n . The y i e l d s used are an average f o r the p e r i o d concerned, and the div idends w i l l be t r e a t e d as not being r e i n v e s t e d . One method i s to c a l c u l a t e div idends over the f u l l p e r i o d of the t e s t , f o r both investment d e c i s i o n s when they are i n the market, and then the i n t e r e s t earned when the investment i s out o f the market. The other method, which i s the one that was used, produces s i m i l a r r e s u l t s . I t considers the d i v i d e n d c a l c u l a t i o n only when the funds are not i n the market. This was achieved by deducting the d iv idend y i e l d from the bond y i e l d when the funds were out of the market, and o m i t t i n g dividends from a l l other c a l c u l a t i o n s . This i s conceived as f o l l o w s : .Consider two investments i n the market, investment A , as a buy and h o l d , and investment B, as one subjected. to buy and s e l l d e c i s i o n s . Let D represent d i v i d e n d s , and I n t . , bond i n t e r e s t . A lso assume that dividends and bond i n t e r e s t are not compounded, and that investment B i s i n the market f o r the f i r s t 9 years and i n bonds f o r the l a s t year , and that investment A i s i n the market f o r 10 y e a r s . Then: n=10 T o t a l b e n e f i t s from A i s A + i = l j£=9 n=10 and. t o t a l b e n e f i t s from B i s B -r^D +^Int. • i = l f=9 n=10 S u b t r a c t ^ ] ) from both sets of b e n e f i t s , i = l then T o t a l b e n e f i t s from A i s A i=9 i=9 il=10 n=10 and t o t a l b e n e f i t s from B i s B +2lnt. - Sift R e c a p i t u l a t i o n : Our t e s t c o n s i s t s of the f o l l o w i n g : 1. S e t t i n g up a c o n t r o l measure. 2 . S e l e c t i n g var ious i n d i c a t o r s i t u a t i o n s . 3. E s t a b l i s h i n g buy and s e l l po in t s f o r each. 4- Measuring the b e n e f i t s under the s tandard, and under the var ious index s i t u a t i o n s . 5- Comparing the r e s u l t s as a d i f f e r e n c e from the•standard, by a percentage. TESTING THE DIFFUSION INDEX The c o n t r o l measure f o r t h i s t ex t i s a buy and ho ld investment i n the Standard and Poor 500 (S. and P . 500), f o r the per iod December 31, 1955 to December 31> 1966. As no dividends are eonrputed on t h i s investment, the r e s u l t s of the investment are : 46 S. & "P. 500 Index Value Dec. 31, 1966 . . 81 .33 pts le s s S. & P. 500 Index Value Dec. 31, 1955 . . 45.48 pts P r o f i t on Investment = 35-85 pts Four s i t u a t i o n s are tested against t h i s c o n t r o l : S i t u a t i o n I : As suggested "by G.H. Moore, the 50 per cent l e v e l i s the c r i t i c a l point at which an i n d i c a t i o n i s given. Therefore, as the i n d i c a t o r proceeds through 50 per cent on the downside, a s e l l s i g n a l i s given, and as i t proceeds through 50 per cent on the upside, a buy s i g n a l i s given. S i t u a t i o n I I : Same as S i t u a t i o n I , except that one extra month of movement i s required f o r confirmation, and then the decision i s made. S i t u a t i o n I I I : The D i f f u s i o n Index proceeds through the 60 per cent l e v e l on the downside, and s e l l i n g i s i n d i c a t e d . Also when the index proceeds through 50 per cent on the upside, buying i s in d i c a t e d . S i t u a t i o n IV: Same as s i t u a t i o n I I I , excepst that one extra month i s required to confirm the s i g n a l of the i n d i c a t o r . (^These l e v e l s were tested by v i s u a l means, and appeared to provide good r e s u l t s . 47 SITUATION I Investment i n the Stock Market Date May 58 Oct 59 Jan 60 Dec 61 Aug 62 Nov 62 Mar 63 J u l y 63 Mar 64 Oct 64 Feb 65 Sept 65 Purchase - Commission 43.71 + 57-00 + 58.03 + 71.74 + 58.52 + 60.04 + 65.67 + 69.07 + 78.80 + 84.85 + 86.75 + 89.38 + • 44 • 57 .58 .72 .59 .60 .66 • 69 • 79 .85 .87 44.15 57-57 58.61 72.46 59-11 60.64 66.33 69.76 79-59 85.70 87.62 90.27 Date J u l y 59 Nov 59 Feb 60 Feb 62 Oct 62 Feb 63 June 63 Feb 64 Sept 64 Jan 65 Aug 65 Apr 66 (50/ l e v e l with 1 month lag) Dates are L 'nd of Month Sales Commission 59-74 57.23 55.78 70.22 56.17 65.92 70.11 77.39 83.41 86.12 86.49 91.60 .60 • 57 • 56 • 70 • 56 .66 .70 o77 .83 - -92 59.14 56.66 55-22 69.52 55.61 64.26 69.41 76.62 82.58 85.26 85.63 90.68 Total Pre f i t (Pts) 15.00 (.91) (3.39) (2.94) (3.50) 3.62 3.08 6.86 2.99 (.44) (1.99) .41 18.79 B - Investment i n Bonds Period out of Market Dec. Ju l y Nov. Feb. Feb. Oct. Feb. June Feb. Sept. Jan. Aug. Apr. 55 to 59 to 59 to 60 to 62 to 62 to 63 to 63 to 64 to 64 to 65 to 65 to 66 to May 58 Oct. 59 Jan. 60 Dec. 61 Aug. 62 Nov. 62 Mar. 63 J u l y 63 Mar. 64 Oct. 64 Feb. 65 Sept.65 Dec. 66 Years 29/12 3/12 2/12 22/12 6/12 1/12 1/12 1/12 1/12 l/l2 1/12 1/12 8/12 Amount (Pts) 45.48 59.74 56.66 55-22 69.52 55.61 64.26 69.41 76.62 82.58 85.26 85.63 90.68 Av.Int. - Av.Dividend - 3.50 - 4.77- 4.71 - 4.66 - 4.54 - 4.40 - 4-38 - 4.40 - 4-48 - 4.52 - 4.52 - 4.64 - 5.36 - 3.70 3.26 3-28 3.05 2.93 3-53 3.22 2.95 2.95 2.92 2.96 2.95 3.68 Hate (.20) 1.51 1.43 1.61 1.61 .87 1.16 1.45 1.53 1.60 I.56 I.69 1.68 Total Return (Pts) (22) .24 .17 1.60 • 56 .04 .06 .07 .08 .08 .09 .09 1.00 .86 Therefore t o t a l p r o f i t i s A + B 22.65 48 SITUATION I I (50/, l e v e l with 1 month l a g and 1 month confirmation) A - Investment i n the Stock Market Date Purchase - Commission Date Sales - Commission P r o f i t (Pts) June 58 Jan. 61 Sept.62 44-75 + -45 = 44-50 59-72 + .60 = 60.32 58.00 + .58 = 58.58 J u l y 59 Mar. 62 May 66 59-74 - .60 = 59.14 70.29 - .70 = 69.59 86.78 - .87 = 85.91 14.84 9.27 27-33 Total 51.14 B - Investment In Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - Rate &) Return (Pts) Dec. 55 to June 58 J u l y 59 to Jan. 6 l Mar. 62 to Sept.62 May 66 to Dec. 66 30/12 6/12 6/12 7/12 45-48 59-14 69-59 85-91 3.50 - 3-70 = ' 4-54 - 3-34 = 4- 49 - 3-26 = 5- 37 - 3-68 = (.20) 1.20 1.23 1.69 Total (23) ' -35 -41 .86 1-39 Total p r o f i t i s A + B 52j-hl 49 A Investment i n the Market SITUATION I I I (60}i on dovmside and 50-/0 on upside with 1 month lag) Dates are End of Month Date Purchase - Commission Jan. 61 59.72 + .60 61.32 Dec. 61 71.74 + .72 = 72.46 Aug. 62 58.52 + .59 = 59-11 Nov. 62 .60.04 + .60 6O.64 Apr. 65 68.76 + .69 = 69.45 J u l y 65 69.07 + .69 = 69-76 Sept.63 72.85 + .73 73-58 Dec. 63 74-17 + .74 = 74.91 May 64 80.72 + .81 = 81 .53 Oct. 64 84.85 + .85 85.70 Feb. 65 86.75 + .87 87.62 Apr. 65 87-97 + .88 88 .85 Sept.65 89.38 + .89 90.27 Date Nov. 61 Jan. 62 Oct. 62 Feb. 63 June 63 Aug. 63 Nov. 63 Jan. 64 Sept.64 Jan. 65 Mar. 65 Aug. 65 Mar. 66 Sales - Commission 71.06 69.07 56.17 65.92 70.11 70.98 72.62 76.45 83-41 86.12 86.83 86.49 88.88 71 69 56 66 70 71 73 76 83 86 87 86 89 70.37 68.38 55.61 65.26 69.41 70.27 71.89 75.69 82 .58 85.26 85.96 85.63 88.99 Total P r o f i t (Pts) 9.0.5 4.08) 3.50) 4.62 (.04) • 51 (1.69) • 78 1.05 (.44) (1.66) 3.22) .1-28) .10 B - Investment i n Bonds Period out of Market Dec. Nov. Jan. Oct. Feb. June Aug. Nov. Jan. Sept. Jan. Mar. Aug. 55 to Jan. 6l 61 to Dec. 61 62 to Aug. 62 62 to Nov. 62 63 to Apr. 63 63 to J u l y 63 63 to Sept. 63 to Dec to May 64 65 to Feb, 65 to Apr. 63 63 64 64 to Oct. 64 65 65 65 to Sept.65 Mar. 66 to Dec. 66 Years 6 l / l 2 l / l 2 7/12 l / l 2 2/12 1/12 1/12 1/12 4/12 1/12 1/12 1/12 1/12 9/12 Amount (Pts) 45-48 70.37 68.38 55-61 65.26 69.41 70.27 71.89 75 .69 82.58 85.26 85 .96 85.63 88.99 Av.Int. - Av.Dividend 3.89 4.59 4.54 4-39 4-38 4.40 4-44 4.47 4.49 4.52 4.52 4.53 4.64 5.29 3.31 2.59 3.36 3-37 3.20 2.70 2.86 3.03 2.93 2.89 2.96 3.03 2.95 3.69 Rate •58 2.00 1.18 1.02 1.18 1.70 1.58 1.44 1.56 I .63 1.56 1.50 I .69 1.60 tf-otal Return (Pts) 1.30 .14 .48 • 05 •13 .07 •07 .07 .38 .08 .09 .09 .09 1.07 4.11 Therefore t o t a l p r o f i t i s A + B 50 SITUATION IV (60fs on downside and 50;i on upside with 1 month l a g and 1 month confirmation) A - Investment i n the Stock Market Date Purchase - Commission Date Sales - Commission P r o f i t (Pts) May 58 Jan. 61 Sept.62 45.70 + .44 = 44.14 59-72 + .60 = 60.32 58.00 + .58 = 58.58 June 39 Peh. 62 Apr. 66 57-46 - .57 = 56.89 70.22 - .70 = 69.52 91.60 - .92 = 90.68 Total 12.75 9.20 32.10 54.05 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - Rate Return (Pts) Dec. 55 to May 58 June 59 to Jan. 6 l Feb. 62 to Sept.62 Apr. 66 to Dec. 66 29/12 19/12 7/12 8/12 45-48 57.46 70.22 91.60 3-55 - 3.70 = ' 4.54 - 3.17 = 4.51 - 3-15 = 5.36 - 3.69 = (.23) 1.37 1.36 1.67 Total .(•22) 1.26 • 56 1.01 2.61 Total p r o f i t i s A + B 56_,66 The c o n t r o l against which these s i t u a t i o n s were tested was a buy and hold investment i n the S. and P. %0 averages. The p r o f i t from t h i s was 35.85 index p o i n t s . To complete the t e s t , the p r o f i t from each of the four investment s i t u a t i o n s was compared to \he c o n t r o l , and that with the "best performance over the c o n t r o l was chosen as the i d e a l s i t u a t i o n . S i t u a t i o n I: T o t a l P r o f i t of Investment - Control ,r , _ C^teoTlnvIslmTen^ ' A 1 0 0 = R e l a t l v e Performance ,v oc X 100 = 38.8/a worse 35.85 1 S i t u a t i o n l i s S i t u a t i o n I I I : S i t u a t i o n IV: 35.85 = 46.5/^  better ii21_-__|5_^85_ x 1 0 Q = 8 Q > 2 5 ^ W Q r s e 56.66 - 35.85 ,r _ , ^ 357^5"^ X 1 0 0 .= 58.04$ better INTERPRETATION OP RESULTS On'the basis of the t e s t s performed, S i t u a t i o n IV has the best performance. To repea,t the procedure followed: when the D i f f u s i o n Index proceeds through the 60 per cent l e v e l on the downside, s e l l i n g i s in d i c a t e d ; v/hen i t proceeds through 50 per cent on the upside, buying i s in d i c a t e d . One extra month i s allowed f o r confirmation of the data, and allowance i s made f o r a one month data l a g . To a s c e r t a i n the performance of the index as r e l a t e d to perfect timing, the leads and lags of the D i f f u s i o n Index as a forecast of the peaks and troughs of the Standard and Poor 500 Index are exhibited i n Figure 4. The q u a l i f i c a t i o n s of S i t u a t i o n IV are the basis f o r the D i f f u s i o n Index. A l s o , as stated i n e a r l i e r c r i t e r i a f o r the Index, the perfect d e c i s i o n i s to s e l l at the peaks and buy at the troughs of the S. and P. 500 Index, one can perceive that with a lead on the S. & P. 500 at peaks and troughs, t h i s d e c i s i o n could be made. Figure 4 Leads or La,gs of the I n d i c a t o r (-) = lead, (+) = l a g Period Peaks Troughs 1 - 5 + 5 2 - 6 + 2 3 - 1 + 3 4 - 0 + 3 Average - 3 + 3.2 I t i s apparent that the D i f f u s i o n Index i s p a r t i c u l a r l y weak at the troughs. The i n d i c a t i o n to buy i s given about 3«2 months past the trough, when p r i c e s are expanding. This could be improved somewhat i f the data f o r the index were more current. As the recent trend i n s t a t i s t i c a l compilation by government departments i s to an improved currency of data, t h i s would be r e c t i f i e d to some extent i n the future. The weakness of the D i f f u s i o n Index at troughs i s recognized. However, on the basis of the test being 58.04 per cent better than the c o n t r o l , one would have to accept the buy and s e l l performance as being good. SUB.'ARY OF CRITERIA FOR THE DIFFUSION INDEX In t h i s chapter, the establishment of c r i t e r i a f o r p r e d i c t i o n s from the D i f f u s i o n Index has been developed. The Index has also been tested f o r e f f e c t i v e forecast d e c i s i o n s , and the proper choice of c r i t e r i a has thus been substantiated. A summary of the c r i t e r i a that was chosen f o r the forecast i s given: 1. The data f o r the Index should be extrapolated to the current month. Al s o , one month should be deducted from the lead time at the point of i n d i c a t i o n , to allow f o r a data l a g , when a h i s t o r i c a l review i s made of the i n d i c a t o r performance. 2. The perfect d e c i s i o n would be, to s e l l at the peaks and buy at the troughs of the averages f o r the greatest r e t u r n on investment. 3. Downside: When the D i f f u s i o n Index proceeds downward through the 60 per cent l e v e l on the downside, and t h i s same movement i s confirmed one month l a t e r , s e l l i n g i s i n d i c a t e d . Upside: When the D i f f u s i o n Index proceeds upward, through the 50 per cent l e v e l on the upside, and t h i s movement i s confirmed one month l a t e r , buying i s i n d i c a t e d . Appendix I D i f f u s i o n Index Data Monthly - Moving Average 1256 1957 > r i s i n g 33 l 7 17 57 91 91 91 67 33 0 17 15 29 29 43 29 15 15 15 0 c M o n t h 1 2 5 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 #1 - - - #30 - + - - #6 + + #29 - - 8 9 10 + + + + + + + + + 0 + - - + + #23 #17 #14 #85 #112 Cons. Sent + - + + + + + _ - + - - - + + + + + - - - - - + + + + + - - 0 + + + + + 125.2 fo r i s i n g 0 29 17 78 89 100 100 100 78 75 100 78 63 Month 1 2 3 4 5 6 7 8 9 10 11 12 1 #1 _ _ 0 + + + + + + + + + -l-#30 - + - + + + + + + + + #6 - - - + + + + + •r + #29 - - - + + + + + + + + #23 + + + + + + + #17 - - - - + + + + 0 + + #14 + + + + + — — + + #85 #112 Cons. Sent - + + + + + + + + + + + + 2 3 4 5 6 7 8 9 16 i i 12 + + 0 - - - --- + + + + + + + + - _ _ _ _ _ + + - - - - _ + + + _ - - + + + + + + + + + + _ _ + _ _ _ _ _ 0 + + + - - + - _ - - 0 ±2§o 1261 ^ r i s i n g 37 44 11 10 22 20 10 10 20 20 50 50 67 80 80 70 70 70 60 100 80 50 60 50 Month - . ^ - . . r - ^ - - - - - - - #1 #30 #6 #29 #23 #17 #14 #85 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 — — — 0 - - - - - - 0 + + + + + - + + + + — + - - - - - + - - + - - + + - + _ + _ + + _ + — + + + + + + + + + + + + + + + - - - + + + + + + + _ + + — — + - - - - - + + + + + _ _ - + + - _ + + + - - _ - _ - + : + + + + + + + + + + + - + + + + + + - - + + + + - - - + + + + _ - - + + + + + + - - + + + + + + + + + + + + + + + + + + _ (a) Appendix I Cont'd 55 • Appendix I D i f f u s i o n Index Data Monthly 1962 Month #1 #30 #6 #29 #23 #17 #14 #85 #112 1 2 3 4 5 - + + + 0 + - + + + + + + + - - + SO 60 40 70 60 70 7 8 9 10 11 12 - - - + - + + + - + - -+ + + + + + + + + + + + + + + + + + + + + + - Moving Average 1961 44 50 78 70 45 60 50 50 80 80 50 50 1 2 3 4 5 6 7 8 9 10 11 12 0 + + + + + + 0 + + + + + 0 + + + + + + + + + + + + + + + + + -- - - - + + + + + - - - — + + + + - + + + - - - + + _ + + + + + + - - + - + + + - - _ - - - - - + + + - + + + - - + + - - + + + + + + + + + + + + + + + + 1964 fo r i s i n g 40 70 60 50 60 50 60 44 80 60 60 40 Month 1 2 3 4 5 6 7 8 9 10 11 12 #1 #30 #6 #29 #23 #17 #14 #85 #112 + 0 0 0 + + + 1965 60 50 70 70 70 60 40 60 66 80 60 70 1 2 3 4 5 6 7 8 9 10 11 12 + _ _ 0 0 + + + + - - - + - + - + - + - - + - + - + ' - — _ + + + + + + - + - + + + + + + - + + + + + + + + + - - + - + - + + + + - _ - + + + + + + + + + + - - + + + + - _ - + + + + + + + - - - + - + + + + + + + + + - _ _ + + + - + - - + - + - + + - - + - + - - + - + + + + + — 0 + + + + + + - - - - - - + + + + + + + + + - + + + - + + + + + + - + + + + + + - - - + + + + - - - + + + + + + + + + _ _ 1966 1967 Month #1 #30 #6 #29 #23 #17 #14 #85 #112 Cons. Sent 60 50 33 30 20 30 11 30 10 30 30 50 55 60 60 66 70 60 60 60 40 60 70 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 + + 0 - - - 0 0 + - _ _ _ 0 _ + + + + + + - - - + - - + - - + - - - - + _ + _ + + + + + + - + + - + + + + + + + + + + + + + + + + + + + + + + - + - - + - + - - - - - - - — _ _ - - + - - - - - - + + + + + + + + + + - - - - - - + - + - + 0 + + + - + _ + - - • + + - - - - - + - + + + + + - - - - + + + + + + + + + _ _ (b) Appendix I Cont'd Appendix I 56 D i f f u s i o n Index Pat; 1962 io r i s i n g 70 50 50 30 40 40 55 33 45 60 60 30 Month 1 2 3 4 5 6 7 8 9 10 11 12 #1 + + + + - - 0 -.+ - + •• #30 + - + + + - + + - + - - #6 + _ _ _ + _ + _ _ + _ + #29 + + - + - + + - + -•+- #23 + _ _ _ _ _ _ + _ + + _ #17 _ _ _ _ _ _ + + 0 - + - #'14 > i n v . - + + - + + - - + - + - #85 + + + - - + - - - + ~ + #112 + + + - + + + - + + - - Cons. Sent _ _ _ _ _ _ _ _ _ + + + fo r i s i n g 70 40 53 60 40 70 88 80 40 40 60 40 Month 1 2 3 4 5 6 7 8 9 10 11 12 #1 - + 0 + - + 0 + - + + + #30 + _ _ _ + _ + _ + _ + _ #6 + _ _ + _ + + _ + _ _ + #29 _ + _ _ _ + _.+ _ _ + _ #23 + 0 + + - + + + + + + - #17 + + - + - + + + - - + + #14, i n v . - - + + + - + + - + - - y/85 + _ _ _ + + + + _ _ _ _ #112 + - + + + - + + - + + + Cons. Sent + + - - - + + + + - _ - 1966 fo r i s i n g 66 55 55 11 40 50 40 30 33 30 33 60 Month 1 2 5 4 5 6 7 8 9 10 11 12 #1 0 + - 0 - - - + 0 - 0 - #30 + + - - - + - + - + - - #6 + + + - + + - - + - - + #29 _ _ + _ _ _ _ _ _ _ + + #23 + + + _ _ + + _ _ _ _ + #17 + 0 0 - + - + - - - - + #14, i n v . + + - - + - + - + + + - #85 0 - + + - + - + + - + +,. #112 +_ + _ + + + _ _ + _ _ Cons. Sent _ _ _ _ _ _ _ _ _ _ _ + .Monthly 1963 + + + + - 1 0 + + + + 0 + + + + 70 90 70 40 40 55 80 70 20 50 3 4 5 6 7 8 9 10 11 12 + - + + - 0 + + + + + - - - + + + _ + + - - + - + + _ _ + + + _ _ - + + - + + + + - + 0 _ + + + + + + + - - + + _ ' 0 - + - + + - _ - + - + + + - + + - - _ - + + - + + + _ - _ + + + + + + + + + + 1965 60 60 60 70 55 33 44 80 40 66 3 4 5 6 7 8 '9 10 11 12 + - + - 0 0 _ + + 0 - + - + - - - + - + + + - + + - + + — + + - + + - - - + + + + + + - - + - + + + + - + + + - - + - + - + - + + - + + + _ - + - + - + 0 + - + - - + - + - + - _ _ + + + +. + + + _ _ _ 1267 66 40 60 60 50 70 50 40 40 60 50 0 - + - + + - + - + + - + + - + + 5 + _ + _ + + - + + + + 5 6 7 8 9 10 11 - 0 + + 0 _ + - + - + - + + + + - - + + + + + - + + + -- + - - 0 - + - - + - - + -+ + + - + - + + - - - - + -- + + - - + -+ + + ' + - _ _ (c) Appendix I Cont'd 57 TABLE VI #1 Average Hours 1956 1958 i960 Jan 40.9 38.8 4O.4 Feb 40.7 58.7 40.1 Mar- 40.5 38.6 39.9 Apr 40.3 38.6 39.8 May 40.2 38.8 40.1 June- ' 40.3 38-9 39.9 J u l y 40.1 39-1 39.9 Aug 40.2 39.3 39*6 Sept- 40.5 39.6 39.4 Oct 40.5 39.5 39-5 Nov 40.4 39.8 39.3 Dec- 40.6 39.9 38.5 1957 1959 1961 Jan 40.5 40.0 39-0 Feb 4O.4 40.1 39.3 Mar- 40.3 40.3 39-3 Apr 40.1 40.3 39.7 May 39.9 40.2- 39-8 June- 59.9 40.I 39-9 Ju l y ^ 39.8 40.2 40.0 Aug 59.7 40.I 40.0 Sept- 59.5 40.1 39-6 Oct 39.3 39.9 40.2 Nov 39.O 40.1 40.6 Dec- 38.9 40.2 4O.4 \/orked/v/eek Hours 1962 I964 I 9 6 6 1956 39.8 40.1 41o4 535 40.3 40.6 41.6 524 40.5 40o6 41.5 552 40.8 40.8 41.5 529 40.6 40.6 41.4 526 40„5 40.7 41.3 515 40.5 40.7 41.2 498 40.2 40.8 41.4 500 40.5 40.6 41.4 509 40.1 40.7 41.3 517 40.4 40.9 41.3 515 40.3 41.2 41.O 510 1963 1965 1967 1957 40.4 41.2 41.0 510 40.3 41.2 40.3 512 40.4 41.3 40.4 500 40.2 41.0 40.5 ' 490 40.4 41.1 40.3 495 40.5 41.0 40.3 500 40.4 41-0 40.5 491 40.4 41.0 40.7 486 40.6 40.9 40.7 473 40.7 41.2 40.6 469 40.5 41.4 40.9 453 4O06 41.4 440 #30 Non A g r i c . Placements 1958 i960 1962 1964 1966 435 506 568 554 570 426 535 548 532 600 400 515 575 523 589 412 504 576 522 522 418 494 602 529 513 433 482 538 518 567 450 460 553 523 542 465 488 555 507 543 465 473 534 518 509 470 460 579 514 533 480 475 573 533 530 485 444 517 524 524 1959 1961 1963 1965 1967 490 443 552 522 554 500 . 444 554 549 519 510 474 •555 528 497 515 433 557 555 474 518 481 546 533 448 522 494 545 548 487 520 470 541 541 484 510 529 543 537 487 505 491 553 529 471 502 530 575 547 474 515 565 533 544 482 510 526 525 563 58 TABLE VII # 6 New Orders f o r Durables B i l l i o n s $ #29 Housing Permits 195 7/59 = 1 0 0 1 9 5 6 1 9 5 8 I 9 6 0 1 9 6 2 1 9 6 4 1 9 6 6 ' 1 9 5 6 1 9 5 8 I960 1 9 6 2 I9t"4 1 9 6 6 Jan 1 6 .63 1 1 . 1 0 1 7 . 0 0 I7.43 1 9 . 7 4 2 3 . 5 8 1 1 1 . 0 9 0 . 1 9 8 . 3 1 0 4 . 2 1 1 6 . 8 1 1 0 . 7 Feb 1 4 . 4 8 1 1 . 2 0 1 6 . 2 0 1 7 . 1 9 1 9 . 5 0 2 3 . 7 4 1 1 1 . 1 7 9 . 1 97 - 9 1 1 3 . 5 1 2 4 . 6 1 ^ 5 - 6 Ivlar- 1 5 . 6 1 1 2 . 1 0 1 5 . 9 4 1 7 . 0 0 1 9 . 2 6 2 4 . 8 9 106.3 8 1 . 0 8 8 . 1 1 0 5 0 7 1 2 1 . 7 1 1 1 . 9 Apr 1 6 . 4 3 1 1 . 2 0 1 6 . 4 7 1 6 . 7 3 2 0 . 4 6 2 4 . 2 0 1 1 0 . 2 8 3 . 2 9 5 - 1 1 1 2 . 9 1 1 5 . 6 1 0 4 . 6 May 1 6 . 2 1 1 2 . 4 0 1 6 . 6 8 1 6 . 9 7 1 9 . 9 4 2 4 . 2 8 I O 6 . 9 8 7 . 0 95 . 9 1 0 3 . 6 1 1 2 . 9 9 6 . 9 June- 1 5 . 9 3 1 2 . 8 0 1 7 . 1 4 16.44 2 0 . 0 2 2 4 . 5 9 1 0 3 . 6 9 4 . 1 8 9 - 5 1 0 4 . 4 1 1 5 . 1 8 4 . 2 J u l y 1 5 . 1 2 1 3 . 1 5 16.44 1 6 . 9 7 2 1 . 2 5 2 4 . 3 7 1 0 1 . 2 1 0 1 . 2 9 1 . 0 108.7 1 1 1 . 5 81.3 Aug 1 8 . 1 0 1 3 . 2 1 1 5 . 9 1 1 6 . 5 9 1 9 . 3 4 2 3 . 5 1 96.7 1 1 0 . 0 91 . 5 1 0 7 . 1 1 1 3 . 4 7 4 - 5 Sept- 1 6 . 2 0 1 4 . 7 0 15.62 I6.55 1 9 . 9 1 2 5 . 2 7 9 5 . 2 1 1 6 . 2 94.4 1 0 9 . 1 1 0 9 . 7 6 4 . 7 Oct 1 5 . 1 0 1 5 . 1 0 1 4 . 7 4 1 7 * 2 9 1 9 . 6 2 2 4 . 2 4 9 4 - 6 1 2 0 . 1 95 . 9 1 0 7 . 2 1 0 9 . l 63 . 0 Nov 1 5 . 6 5 1 5 . 6 2 1 4 . 6 0 1 6 . 7 3 1 9 . 4 5 2 3 . 0 3 93-7 1 2 6 . 2 9 L 4 1 1 3 . 0 1 1 0 . 8 6 5 . 1 Dec- 1 5 . 6 9 1 5 . 2 0 1 4 . 9 2 1 7 . 3 5 2 0 . 7 2 2 3 . 9 6 92 . 5 1 2 5 . 1 9 3 . 1 1 1 2 . 0 105 .4 6 7 . 0 1957 1959 1961 1963 1965 1967 Jan 15.50 16.26 14.88 18.47 21.27 22.07 Feb 15.70 18.10 14.36 18.23 21.15 22.33 Mar- 14.70 17.30 14.82 18.78 21.71 22.06 Apr 14.80 17.90 15.38 19.04 22.04 22.23 May I4.3O 17.28 15.79 18.74 20.99 25.86 June- I4.6O 16.54 16.90 17.68 21.31 24.26 J u l y 14.50 14.99 16.40 18.28 22.20 23.66 Aug 14.00 16.10 I6063 18.06 21.51 23.36 Sept- 14.10 16.26 16.74 18.24 22.16 22.61 Oct 13.00 15.30 17.07 18.62 22.42 23.36 Nov 13.20 16.80 17.10 18.11 22.39 24.11 Dec- 11.90 17.10 17.24 17.97 23.40 1957 1959 1961 1965 1965 1967 86.1 120.1 92.5 111.8 112.5 83.I 85.2 124.2 89-4 108.2 108.2 78.9 86.8 119.6 92.5 112.9 119.9 81.9 87.2 117.6 93-5 113.6 106.2 90.7 84-3 115.5' 95-0 120.0 109.7 91.1 86.1 112.2 100.1 119.3 109.9 97.9 87.2 111.5 100.4 116.5 108.9 96.4 84-3 110.2 101.2 113.5 108.4 99.4 88.2 106.1 100.4 121.0 104.1 102.5 88.1 100.0 103.1 125.6 109.8 106.9 87.1 105.1 102.7 119.9 H 2 . 9 102.5 88.6 101.2 103.6 123.7 114.0 59 TABLE V I I I #23 I i -dus t r i , a l Hat . P r i c e s 1957-9 = 100 #17 P r i c e / U n i t Lab.out Index 57 -59 = 1956 1958 I960 1962 1964 1966 1956 1958 i960 1962 I964 1966 Jan 111.6 94.1 105.7 102.9 98.5 120.5 102.4 99.1 102.0 101.7 101.6 105.1 Feb 110.4 93-4 104.3 100.6 98.5 122.9 102.5 98.7 102.1 101.6 101.9 105.1 Mar- 110.3 93.5 102.4 100.4 98.9 123.5 101.8 97*1 102.9 101.3 101.5- 105.1 Apr 110.2 92.4 103,8 98.3 102.4 121.5 102.1 96.8 102.1 101.2 101.9 IO4.5 May 106.8 • 91.0 104.1 97.8 100.9 118.5 101.2 95.2 101.4 101.1 101.7 105.0 June-• 105.2 91.2 102.7 95-4 101.4 118.4 100.8 96.0 101.5 100.5 100.8 104.7 J u l y 103.9 93-2 101.6 94-2 102.5 H8 . 8 98.7 99-1 101.6 100.9 101.2 105.2 Aug 104.2 94-5 102.1 94.5 105.7 111-7 101.0 100.0 101.2 101.2 101.6 IO4.6 Sept- 107.0 94.6 101.2 94-0 108.2 108.9 101.6 100.5 101.1 101.2 100.8 103.9 Oct 107.1 95.1 99.7 94«9 H2 . 0 106.3 102.5 100.7 100.7 101.1 100.6 103.7 Nov 108.6 100.0 98.5 96.4 113.2 105.9 102.5 100.0 100.1 100.0 101.8 102.7 Dec- 110.0 101.2 96.8 95.8 112.5 105.8 101.9 101.0 100.2 99-9 102.6 102.8 1957 1959 1961 1963 1965 1967 1957 1959 1961 1963 1965 1967 Jan 110.1 99.8 97.5 95-5 H0.6 106.8 101.7 101.0 100.4 100.4 103.0 101.5 Feb 105.2 99.6 99»5 95.1 110.7 105.2 101.9 100.9 99.6 100.1 103.0 101.0 Mar- 104.5 100.1 103.1 94-4 115.2 102.5 102.1 102.1 99.8 100.5 103.1 100.6 Apr 105.5 100.4 104.I 94-5 116.7 100.1 .101.9 104.1 100.6 100.8 103.5 100.8 May 102.9 100.7 104.4 95.2 116.9 99.6 102,0 104.5 101.0 101.5 103.7 100.3 June- 103.0 100.9 101.0 93.9 115.3 99.8 102.2 104.9 101.3 102.2 104.5 99-8 J u l y 102.1 100.9 101.7 94.2 114.6 98.3 102.6 IO4.7 101.7 101.7 104.6 100.2 Aug 100.2 101.4 102.9 94.2 115.2 98.1 102.6 102.5 101.9 100.9 104.2 99.6 Sept- 99-6 102.5 102.9 94.1 114.8 98.1 102.1 102.0 102.1 101.0 103.5 99.1 Oct 98.3 103.2 102.3 96.3 115.0 97.7 101.1 101.2 102.2 101.5 103.2 99.4 Nov 95.1 104.3 98.9 97.3 115.5 99.0 100.0 100.9 101.6 100.8 105.6 99-0 Dec- 94-9 105.9 101.0 97.7 117.1 99.8 99-9 101.8 100.8 104.4 60 TABLE IX (inverted) #14 Bus. F a i l u r e s & L i a b i l i t i e s 1956 1958 I960 1962 1964 1966 Jan 59-61 52.88 IOI.53 91.69 111.67 Feb 61..20 57.60 86.03 119.29 94.5? Mar- 54.61 61.57 74.89 110.67 98.73 Apr 58.12 65.71 108.58 107.10 IO6.93 May 61.20 76.52 94.54 97.92 92.41 .June- 59.15 121c31 91.70 I56.I9 111.23 J u l y 52.10 71.04 107.98 125.14 62.84 Aug 53-20 94-66 121.85 90.99 159.29 Sept- 52.90 86.02 106.02 118.59 128.77 Oct 56.10 85.98 129.87 97.98 128.02 Nov 58.12 8O.44 96.62 111,00 116.90 Dec- 59-85 82.78 99.61 126.49 194.09 1957 1959 1961 1963 1965 1967 Jan 62.12 77.79 I46.46 84.54 118.61 Feb 52.80 83-73 93.05 107.57 111.23 Mar- 56.21 116.17 94-12 146.29 108.87 Apr 55.71 76.88 88.15 79.51 110.80 May 46.71 82.96 115.05 159.09 93.00 June- 50.90 86.69 91.07 135.66 87.20 J u l y ' 51.92 80.15 144.50 120.64 64.15 Aug 55.10 94.47 52.86 128.98 98.29 Sept- .57.61 126.12 94-52 108.56 93-10 Oct 55-32 72.28 99-92 85.67 98.0 Nov 55.40 119.93 255.72 66.65 77.24 Dec- 59.72 71.81 87.17 128.06 Index of Consumer Sent - By Smoothing the Curve of Quarter Dat 1956 1958 i960 1962 1964 1966 78.5 98.0 97.2 99-0 101.0 78.5 98.9 97-2 99.0 99.8 78.8 97-0 97-0 98.8 98.0 79.2 96.O 96.2 98.5 96.7 80.9 92.9 95.4 98.1 95.8 98.1 80.9 92.0 94-3 98.1 94.0 98.7 84.0 91.2 93-0 98.8 92.2 99.9 86.0 90.7 91.6 99-4 91.1 100.0 88.0 90.5 91.6 100.2 90.4 100.1 90.8 90.1 92.8 100.0 89.5 100.2 92.0 90.2 95.0 99.8 88.5 100.2 93.0 90.7 95-0 99-4 88.5 1957 1959 1961 I963 1965 1967 99-5 93.8 91.1 94-8 100.0 90.1 98.0 94.4 91-4 94.8 101.5 92.2 97.3 94-8 91.7 93-4 101.7 93-0 96.0 95.1 91.9 92.3 101.9 93-7 95.0 95.5 92.3 91-4 102.2 94-9 92.9 95-1 92.5 92.0 102.4 95-0 91.4 95-0 93-0 95.0 103.0 96.O 90.0 94.8 93.2 96.2 105.2 96.5 88.0 94-2 93-7 96.4 103.0 96.0 86.2 94-0 94.0 9606 102.8 94.5 83.7 95-8 94-4 96.9 102.6 93.O 83.7 93-8 95-0 97.2 102.0 61 TABLE X #85 Change i n Money Supply 1956 1958 I960 1962 1964 1966 Jan -1.25 2.75 4-58 7.92 Feb -.90 3.00 5-28 2.88 Mar- -2.60 +5.6O 5.17 6.36 Apr .75 +2.85 ' 3.10 9.24 May '4.90 -1.20 4-10 -2.16 June- 4.60 1.60 4.55 2.88 J u l y +2.01 +.95 +5.10 4.92 Aug -.61 -.70 8.10 1.44 Sept-r -2.43 -1.02 6.10 2.88 Oct 0.00 5.04 5.26 -2.76 Nov 3.60 4-95 4-85 0.00 Dec- 2.75 5-05 2.50 2.16 #112 Change i n Bus. Lotus B i l l i o n $ 1956" 1958. i960 1962 1964 1966 3.25 5.01 3.45 14.10 6.10 3.25 1.01 6.24 4.10 4-00 3.20 8.76 6.85 3.80 5.00 8.50 2.10 4.40 5.05 9-58 -.70 4-69 4.20 17.70 1.85 4-75 5.15 21.11 2.00 4.70 8.21 2.89 1.60 4.73 4.25 0.67 .85 4-85 8.21 5.93 -.10 3-40 9.20 2.63 + .60 2.05 12.20 .14 1957 1959 1961 1963 1965 1967 1957 1959 1961 1963 1965 1967 Jan 4.90 5.15 2.28 -0.72 •98 1.90 9.90 6.01 Feb 4.65 4.75 3.00 8.40 .90 i»97 12.67 .86 Mar- 3.90 2.45 2.28 11.16 2.79 2.75 11.34 6.83 Apr 4.60 4'. 60 3.72 -2.76 1.95 2.85 7.68 9.25 May 3.20 4.75 0.00 12.48 1.75 3.10 10.38 I.63 June- •79 5-10 6.72 II.64 1.00 2.51 10.09 8.16 J u l y 4.25 2.38 5-16 11.52 • 90 2.63 14.12 16.46 Aug 5.80 4-95 5-88 8.04 5.80 • 50 5.25 5.39 -9.44 Sept- 4.10 7-85 5-88 1.32 4.05 2.15 10.00 7.87 -2.34 Oct 6.13 5.20 8.76 6.72 4.16 1.10 6.51 7.45 5-38 Nov 4.10 4.10 3.60 -7.32 3.68 1.95 5.80 6.96 1.88 Dec- 2.60 -2.15 7.92 4.05 3.00 -•30 5.30 TABLE XI Survey Research Centre The U n i v e r s i t y of Michigan F ive -Ques t ion I n d e ^ j o f J ^ o n s ^ Sentiment ( f o r a l l f a m i l i e s — 1952 to May 1965) Nov-Dec. 1952 86.2 Jan-Feb. 1962 97.2 Jan-Feb. 1953 90.7 May 1962 95.4 Sept -Oct . 1953 80.8 Aug-Sept . 1962 91.6 J an-Feb. 1954 82o0 Nov-Dec. 1962 95-0 June 1954 82.9 Jan-Feb. I963 94.8 October 1954 87.0 May 1963 91.4 June 1955 99-1 August 1963 96.2 October 1955 99.7 November 1963 96.9 May 1956 98.2 Jan-Feb. I964 99-0 August 1956 99.9 May-June I964 98.1 Nov-Dec. 1956 100^2 September 1964 100.2 June 1957 92.9 December I964 99-4 Nov-Dec. 1957 83-7 February 1965 101.5 Jan-Feb. 1958 78.5 May-June 1965 102.2 May-June 1958 80.9 August I965 103.2 October 1958 90.8 November 1965 102.6 May-June 1959 95.3 February 1966 99.8 Oct-Nov. 1959 93.8 May 1966 95-8 ' Jan-Feb. i960 98.9 August 1966 91.1 May i960 92.9 Nov-Dec. 1966 88.3 Oct-Nov. i960 90.1 February 1967 92.2 Jan-Feb. 1961 91.1 May-June 1967 94-9 May-June 1961 92.3 August 1967 96.5 November 1961 94.4 TABLE X I I Standard and Poor 500 1956 Jan 44.15 1959 Jan 55.62 Feb 44-43 Feb 54.77 Mar 47.49 Mar 56.15 Apr 48.05 Apr 57.10 May 46.54 May 57.96 June 4-6.27 June 57.46 J u l y 48.78 J u l y 59-74 Aug 48.49 Aug 59-40 Sept 46.84 Sept 57.05 Oct 46.24 Oct 57-00 Nov 45.76 Nov 57.25 Dec 46.44 Dec 59-06 1957 Jan 45.43 I960 Jan 58.05 Feb 43.47 Feb 55-78 Mar 44.03 Mar 55.02 Apr 45.05 Apr 55.73 May 46.78 May 55.22 June 47.55 June 57.26 J u l y 48.51 J u l y 55.84 Aug 45.84 Aug 56.51 Sept 43-98 Sept 54.81 Oct 41.24 Oct 55-73 Nov 40.35 Nov 55-47 Dec 40.33 Dec 56.80 1958 Jan 41.12 1961 Jan 59.72 Feb 41.26 Feb 62.17 Mar 4 2 . l l Mar 64.12 Apr 42.34 Apr 65.83 May 43-70 May 66.50 June 44.75 June 65.62 J u l y 45-98 J u l y 65.44 Aug 47.70 Aug 67.79 Sept 48.96 Sept 67.26 Oct 50.95 Oct 68.00 Nov 52.50 Nov 71.08 Dec 55-49 Dec 71.74 Index 1941-5 = 100 1962 Jan 69.07 I965 Jan 86.12 Feb 70.22 Feb 86.75 Mar 70.29 Mar 86.85 Apr 68.05 Apr 87-97 May 62.99 May 89.28 June 55.63 June 85.04 J u l y 56.97 J u l y 84-91 Aug 58.52 Aug 86.49 Sept 58.00 Sept 89.38 Oct 56.17 Oct 91 = 39 Nov 60.04 Nov 92.15 Dec 62.64 Dec 91.75 1963 Jan 65.O6 1966 Jan 93.22 Feb 65.92 Feb 92.69 Mar 65.67 Mar 88.88 Apr 68.76 Apr 91.60 May 70.14 May 86.78 June 70.11 June 86.06 J u l y 69.07 J u l y 85.84 Aug 70.98 Aug 80.65 Sept 72.85 Sept 77.81 Oct 73.03 Oct 77.13 Nov 72.62 Nov 80.99 Dec 74.17 Dec 81.35 1964 Jan 76.45 1967 Jan 84-45 Feb 77.59 Feb 87-56 Mar 78.80 • Mar 89.42 Apr 79-94 Apr - 90.96 May 80.72 May 92.59 June 80.24 June 9-1.43 J u l y 83-22 J u l y 93-01 Aug 82.00 Aug 94.49 Sept 83-41 Sept 95.81 Oct 84.85 Oct 94.92 Nov 85-44 Dec 85.96 Dec 96.11 CHAPTER IV TECHNICAL INDICATORS In t h i s chapter v/e w i l l examine the theory of the te c h n i c a l study and p o s i t i o n of the market, and (the d e s c r i p t i o n of the market movement under) the Dow Theory - An explanation of what te c h n i c a l i n d i c a t o r s are w i l l be provided, along with a l i s t of the c u r r e n t l y used ones that w i l l be included i n our a n a l y s i s . The l o g i c of t h e i r use and method of a p p l i c a t i o n w i l l also be reviewed. A method of using them In an aggregate measure w i l l be discussed, and i t s construction w i l l be l e f t f o r Chapter V. THEORY OP THE TECHNICAL STUDY AND POSITION 01' THE MARKET The t e c h n i c a l study of the market has often been r e f e r r e d to as a study of the supply and demand schedules f o r a stock or f o r the stock market as a whole. As mentioned e a r l i e r , Cohen & Zinbarg l i k e n i t to the study of recurrent patterns of p r i c e movements and other market data.(^) They recognize that p r i c e movements r e f l e c t the opinions of m i l l i o n s of d i f f e r e n t people, and thus i t i s u n l i k e l y that the analyst would know i n a l l cases why the discovered patterns occur. (1) G a r f i e l d Drew sees the t e c h n i c a l study of the market as an attempt to measure the psychological changes that are taking place i n the thousands of i n d i v i d u a l s whose c o l l e c t i v e a c t i o n makes up a l l the pr i c e movements of the market.(2) This he believes i s the heart of t e c h n i c a l study, although he concedes that i t i s u s u a l l y c a l l e d determining supply and demand. Drew (^Cohen, J.B. and Zinbarg, E.D. Investment Analysis and P o r t f o l i o Management, p. 503, Publ. R.D. Irwin i n c . I967. (2) 'Drew, G a r f i e l d A. New Methods f o r P r o f i t i n the Stock Market p. I69, Publ. Eraser P u b l i s h i n g Co., 1966. ' ana;. views that the market r e f l e c t s human behaviour. I t s p r i c e f l u c t u a t i o n s r e s u l t from the actions of many human beings motivated i n buying and s e l l a He st a t e s : " I f i t was known j u s t how the pu b l i c would react to any given market s i t u a t i o n , how p r o f e s s i o n a l traders would behave, what investment t r u s t s would do, etc., beating the market would be comparatively easy."(2) Eiteman describes the te c h n i c a l study of the market as a study of the momentary structure of the market i t s e l f . ( 4 ) g e categorized the conditions that make up the market and c a l l e d them t © clinic cil f a c t o r s . The i n t e r a c t i o n of these c o n d i t i o n s , taken at any one time, comprise what i s c a l l e d the t e c h n i c a l p o s i t i o n of the market. His t e c h n i c a l f a c t o r s are described as follows:(5) 1. Investors: shareholders i n t e r e s t e d i n long term p r i c e trends 2. Traders: shareholders i n t e r e s t e d i n short term p r i c e trends 3- B u l l s : those hoping f o r r i s e s 4 . Bears: those hoping f o r declines 5. Longs: those who own the shares they hold 6. Shorts: those who have so l d shares they borrowed 7. F l o a t i n g Supply: shares that can be purchased s l i g h t l y higher than current quotations 8. Investment Holdings: shares that can be purchased only at prices much higher than current quotations ^ I b i d . , p. 169. (^Eiteman, Y7.J. et a l The Stock Market, 4th Ed., r>. 403 Publ. McGraw-Hill 1966. ^ I b i d . , p. 403 With the i n t e r a c t i o n of a l l these f a c t o r s i n the market, Eiteman v i s u a l i z e d many combinations of s i t u a t i o n s , or t e c h n i c a l s i t u a t i o i . s that could develop. For example, the f l o a t i n g supply of stock could be in stron hands, (wealthy traders) or i n weak hands, (small traders) or traders may have accumulated more stock than they can d i s t r i b u t e at current p r i c e l e v e l s , or at times they may be short more stock than what i s contained i n the f l o a t i n g supply. Eiteman develops a theory of i n t e r a c t i o n between fundamental f a c t o r s and t e c h n i c a l f a c t o r s to expla i n four possible market s i t u a t i o n s with these two classes of v a r i a b l e s . (^ The theory runs as follo w s : A short term p o s i t i o n of e q u i l i b r i u m w i l l e x i s t when no c o r r e c t i o n between the t e c h n i c a l s i t u a t i o n s i s necessary. However, t h i s i s short l i v e d , as the f l o a t i n g supply of stock i s too large or too small, or short term traders are overbought or oversold. A market d i s e q u i l i b r i u m develops, and as i t gets f u r t h e r away from i t s short term e q u i l i b r i u m a set of c o r r e c t i v e forces develop and b r i n g about a r e v e r s a l of the e x i s t i n g p r i c e movement. This i s characterized by a se r i e s of wave l i k e p r i c e movements. The market being t e c h n i c a l l y weak i f the s i t u a t i o n c a l l s f o r downward movement, and t e c h n i c a l l y strong i f i t c a l l s f o r an upward movement. As these t e c h n i c a l movements are occurring, another movement created b y the re v a l u a t i o n of i n t r i n s i c stock values by fundamentalists i s occurring. This movement was recognized by Eiteman as an underlying trend, and was upward or downward depending on the appra i s a l of fact o r s such as earnings per share, costs of production, and dividend p o l i c y . The market being fundamentally strong when successive notions of i n t r i n s i c value are ^ I b i d , , p. 403. 67 h i g h e r , and fundamental ly weak when the reverse o c c u r s . As the theory r e l a t e s , the market i s thus composed of two movements; a general vpward or downward'trend, r e f l e c t i n g fundamental f a c t o r s ; and wavel ike d e v i a t i o n s above and below t h i s t r e n d , r e p r e s e n t i n g t e c h n i c a l f a c t o r s . These movements are i n d i c a t e d by F igures 5 and 6, and represent four market s i t u a t i o n s . 1 . Fundamentally weak and t e c h n i c a l l y s t rong 2. Fundamentally weak and t e c h n i c a l l y weak 3. Fundamentally s t rong and t e c h n i c a l l y s t rong 4. Fundamentally s t rong and t e c h n i c a l l y weak Condi t ions 1 and 2 are represented i n F igure 5- The XY l i n e represents the downward t rend o f the fundamental s i t u a t i o n when i t i s weak. The mn curve represents the t e c h n i c a l movements. F igure 5 Fundamentally weak market T e c h n i c a l l y s t rong or weak market C o n d i t i o n one occurs as XY represents the downward .fundamental t r e n d , and p o i n t s b , d , f , ' & h represent t e c h n i c a l l y s t rong p o i n t s . Cond i t i on two occurs w i th XY, and at p o i n t s of t e c h n i c a l weakness a , c, e, & g . . > — — p t Figure 6 Fundamentally s t rong market T e c h n i c a l l y weak or s t rong 68 C o n d i t i o n three i s represented by a Fundamentally s t rong trend XY, and T e c h n i c a l l y weak p o i n t s a , c , e, g . C o n d i t i o n f o u r i s represented by a Fundamentally s t rong t rend XY and T e c h n i c a l l y s t rong p o i n t s b , d , f . Eiteman thus expla ined the t e c h n i c a l market a c t i o n i n an uptrend and a downtrend o f u n d e r l y i n g market s t r e n g t h . These t e c h n i c a l movements are synonymous w i t h the secondary trends that are descr ibed i n the Dow Theory. DOW THEORY A c o n s i d e r a t i o n of the Dow explanat ion of market movements can draw Ei teman 1 s exp lana t ion o f t e c h n i c a l f a c t o r s i n t o the concept of a complete s tock market c y c l e . To e x p l a i n the Dow Theory of the t e c h n i c a l a c t i o n of the market , we can combine F igures 5 and 6 to g ive a complete c y c l e from Bull through Bear market . F igure 7 Dow Concept of a Market Major Trend D i s t r i b u t i o n primary Trend-> ^ # "-Secondary Dynamic / [ / Trend X \ Panic Stage J/ \ ' s e l l i n g B u l l Market Bear Market The theory as explained "by Edwards and Magee i s describea as f o l l o w s : (7) The p r i c e s of stocks move i n three trends; Primary, Secondary and Minor. As minor trends, being day to day f l u c t u a t i o n s are not pertinent to our a n a l y s i s , they w i l l be disregarded. Primary trends are the broad up and down, movements that l a s t f o r more than a year. They are comprised of secondary trends, - or contrary p r i c e movements, to the long term trend, which l a s t f o r at l e a s t 3 weeks. They are the corrections that occur during B u l l Markets, and recoveries which occur i n Bear Markets. Normally they retrace 1/3 to 2/3 of the gain (or l e s s as the case may be) i n p r i c e s r e g i s t e r e d i n the preceding swing i n the Primary d i r e c t i o n . The ac t i o n of these trends has been l i k e n e d to a movement of the t i d e and waves. The primary movement being the t i d e , and the secondary movement being waves. The incoming t i d e i s analogous to a B u l l Market, and outgoing t i d e to that of a Bear Market. As the t i d e reaches to i t s peak, the waves wash fur t h e r and f u r t h e r on the shore, t i l l a high water mark i s reached and then t h e i r successive momentum gradually diminishes. Then follows the ebb t i d e comparable to a Bear Market and t h e i r movement recedes from the high wa.ter mark. Dow theory c l a s s i f i e s market a c t i o n i n t o four phases; accumulation, dynamic, d i s t r i  bution, and panic. Figure 7 i l l u s t r a t e s these phases and the primary and secondary movements i n the market. Phase I - Accumulation: This phase u s u a l l y occurs at the bottom of a Bear and beginning of a B u l l market. At t h i s point, f i n a n c i a l reports of companies are bad, and business conditions are depressed. Far sighted investors can forecast a (^Edwards, R. and Magee, J . Technical Analysis of Stock Trends p . 13. business upturn and proceed to pick up stocks from discouraged and d i s t r e s s e d s e l l e r s . . As they accumulate the f l o a t i n g stock, p r i c e s tend to r i s e , Phase I I - Dynamic: Business reports and earnings s t a r t to improve and i n t e r e s t i s created i n the market. Stock p r i c e s advance s t e a d i l y , and at t h i s p o s i t i o n , the t e c h n i c a l trader i s most a c t i v e . The small investor also regains some i n t e r e s t and p a r t i c i p a t e s s l i g h t l y . Phase I I I - D i s t r i b u t i o n : A l l f i n a n c i a l news i s good, and p r i c e s on some issues advance i n a spectacular fashion. New issues appear, the p u b l i c gets aroused and purchases run rampant, causing the market to b o i l over. At t h i s stage, the trader who purchased i n the dynamic stage i s taking h i s p r o f i t s as he d i s t r i b u t e s h i s stock to the eager buyers. This stage characterizes a switch from a B u l l to a Bear market. The p r o f e s s i o n a l traders, astute investors and some of the i n s t i t u t i o n s have lightened t h e i r p o r t f o l i o s i n a n i t i c i p a t i o n of weaker business conditions. Much of the stock i s now i n weaker hands, but the value and trading remains high, with more frequent market dips as some of the fervour diminishes. As unfavourable earnings and business reports appear much of the public shows signs of f r u s t r a t i o n as hoped f o r p r o f i t s fade away. Phase IV - Panic S e l l i n g : Buyers t h i n out and s e l l e r s become more urgent, the downward, trend accelerates i n t o an almost v e r t i c a l drop and volume mounts to c l i m a c t i c proportions. A f t e r t h i s s e l l o f f , there i s a sidewise a c t i o n , previous to the holdouts from panic s e l l i n g g e t t i n g discouraged. There i s now a second s e l l o f f , mainly of a l l the poorer q u a l i t y stocks that had appreciated out of proportion during the dynamic stage. As we approach the bottom of the Bear Market, the holders of blue chip stocks, who had the courage to weather the panic s e l l i n g , now become discouraged from the length of market depression, and s e l l o f f at low p r i c e s a n t i c i p a t i n g that they w i l l buy back at s t i l l lower l e v e l s . According to the Dow theory, the f i n a l stage of a Bear Market i s frequently concentrated i n such issues and the end i s reached when the worst news to be expected has been discounted. WHAT ABE TECHNICAL INDICATORS AND YJHAT ARE USED? Eiteman described t e c h n i c a l i n d i c a t o r s as s t a t i s t i c a . l data that are used to a s c e r t a i n the t e c h n i c a l p o s i t i o n of the market. (8) He stressed that there are no absolute c r i t e r i a , but c e r t a i n ascertainable f a c t s y i e l d clues about what i s going on i n the market. He i s also ever cautious to the fa c t that changing circumstances can destroy the v a l i d i t y of a past r e l a t i o n s h i p . Some of the more important s t a t i s t i c a l data used to judge the tec h n i c a l strength of the market include: (9) 1. Number of advances and declines 2. New Highs and New Lows 3. C r e d i t Balances i n Brokers Accounts 4. Q u a l i t y of Market Leadership 5. Volume of tr a d i n g 6. Odd l o t purchases and sales (^Eiteman, Y/.j. o p . c i t . , p. 4O8 (9) w ; I b i d . , p. 4O8 LOGIC OF USE AND tIBTHOD OF APPLICATION OF THE INDIVIDUAL INDICATORS Technical analysts are i n t e r e s t e d i n p r e d i c t i n g minor and i n t e r  mediate, at v/ell as primary trends i n the market. The coverage of a n a l y s i s i n t h e i r method i s therefore much broader than that of business cycle a n a l y s i s . In the l a t t e r we are p r i m a r i l y concerned with detecting the changes i n primary trend. As the a p p r a i s a l i n t h i s study i s concerned with the movements i n the primary trend, our i n v e s t i g a t i o n i n the f i e l d of t e c h n i c a l a n a l y s i s w i l l be so d i r e c t e d , and consideration w i l l be given to the secondary trend only as an influence on the primary trend. The l o g i c of the use of t e c h n i c a l i n d i c a t o r s i s explained by G.K. Freeman.(x®) A d e s c r i p t i o n of h i s support f o r t h e i r use i s as f o l l o w s . The underlying trend of the market Is not always recognized by the w e l l known averages. This i s p a r t i c u l a r l y noticeable towards the end of a B u l l market, where the performance of a large group of stocks f a l l s below the averages. Freeman recognizes t h i s pattern even under Dow Theory, which i s based on averages. Under Dow theory, a recognition i s given to the over lapping of two phases under a B u l l and a Bear market. In the d i s t r i b u t i o n phase of a B u l l market there Is disparate movement, that i s not recognized by the averages, when investors s e l l stocks to f e v e r i s h latecomers. The same s i t u a t i o n e x i s t s at the end of a Bear market i n the accumulation phase, where astute investors buy stocks from the discouraged p u b l i c . Here again, the i n t e r n a l d e t e r i o r a t i o n of one market and the strengthening of another i s not s i g n a l l e d by the averages. Freeman sees the averages as a means of d e p i c t i n g (10Weman, G.K. "Advance Decline Line" Elements of Investments Zakon et a l . , p. 408, Publ. Holt Rhinehart & Winston, I965. the sub surface c o n d i t i o n of the market only i n the middle phases of a B u l l or a Bear market. On t h i s l o g i c , he sees the v a l i d i t y of s t a t i s t i c a l i n d i c e s i f they are able to i d e n t i f y vhe u n d e r l y i n g c o n d i t i o n of the market at p o i n t s of d i spara te movements such &v the d i s t r i b u t i o n or accumulation phase. One of the i n d i c a t o r s which he p a r t i c u l a r l y advocates as being an e f f e c t i v e measure, i s the Advance-Decline L i n e . ADVANCE-DECLINE INDICATOR The s t a t i s t i c s used i n t h i s se r i e s are der ived from New York Stock Exchange da ta . Advances are the number of i ssues that c losed up, and d e c l i n e s are the number of i ssues that c losed down on a c e r t a i n day. The method of a p p l i c a t i o n i s based on a comparison of the Advance-Decline data w i t h current movements of the Standard and Poor 500 s tock p r i c e index , to der ive a f o r e c a s t of the most l i k e l y next movement of the index . Eiteman descr ibes four bas ic r u l e s upon which forecas ts of t h i s i n d i c a t o r are based. (11) 1. I f advances exceed d e c l i n e s , and the p r i c e index r i s e s , the index w i l l continue to r i s e . 2 . I f advances exceed d e c l i n e s , and the p r i c e index d e c l i n e s , the downward movement of the index i s about to be reversed . 5. I f dec l ines exceed advances and the p r i c e index i s r i s i n g , the r i s e of the index i s about to be reversed . 4 . I f dec l ines exceed advances and the p r i c e index i s f a l l i n g , the d e c l i n e of the index w i l l cont inue . ^ E i t eman, XI.J. o p . c i t . , p . 409-He bases h i s l o g i c f o r these r u l e s on the f o l l o w i n g assumption: A p r i c e index of the averages i s based on a c e r t a i n number of stocks and tends to be more representative of the market leaders. By contrast, an i n d i c a t o r r e l a t e d to advance-decline data i s representative of the market as a whole. I t i s beli e v e d that the p r i c e s of market leaders cannot continue to move i n opposition to the market as a whole, and eventually w i l l move to conform to that of the market. The longer that the market leaders r e s i s t t h i s change, the more c e r t a i n i t i s that the d i r e c t i o n of the movement w i l l be reversed. This i n d i c a t o r i s compiled on d a i l y or weekly data, depending on the purpose f o r which i t i s used. D a i l y data i s used to form i n d i c a t o r s that are u t i l i z e d i n f o r e c a s t i n g minor and po s s i b l y secondary trends i n the stock indexes. Yfeekly data i s more often used i n the f o r e c a s t i n g of secondary and primary trends. In t h i s a n a l y s i s , the l a t t e r data only i s consid.ered, as i t i s more e a s i l y a p p l i c a b l e to our purpose. "various s t a t i s t i c a l combinations are used by analysts such as 3 day moving averages and res i s t a n c e indexes, however, we w i l l be concerned with the more c u r r e n t l y used Advance-Decline Line i n t h i s a n a l y s i s . Hereafter, the Advance-Decline l i n e w i l l be r e f e r r e d to as the A-D l i n e . Freeman as prev i o u s l y mentioned, i s a strong advocate of the A-D l i n e as an i n d i c a t o r . He has found that the trend of the A-D l i n e reveals whether the number of stocks which are r i s i n g i s growing l a r g e r or smaller, and he recommends i t as a barometer of the strength of B u l l markets and the weakness of Bear m a r k e t s . ( x ^ His d e s c r i p t i o n of construction, and method of a p p l i c a t i o n i s as fo l l o w s . The compilation from weekly data, i s presented, as Freeman found that these r e s u l t s formed an index of good fore c a s t i n g (12) v /Freeman, G.K. o p . c i t . , p.410 q u a l i t i e s , coraparable to the d a i l y index. The data are the weekly t a b u l a t i o n of Friday through Friday p r i c e changes which appear i n Barron's. The c a l c u l a t i o n i s a simple cumulative algebraic t o t a l of advances and decl i n e s as reported weekly. For example: Net Advance-Declines Index Value Week I - 200 Declines (- 200) - 200 Week I I - 350 Advances (+ 350) + I50 Week I I I - 75 Advances 75) + 425 Week IV - 120 Declines (- 120) + 305 Freeman compared the performance of the Advance-Decline Line against the Dow Jones I n d u s t r i a l Index from the period of 1950 to I962. to) His observations were as fo l l o w s : 1. B u l l markets as i n d i c a t e d by the A-D l i n e generally reach a momentum peak w e l l before the averages. 2. In e a r l y 1955> early 1959 and mid-196l, the i n d i c a t o r reached a peak s u b s t a n t i a l l y ahead of f a r more important peaks i n the average. '3« The t y p i c a l pattern i s revealed i n Figure 8. The absolute peak i n the A-D l i n e appears before a market peak of importance. I t seldom coincides with the f i n a l top of the Average. The market rebounds from i t s c o r r e c t i o n , and goes on to new highs, but the A-D l i n e which has passed i t s major peak, f a i l s to reach a new high on the upswing. This d i s p a r i t y i n d i c a t e s that some stocks have already passed B u l l market peaks. This sequence may occur f o r several Freeman, G-.K. o p . c i t . , p. 409 months, and e v e n t u a l l y , the average f i n d i n g fewer and fewer stocks p a r t i c i p a t i n g i n p r i c e advances, dec l ines as th^ A-D l i n e had done long be fore . 700 - Fi/-<ure 8 The Advance-Decline Line • i p — — p — — - p Source: Elements of Investments Zalcon, A . J , NEtf HIGHS AND UM LOV/S A measure of d i s p a r i t y between p r i c e and market breadth i s attempted by the use of an index formed from new highs and new lows (hereafter des crib e d as NH's and NL's). As i n the theory underlying the A-D l i n e , the NH's and NL's index may r e v e a l an impending weakness of p r i c e trends near market peaks and strength near market lows. I t i s argued that as a p r i c e appreciation continues, a decline i n NH's and an increase i n NL's, i s evidence that fewer stocks are p a r t i c i p a t i n g i n the trend. S i m i l a r l y , as a market de c l i n e continues, fewer NL's and greater NH's may i n d i c a t e that the trend i s about to reverse. (14) The use of t h i s index Is of p a r t i c u l a r value a/t t u r n i n g points i n the market c y c l e . I n i t i a l weakness i s i n d i c a t e d i n a t r a d i n g phase when NH's decline p r i o r to an advance i n NL's. S i m i l a r l y , i n an accumulation phase, a decline i n NL's with an increase i n fi l l ' s w i l l occur. A technique s i m i l a r to that used i n the c a l c u l a t i o n of the advance- decline l i n e i s used, where an algebraic cumulative t o t a l i s computed on the data of the NH's and NL's. The cumulative t o t a l of NH's and NL's (henceforth r e f e r r e d to as N.H.N.L. Index) operates i n a manner s i m i l a r to the advance-decline l i n e . This i s i l l u s t r a t e d i n Figure 9- These concepts are discussed by G.A, Drew, New Methods f o r P r o f i t i n the Stock Market. 70 Quanti Vy Figure 9 . N . L . ex S.& P.500 Index Time F igure 9 As the dynamic phase begins , the net new highs are p o s i t i v e , " a n d therefore the index r i s e s wi th the p r i c e averages, u n t i l at some po in t near the onset of the t r a d i n g area the ra te of increase of NH's decrease and N L ' s inc rease , and the NIINL Index diverges from the movement of the p r i c e averages.. As the t r a d i n g area i s passed, the index of p r i c e averages d e c l i n e s , and i t s d i r e c t i o n has been preceded by the NHNL Index. As the Bear market ensues and the accumulation stage i s reached, the NH's tend to exceed the N L ' s , and an upturn i n the index occurs . The w r i t e r uses a monthly c a l c u l a t i o n of the NH's and N L ' s i n h i s index , and p l o t s them against the monthly f i g u r e f o r the S. and P . 500 p r i c e average. 79 CREDIT BALAECES IN BROKERAGE ACCOUNTS The theory behind the use of th i s i n d i c a t o r has been ou t l i n e d by Cohen & Zinbarg ana i s described as f o l l o w s . ( 1 5 ) When an Investor disposes of a. holding of stock he can do e i t h e r of two things with h i s funds: a. He can leave an account balance, i f he intends to reinves t h i s funds, and draw i n t e r e s t on the balance. b. He can withdraw h i s funds, i f he does not foresee any r e  investment opportunity. When t h i s amount r i s e s s t e a d i l y , i t in d i c a t e s that strong buying'potential i s b u i l d i n g up, as investors are keeping funds f o r reinvestment. The c r u c i a l part of the theory, i s s i m i l a r to that of the odd l o t t e r that sentiment u s u a l l y tends to change at the wrong time. The owners of these funds are awaiting a market setback, to step i n and buy, but, l i k e the odd l o t t e r , as the market moves toward i t s peak, they begin t h e i r reinvestment, and t h e i r c r e d i t balances d e c l i n e . This decline i n balances, which represents a weakening of p o t e n t i a l buying support, u s u a l l y precedes major stock declin e s . This i s expressed i n Figure 10. I t can also be noted, that the downtrend i n customers' balances has u s u a l l y ended before the bottom of the Bear market. The p r e d i c t i o n of t h i s i n d i c a t o r i s , however, better at tops than at bottoms. The i n d i c a t i o n of an upturn i n the years 1949 and 1953 were almost coincident with the stock index, whereas the end of a primary phase expansion was predicted i n 1946, 1951, 1955, 1959 and ]96l (15) v ^Cohen, J.B. and Zinbarg, E.D. o p . c i t . , p. 514 80 Figure 10 Stock Prices and Credit Balances in Brokerage Accounts 1941-43=10 ratio scale Source: Investment A n a l y s i s and P o r t f o l i o Management - Cohen and Zinbarg The w r i t e r has chosen to form a monthly index o f C r e d i t Balances i n Brokerage Accounts to cover the per iod 1956 to 1967• This index i s compared to the Standard and Poor 500 index on a monthly b a s i s , and a short term f o r e c a s t i s made. This d e c i s i o n i s incorpora ted i n t o the composite index of t e c h n i c a l i n d i c a t o r s . QUALITY OP MARKHP LBaDERSHIP The s t a t i s t i c s used are the d a l l y quotations In the Wall Street Journal of the average c l o s i n g p r i c e of the 10 most a c t i v e stocks. This average v a r i e s s i g n i f i c a n t l y from day to day, and i t i s believed by seme t e c h n i c a l analysts that i t reveals the q u a l i t y of market leadership. Eiteman explains the l o g i c of t h i s theory i n the f o l l o w i n g manner. (16) The basic assumption of the theory i s that high q u a l i t y Issues s e l l f o r higher p r i c e s than do low q u a l i t y issues. Thus on any one day, the 10 most a c t i v e stocks may be market leaders or on another day they may be low q u a l i t y , commonly r e f e r r e d to as "cats and dogs". In the accumulation stage of a B u l l market, a l l stocks tend to be underpriced, hence investors p r e f e r and w i l l purchase high q u a l i t y i s s u e s . As high q u a l i t y issues move up i n p r i c e , they tend to be u n a t t r a c t i v e , so investors switch some of t h e i r preference to lower q u a l i t y issues which now seem underpriced. As the p r i c e s r i s e i n the market and we pass through the dynamic phase i n t o the d i s t r i b u t i o n phase, we f i n d many investors becoming l e s s d i s c r i m i n a t i n g and bold, hence we have much a c t i v i t y i n the "cats and dogs". I t i s at t h i s point that traders b e l i e v e that the end of a market r a l l y i s approaching and a c o r r e c t i o n i s imminent. As applied to the averages, Eiteman explained that when an important stock p r i c e average Is moving up, but the q u a l i t y measure was low or d e c l i n i n g , a near term decline of the stock averages was imminent. Also, i f the stock index was d e c l i n i n g and the q u a l i t y index was also d e c l i n i n g , the end of a Bear market was In the o f f i n g . An increase i n the q u a l i t y measure (16)T,.. 'EiL-eraan, vY.J. o p . c i t . , p. 420 p a r t i c u l a r l y i f associated with a high volume of tr a d i n g was thought to he i n d i c a t i v e of a continuing higher trend. An index formed from the monthly average of the data i s used i n t h i s a p p r a i s a l A p r e d i c t i o n w i l l be made on a monthly basis, and then incorporated i n t o a composite index. VOLITLIG OF TRADING H.M. Gartley r e l a t e s volume of tra d i n g to demand and supply. Ke develops a dif f e r e n c e between "demand" volume and "supply" volume to t h e i r value as i n d i c a t o r s . ( " ^ He assumes that the number of shares involved i n a purchase and sale constitutes volume. Then states that every .transa c t i o n i s the r e s u l t of a meeting of demand, on the one hand and supply on the other. When demand exceeds supply, p r i c e s tend to r i s e . Conversely, when supply exceeds demand, p r i c e s tend to f a l l . Therefore: 1. Volume which occurs during advances may be designated as demand volume. 2. Volume which occurs during declines may be termed supply volume According to Gartley, four r u l e s are generally accepted by t e c h n i c a l (IB) students f o r using volume of shares as an indicator.*- ' 1. When volume tends to increase during p r i c e declines, i t i s a bearish i m p l i c a t i o n . 2. When volume tends to increase during advances, i t i s a b u l l i s h i n d i c a t i o n . (17) ' G a r t l e y , H.M. "Volume of Trading - A Forecasting Factor" A Treasury of Wall Street Wisdom, p. 248. Shultz, H. and Coslow, S. T ' ' 5ress, Palisad ' i b i d . , p. 24c Investors Press es l\.1. 196 (18) o5-85 3. When volume tends to decrease during p r i c e declines, I t i s b u l l i s h . 4. When volume tends to decrease during p r i c e advances, i t i s bean sh. These premises being based on the changing l e v e l s of volume, not on any p a r t i c u l a r l e v e l . The l o g i c of these r u l e s i s strengthened by t r a c i n g the a c t i v i t y of volume through a major trend. Gartley gives a d e s c r i p t i o n of share volume through a b u l l and bear market that i s summarized as fo l l o w s , to) B u l l markets s t a r t out of the terminating dullness of bear markets. The f i r s t crescendo of a c t i v i t y i s characterized by a high volume of trad i n g , which c a r r i e s through to the peak of the intermediate trend, which terminates i n d u l l n e s s , from which the next intermediate trend begins. As the b u l l market continues, each intermediate advance occurs on greater volume than the previous one. F i n a l l y , a long period of trading f a i l s to produce a p r i c e r i s e , and a moderate decline occurs, with the volume remaining high. This i s the d i s t r i b u t i o n stage, and the beginning of the bear market. Bear markets s t a r t with a moderate decline i n prices and an increase i n volume, as the pu b l i c s t a r t s to worry. As the p r i c e declines i n a b u l l market, volume tends to decrease, but i n a bear market, the opposite occurs. When bearish sentiment develops, fear grows to panic, and the s e l l i n g volume r i s e s to a point where d a i l y trading f o r a time exceeds any seen i n the preceding b u l l market. The s e l l i n g climax, of the panic produces a r a l l y which terminates an intermediate trend. The major downtrend i s again to)Ibid., p. 254 84 resumed, accompanied by heavy volume, which does not equal that of tho f i r s t s e l l i n g c l i m a x . This sequence continues through the bear market, w i th each c l imax showing l e s s volume than the p r e v i o u s . In t ime, the force of the l i q u i d a t i o n becomes spent , and we reach the bottom of the bear market. As an a p p l i c a t i o n of volume o f shares to a n a l y s i s , Eiteman recommended the use of weekly or monthly data ra ther than d a i l y f i g u r e s , ' as he found the former more i n d i c a t i v e of a change i n major t rends . (20) Cohen and Z inbarg use a 6 month moving average of the volume of t r a d i n g , and compare t h i s to the Standard and Poor 425 I n d u s t r i a l Index as i n F igure 11. " M i l l . S h s . r a t i o s c a l e 8.0 7 - 2 6.4 5.6 4.8 4.0 .3.2 2.4 1.6 Figure 11 Stock P r i c e s and Volume of Trading Stock P r i c e s and Volume of Trading 1941-43=10 r a t i o s c a l o r - • — 1 j i ! - \ —Krh i V / / ^ / N / 1 A V C J 1 Ave (6 cage - m o n t ( D a i l y " I m o v l e f t s c ' r o d i n n g a v a l e ) g V o l i e r o g e ] m e / - A f i / i / A / \ 1 \ V , f S & f 'rt 1/ / / 1 i \ \ 1 1 4 A V ' 425 ( r i g h t n d u s f r s c a l e ) f a l s i • i 7 / t \ \ 1," 1 \ 1 ( A j > j ( / / ; 'N 1 1 u i / / i > i \ *\ / ' V . 1 1 / V ij i i 1 1 \ I 1 135 120 105 90 75 60 45 30 15 Source: Investment A n a l y s i s and P o r t f o l i o Management - Cohen and Zinbarg (20) Eiteman, V/ . J . o p . c i t . , p . 419 The author has chosen to use a monthly average of d a i l y volume and to smooth the s e r i e s with moving averages. The monthly p r e d i c t i o n derived from t h i s index w i l l he incorporated i n t o the composite index. ODD LOT FURCHASKS AND SALES The Odd Lot theory i s based on the psychology of act i o n of the small i n v e s t o r . He i s i d e n t i f i e d s t a t i s t i c a l l y as a purchaser of from 1 to 99 shares of a stock on the Hew York Stock Exchange, when the board l o t i s considered as 100 shares. The psychology of action of the small investor has been described by G a r f i e l d A. Drew, who i s recognized as the high p r i e s t of the Odd Lot Theory.^ J Drew explains the act i o n of the odd l o t t e r i n the market i n terms of the Humphrey B. N e i l l ' s theory of Contrary O p i n i o n . ^ ) The theory states that mass psychology i s the element of primary importance i n market speculation. (23) N e i l l believed that p r i c e i s determined by human opinion, and i f something changes that opinion, there w i l l be changes i n p r i c e , regardless of whether the cause of the change was r a t i o n a l . He assumed that any very widely held opinion may be proved wrong, and then would i n v e s t i g a t e the reasons f o r b e l i e v i n g i t may be wrong. Drew v i s u a l i z e s the market as c o n s i s t i n g of the less informed p u b l i c , and the p r o f e s s i o n a l s . The pub l i c outnumbers the pro f e s s i o n a l s , but the prof e s s i o n a l s have more influence on the market by nature of t h e i r knowledge, commitment, and access to funds. They are able to test the market, by buying large blocks of stock, to f i n d out whether purchase i s d i f f i c u l t or easy, (ol) v '"Is the Odd L o t t e r always wrong?" Business V/eek, Hay 6, 1967 p. 147 (22) v 'Drew, G a r f i e l d A. Hew Methods f o r P r o f i t i n the Stock Market, p. 190 Publ. 1955 - Eraser P u b l i s h i n g , V/ells Vermount to^Ibid., p > igy thereby l e a r n i n g how the p u b l i c f e e l s i n order that they may do the opposite.( 24) Drew does concede that the pub l i c i s not always wrong, but i n s i s t s that the p r o f e s s i o n a l s are more apt to be r i g h t because they are pl a y i n g a game they know.(^5) The odd l o t s t a t i s t i c s have been made a v a i l a b l e f o r current p u b l i c a t i o n by two large brokerage firms that transact most of the odd l o t business on the New York Stock Exchange. The figures have b^en a v a i l a b l e c a d a i l y published basis since early 1950- Many ap p l i c a t i o n s of these s t a t i s t i c s are i n use, but the more c u r r e n t l y accepted ones such as the Balance Index and Short Sales Index of Drew's, and Net Purchase or Net Sale indexes as commonly used w i l l be considered. Drew has est a b l i s h e d some points concerning the odd l o t trades that perhaps should be stressed, to better guide i n t e r p r e t a t i o n of the theory. a. Odd l o t dealings represent speculative t r a d i n g more so than investment. I t has been established that 80 per cent to 93 P e r cent of a l l odd l o t trades are turned over w i t h i n one month. ( 2^) b. The changes of sentiment, as measured by the index, are almost always wrong. 'The pub l i c i s never wrong i n that i t buys around the bottom, but i s i n v a r i a b l y wrong i n that it'buys proportionately l e s s at the bottom. S i m i l a r l y , as an advance proceeds towards i t s peak, s e l l i n g may e i t h e r become l e s s or change to buying.(^7) ( ^ I b i d . , p , to^Ibid., p. 192 ( 2 6 ) l b i d . , p > 1 9 5 ^ 2 7 ^ I b i d . , p. c. "The odd l o t short s e l l e r i s apparently a d i f f e r e n t treed of cat than the average member of the odd l o t p u b l i c , which ii.-. not s u r p r i s i n g , since comparatively few members of the pub l i c understand short s e l l i n g , and even fewer are w i l l i n g to put i t i n t o p r a c t i c e . However, he i s even l e s s ' r i g h t ' than the average odd l o t trader, and the reactions of those w i l l i n g to employ the short side more nearly conform to the supposed habits of the pu b l i c than i s indicated by the buying and s e l l i n g share balances themselves. -(28) The a p p l i c a t i o n of Net Purchases and Net Sales Index to the odd l o t theory has been explained by Eiteman.(^9) This index i s ca l c u l a t e d by use of the data r e s u l t i n g from the excess of odd l o t purchases to odd l o t sa l e s , or v i c e versa. Eiteman perceives that the machinery f o r executing odd l o t orders i s such as to cause odd-lot traders to buy and s e l l among themselves to the maximum extent p o s s i b l e . Only when there i s an excess of buy or s e l l orders can i t be s a i d that odd l o t traders purchase from or s e l l to f u l l - l o t t raders. This implies that only the excess orders are of value i n an a n a l y s i s , as the remainder are n e u t r a l i z e d . The Net purchases and Net sales index i s calculat e d on a monthly ba s i s , and compared to the S. & P. 500 index f o r the period being evaluated (1956 to 1967). On the basis of the odd l o t theory, pr e d i c t i o n s are made monthly, and the r e s u l t i s combined i n the composite i n d i c a t o r index. A compilation of Drew's Major Balance Index i s used. The Balance Index i s a 10 day moving average of the r a t i o of Odd Lot Sales to Odd Lot Purchases. (28)±bid., p. 205 (^)Eiteman, V/.J. o p . c i t . , p. 416 L S more The v a r i a t i o n w i l l be to use the Sales to Purchase r a t i o , which i cu r r e n t l y used. The average range of t h i s r a t i o i s sai d to be between 60 and 140.(30) Konthly p r e d i c t i o n s w i l l be made with t h i s index on the b a s i of the Ode Lot Theory. These predictions are included i n the composite i n d i c a t o r index. The short p o s i t i o n of the odd l o t t e r i s used i n the Short-Sales Index as o r i g i n a t e d by Drew.(3l) i t consists of a r a t i o of the number of shares sold short i n each day to a l l odd l o t sales f o r the day. A ten day moving average w i l l be used on t h i s r a t i o , to form a se r i e s c a l l e d the Short-Sales Index. An i n t e r p r e t a t i o n as suggested by Drew i n point (c) of t h i s Chapter, i s that the odd l o t shorts should be r e l a t i v e l y high at the bottom of a bear market, and r e l a t i v e l y low at the top of a b u l l market. \ would then expect a higher index reading at the bottom of a bear market as r e l a t e d to the e a r l i e r stage of the downward trend. Conversely, a'lower index reading at the top of a b u l l market as r e l a t e d to the e a r l i e r stage c the upward trend. A monthly p r e d i c t i o n i s made with t h i s index, and the r e s u l t s are incorporated i n the Composite Indicator Index. to^Hager, R . J . Investment Counsellor, P h i l l i p s , Eager & North, Vancouver, B.C. ^ 1 ) i ) r e w , G.A. o p . c i t . , p. 205 CHAPTER V A COMPOSITE INDEX In t h i s chapter we w i l l describe what a composite index i s , and how propose to use i t i n our model.W V/e also w i l l t est the te c h n i c a l i n d i c a t o r s , that we have chosen, f o l l o w i n g the procedures used i n Chapter I I I f o r the D i f f u s i o n Index. I f t h e i r performance i s equal to, or better than, the c o n t r o l measure, c r i t e r i a w i l l be stated f o r t h e i r i n d i v i d u a l performance, and they w i l l be incorporated i n t o the composite index. The composite index w i l l then be formed by the method ou t l i n e d i n the next se c t i o n . The composite w i l l be tested i n the same manner as the other indexes, and c r i t e r i a developed f o r i t s performance. DESCRIPTION A composite index i s ' a summarizing device used to measure a consensus of opinion that i s expressed by a group of i n d i c a t o r s . I t i s very s i m i l a r i n construction to d i f f u s i o n indexes that are used f o r business cycle i n d i c a t o r s . An example of a composite index that i s used by an investment (?) service i s given by Cohen and Zinbarg i n t h e i r recent publication.^~> I t consists of a monthly measure of the percentage of i n d i c a t o r s that p r e d i c t a b u l l market. The i n d i v i d u a l i n d i c a t o r s that comprise the index are assigned weights to increase or decrease t h e i r influence on the aggregate. The percentage of i n d i c a t o r s that are favourable, Is then calculated from the t o t a l number of i n d i c a t o r s . The composite index that the w r i t e r used, was of a s i m i l a r s t r u c t u r e , with the exception of a system of weighting which we ^\'Iodel i s described i n Chapter I. ^ C o h e n , J.B. and Zinbarg, E.D. o p . c i t . , p. 5^ 2. was devised f o r t h i s a p p r a i s a l . The weighting system i s described below, with the a c t u a l construction l e f t to the l a t t e r part of the chapter. The r e l a t i v e performances, measured by the p r o f i t a b i l i t y of the buy and s e l l decisions made by each i n d i c a t o r i n the ten year per i c d (I956-I966) as r e l a t e d to the performance from a buy and hold decision i n the same period, are the c r i t e r i a f o r assigning points to each i n d i c a t o r . The performance of a buy and hold decision was measured i n Chapter I I I under C r i t e r i a f o r Buy and S e l l I n d i c a t i o n s , as the p r o f i t i n Index points r e s u l t i n g from an investment i n the S. and P. 500 between 1956 and I966. The method of c a l c u l a t i o n i s explained i n Figure 12. P r o f i t i n S. & P. 500 index points i n the ten year period 1956-19&6 P r o f i t Source Benchmark Buy and Hold Index #1 Index #2 Index #5 Index #4 Index #5 Index #6 Index #7 Index #8 Stock Market Bonds Total p r o f i t 35-85 35-85 Index P r o f i t as °/o improve ment of the Benchmark 35-85 .= 100$ n=c of °/0 = 100 points i = l Points f o r Indicators • i i 1» i° i i i° i Figure 12 23"cea The indexes that are considered i n this system are tes individually. The control against which they are tested i s the benchmark in Figure 12, and i f they are not equal to, or better, they are discarded. METHODOLOGY The technical indicators are individually subjected to the same text that was used on the Diffusion Index i n Chapter I I I . On the basis of this test either c r i t e r i a for ideal performance of the indicator are established, or the indicator i s not used i f performance i s not equal to or better than that of the control measure. In a l l of the tests, the control measure w i l l be a buy and hold investment decision i n the S. and P. 500- Tbe test w i l l cover the period 195&" to I966 inclusive. Also, the treatment of dividends and interest and brokerage commission w i l l be as described under C r i t e r i a for Buy and S e l l Indications i n Chapter I I I . 92 TABLE X I I I INDUSTRIAL BOND YIELDS °/o 1955 December January February March A p r i l May June J u l y August September October November December January February March A p r i l May June J u l y August September October November December 3.25 1956 3.23 5.20 3.24 3.37 3.40 3.39 3.42 3-55 3.68 3-75 3.82 3.95 1957 4.02 3- 94 3.90 3.89 3.96 4.14 4.19 4.29 4.31 4- 32 4-34 4.11 195= 4.28 4.31 4.28 4.35 4,46 4.55 4-58 4.56 4.68 4-70 4.69 4.70 i960 4.75 4.74 4.71 4.64 4.61 4.65 4.64 4.61 4-49 4.46 4.50 4-55 1962 4-57 4.57 4.52 4.46 4.42 4.45 4.52 4.51 4.45 4.40 4-39 4.40 1965 4.39 4-38 4-37 4-38 4.40 4.40 4.40 4.43 4-45 4.46 4-47 4-47 1965 4-53 4.52 /!.52 4-54 4.55 4.59 4.62 4.63 4.65 4.67 4.71 4-79 1966 4.84 4.91 5.06 5.09 5.12 5.25 5-55 5-49 5.71 5.63 5-59 5.65 These y i e l d s are used i n the ca l c u l a t i o n s f o r v.Iien the invest ments are i n the bond market 1958 1961 1964 1967 January 3.91 4.53 4 50 5. 45 February 3.86 4.52 4 48 5-33 March 3-86 4.46 4. 49 5. 39 A p r i l 3.83 4.40 4. 53 5-37 May 3.80 4-45 4. 54 5-46 June 3-77 4-48, 4-54 5-64 J u l y 3.81 4-54 4. 52 5. 79 August 3-94 4.59 4. 52 5-84 September 4.24 4.60 4. 52 5. 95 October 4.25 4.61 4-53 6. 05 November 4.23 4.60 /i 'r • 53 6. 28 December 4.24 4-58 4-54 6. 39 Source: Federal Reserve B u l l e t i n STANDARD & POOR COi.IPOSITE INDEX Quarterly Dividends Y i e l d s 1955 11 1.64/45.48 X 100 1956 l 1.73/48.48 X 100 2 1.80/46.97 X 100 3 1.8J/45.35 X 100 4 1.74/46.67 X 100 1957 1 1.73/44.11 X 100 2 1.73/47.37 X 100 3 1.76/42.42 X 100 4 1.79/39.99 X 100 1958 1 1.77/42.10 X 100 2 1.73/45.24 X 100 3 1.73/50.06 X 100 4 1.75/55.21 X 100 1959 1 1.77/55.44 X 100 2 1.79/58.47 X 100 3 I.8I/56.88 X 100 4 1.85/59-89 X 100 i960 l 1.94/55.34 X 100 2 1.95/56.92 X 100 3 1.95/53.52 X 100 4 1.95/58.11 X 100 1961 1 1.94/65.06 X 100 2 1.94/64.64 X 100 3 1.96/66.73 X 100 ' 4 2.02/71.55 X 100 = 3.607^ = 3.56$ = 3 . 8 3 $ = 4.05$ = 3.727b = '3.92/ = 3.65/0 = 4.14$ .= 4-47°/ = 4.20$ = 3.81/> = 3.45/o = 3.16$ = 3.19/0 = 3-35>i = 5-18/ = 3-05/0 = 5 . 5 $ = 3.42/ = 3.64$ = 3-35f/ = 2 . 9 870 = 3.8/ = 2.93$ 1962 1963 1964 1965 1966 1967 1 2 3 4 1 2 3 4 1 2 3 4 1 2 5 4 1 2 3 4 1 2 3 4 2.04/69.55 X 100 2.06/54.75 X 100 2.08/56.27 x 100 2.3/63.10 X 100 2.15/66.57 x 100 2.20/69.37 x 100 2.21/71.70 X 100 2.28/75.02 X 100 2.33/78.98 X 100 2.58/81.69 X 100 2.44/84-18 X 100 2.50/84.75 X 100 2.55/86.16 X 100 2.61/84.12 X 100 2.66/89.96 X 100 2.72/92.43 X 100 Source: Survey of Business 2-935 3.76/ 5-69; 3.37) 3.22) 3.17) 2.707 3.03/ 2.955 2.9lc/ 2.897 2.94/ 2.967 3. i c y 2.955 5.365- 3.595 3.765 3.78/0 3-44/ 3.39/o 3.19/ (These y i e l d s are used f o r the c a l c u l a t i o n s f o r when the investments are out of the stock market) Source: Standard and Poor's Security P r i c e Index Record I966 and 1967 Edi t i o n s 94 TEST I : THE ADVi'J\CE-DECLIHE LINE This i n d i c a t o r was prepared by t a k i n g the cumulative a lgebra ic t o t a l o f advances and dec l ines of the i ssues traded d a i l y on the N . Y . S . E . To s t a r t the s e r i e s w i t h a p o s i t i v e number, the o r i g i n was assumed to be t w e n t y - f i v e thousand, and thus, p o s i t i v e values were maintained f o r most of the s e r i e s . The monthly s t a t i s t i c s of the s e r i e s were p l o t t e d on Charts IV and V w i t h the S. and P . 500, and the data are recorded i n Table XV. The index was then tes ted by the method p r e v i o u s l y es tab l i shed f o r the e v a l u a t i o n of c r i t e r i a and i n d i c a t o r performance. S i t u a t i o n I When the index value on the downside reaches 20 per cent below- a preceding peak, a s e l l s i g n a l i s I n d i c a t e d . When the index value has r i s e n 20 per cent above the lowest value i t reached a f t e r the s e l l s i g n a l was g i v e n , a buy s i g n a l i s then i n d i c a t e d . 95 SITUATION I A - Investment i n the Market (End of month-dates) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Jan . 58 Dec. 60 J u l y 62 June 64 J u l y 65 41.12 + .41 = 4I.53 56.80 + .57 = 57.37 56.97 + .57 = 57-54 80.24 + .80 = 81.04 84.91 + .85 = 85.76 Sept 59 Mar. 62 Oct . 63 Mar. 65 Feb. 66 59-06 - .59 = 58.47' 70.29 - .70 = 69.59 73.03 - .73 = 72.30 86.83 - .87 = 85.96 92.69 - .93 = 91.76 T o t a l 16.94 12.22 14.76 4.92 6.00 54-84 B - Investment i n Bonds Per iod out of Market Dec. 55 to Jan . Sept.59 to Dec. Mar. 62 to J u l y Oct . 63 to June Mar. Feb. 65 66 58 60 62 64 to J u l y 65 to Dec. 66 Years 25/12 14/12 4/12 8/12 4/12 10/12 Amount (Pts) 45-48 58.47 69.59 72.30 85.96 91.76 A v . I n t . (70 Av.Div idend (#) 3-58 4.69 4.47 4.48 4.56 5-27 3.90 3.27 3.34 2.99 2.95 3-57 Rate (#) (32) 1.42 1.13 1.49 1.61 1.70 Tota l Return (Pts) T o t a l p r o f i t from S i t u a t i o n I i s A + B The c o n t r o l investment i s 35.85 The improvement i s 21.63/35.85 X 100 = 57-48 po ints 50.33?= be t ter S i t u a t i o n I I Y/hen the index value on the downside reaches 20 per cent below a preceding' peak, a s e l l s i g n a l i s Indicated. Y/hen the index value has r i s e n 10 per cent above the lowest value reached a f t e r the s e l l s i g n a l was given, a buy s i g n a l i s ind i c a t e d . 97 SITUATION I I A - Investment i n the ir k e t (End of month dates) Date Jan. 58 Nov. 60 June 62 Feb. 64 J u l y 65 Purchase + Commission 41.12 + 55-47 + 55.65 + 77-59 + 84.91 + •41 = 41.53 •55 = 56.02 .56 = 56.19 .77 = 78.16 .85 = 85.46 Date Sept.59 Liar. 62 Oct. 65 l i a r . 65 Feb. 66 Sale - Commission 59-06 70.29 75.03 86.83 92.69 .59 = 58.47 .70 = 69.59 •73 = 72.30 .87 = 85.96 .93 = 91.76 Total P r o f i t (Pts) I6.94 13.57 16.11 7.80 6.30 60.72 B - Investment i n Bonds Period out of Market Dec. 55 to Jan. 58 Sept.59 to Nov. 60 Mar. 62 to June 62 Oct. 63 to Feb. 64 Mar. 65 to J u l y 65 Feb. 66 to Dec. 66 Years 25/12 14/12 5/12 4/12 4/12 10/12 Amount (Pts). 45-48 58.47 69.59 72.30 85.96 91.76 Av.Int, (/*) 5-58 4.68 4.43 4-47 4-57 5.27 iv,Dividend (%) 3.90 3.27 3-34 2.99 2.95 5.57 Total p r o f i t from S i t u a t i o n I I i s A + The control investment i s 35.85 The improvement i s 27.O8/35.85 X 100 = Rate (#) (32) 1.41 1.09 1.48 1.62 1.70 Total Return (Pts) B 62.93 points 75-53$ better 2.21 9S Conclusion: S i t u a t i o n I I i s the be t t e r , therefore i t was selected as the Advance-Decline Line I n d i c a t o r . The c r i t e r i a f o r use of the i n d i c a t o r are; When the index value on the downside reaches 20 per cent below a preceding peak, a s e l l s i g n a l i s i n d i c a t e d . When the index value has r i s e n 10 per cent above the lowest value, i t reached a f t e r the s e l l s i g n a l was given, a buy s i g n a l i s i n d i c a t e d . TABLE XV CITMULATIVE ADVANCES AND DECLINE; (+ 25,COO shares) 1956 1959 1962 January February March A p r i l May June J u l y August September October November December January February March A p r i l May June J u l y August September October November December 25765 25918 26580 25345 22836 24118 25290 25587 20423 20246 18566 18641 1957 17750 17160 18046 18624 18249 17123 15790 11743 9057 6691 6891 6635 1958 24212 26136 25889 25203 23099 23415 23755 22850 19801 19852 19932 19478 i960 17097 15648 16429 14474 14798 15837 16040 12808 11525 12417 15060 17052 1961 18240 17255 15819 8805 4192 5700 7540 5855 4015 8080 8609 H559 1963 11552 11332 15387 14862 15865 12034 14264 13683 12867 11237 11387 11489 1964 J anuary 10715 17627 12159 February 10491 19446 15389 March 11507 19325 12995 A p r i l 13450 20967 II813 May 15281 18449 12747 June 16149 17685 14251 J u l y 18001 18508 15424 August 18998 17129 14328 September 20375 17559 ' 14851 October 21197 19250 14369 November 22069 18383 12862 December 23403 17200 15741 1965 16459 16795 17951 I6284 1175? 12010 14441 15516 16577 16218 15768 16225 1966 14555 11995 11891 6850 6761 4180 (1352) (2367) (2740) (3212) (3845) (4316) 1967 ).ta Source: Barron's Weekly, Issues traded + 25000 102 TEST I I : THE HE,7 HIGHS. AND HEW LOWS TSDSX. Tie index was c a l c u l a t e d from the s t a t i s t i c s f o r the number of new highs and new lows that were traded on the N.Y.3.E. I t i s a cumulative algebraic to ';al of the new highs as a p o s i t i v e number, and new lows as a negative number. The index at the beginning of the period was assumed to be 15,000, as t h i s kept the r e s u l t i n g data p o s i t i v e . In t h i s a p p r a i s a l , the monthly f i g u r e s f o r the index were used, and a three month moving average was used to smooth the data. The moving average made the index values when p l o t t e d , easier to analyze. The index was p l o t t e d against the S. and P. 500 on Charts VI arid V I I . The values f o r the Hew Highs and New Lows Index are recorded i n Table XVI. A v i s u a l i n s p e c t i o n of the index was made, i n order that s i t u a t i o n s f o r t e s t i n g the index might be construed. The series appears to be h i g h l y c o r r e l a t e d to the S. and P. 500, but the lead q u a l i t i e s that one would expect, i f the i n d i c a t o r were to be of use i n t h i s a p p r a i s a l , appear to be non-existant i n the time regions of the major breaks i n the S. and P."500. As the w r i t e r could a s c e r t a i n no v i s u a l leads f o r the index, i t was decided not to submit the se r i e s to t e s t s and to conclude that there were no s i g n i f i c a n t lead q u a l i t i e s . TABLE XVI CUI,iULATIVE MEW HIGHS AND HEW LOWS 1956 195; 1962 January February March A p r i l June J u l y August September October November December January February March A p r i l May June J u l y August September October November December January February March A p r i l May June J u l y Augus t September October November December Data Source: 16.2 I6.3 I6.5 I6.5 I6.3 15.8 15.5 14.8 14.1 13.9 1957 13.5 15.6 14.1 14.7 15.0 15.3 15.1 14.4 12.6 10.8 8.7 6.9 1958 5-6 5.2 5-2 5.9 7.0 8.4 10.2 12.2 11.9 16.2 18.4 20.3 22.4 24.3 26.1 27.6 28.7 29.5 30.1 30.4 30.3 29.9 29.7 29.2 I960 28.7 28.2 27.7 27.2 26.6 25.9 25.5 25.4 25.2 24.9 19.9 24.5 1961 24.3 24.7 25.9 27.6 29.4 50.9 32.1 32.9 33.3 33.6- 34.1 54-5 35.0 35-4 55.9 36.0 55.7 34.6 52.6 30.2 27.9 25.9 24.6 24.1 1963 23.9 24.0 24.3 25.2 26.5 29.5 32.0 54-6 36.9 58.9 39-3 39-8 1964 40.0 40.3 4-0.6 41.5 42.4 45-9 44.6 45-5 46.0 46.6 47.5 48.2 1965 49.1 50.1 51.1 52.2 53.5 55.1 56.2 56.9 57.0 56.9 56.8 58.0 1966 57.8 59.0 60.5 61.6 62.6 63.O 63.1 62.4 61.4 59.9 58.4 57.7 1967 Barron's Weekly, 3 month moving average 15,000 added 106 ' . TEST I I I : CREDIT BALANCES IN BROKERAGE ACCOUNTS The s t a t i s t i c s on Credit Balances i n Brokerage Accounts are a v a i l a b l e monthly i n the Federal Reserve B u l l e t i n . These s t a t i s t i c s , recorded as b i l l i o n s of d o l l a r s were used as raw data and were not smoothed by moving averages. The raw data p l o t t e d a smooth s e r i e s , so i t was considered appropriate. The s t a t i s t i c s and the p l o t t e d index are i n r e s p e c t i v e l y Table XVII and Charts V I I I and IX. Two s i t u a t i o n s were construed by v i s u a l comparison of the index to the S. and P. 500 f o r i d e a l buy and s e l l i n d i c a t i o n s . They are tested with the assigned t e s t and the investment c o n t r o l of a buy and hold dec i s i o n , over the ten year period 1956 to 1966. S i t u a t i o n I When the c r e d i t balance index expands beyond 100 m i l l i o n d o l l a r s from, the previous low since the l a s t s a l e , a buy i s in d i c a t e d . When i t contracts beyond a 100 m i l l i o n d o l l a r s from the previous high since the l a s t purchase, a s e l l i s i n d i c a t e d . 107 SITUATION I (100 m i l l i o n on the upside and 100 m i l l i o n on the downside) A - Investment i n the Market (Dates are the end of month) Date Purchase + Commission Date Sales - Commission P r o f i t (Pts) Jan. 58 Oct. 60 J u l y 62 Dec. 62 Jan. 65 41.12 + .41 = 41.55 55.73 + -54 = 54.27 56.97 + -57 = 57.54 62.64 + .63 = 63.27 86.12 + .86 = 86.98 J u l y 59 Aug. 61 Sept.62 May 64 J u l y 66 59-74 - .60 = 59.14 56.51 - .57 = 55.94 58.00 - .58 = 57.42 70.14 - .70 = 69.44 85.84 - .86 = 84.98 T o t a l 17.61 1.67 (12) 6.17 2.00 27.33 B - Investment i n Bonds Period out of Market Dec. 55 to Jan. 58 24/12 J u l y 59 to Oct. 60 15/12 Aug. 61 to J u l y 62 11/12 Sept 62 to Dec. 62 3/12 May 64 to Jan. 65 8/12 J u l y 66 to Dec. 66 5/12 Years Amount (Pts) Av.Int. Av.Dividend 45-48 3-58 -- 3.90 59.14 4.51 -- 5-49 55-94 4-56 -- 3-74 57.42 4.43 -• 3.54 69.44 4-54 -- 2.94 84.98 5-44 -- 3-77 Rate (#) (.32) 1.02 .82 •89 1.60 1.67 Total P r o f i t (pts) (-27) •71 • 39 .17 • 76 .60 2.36 Total p r o f i t from S i t u a t i o n I i s A + B The performance of the control i s 6.I6/35.85 X 100 than that of the index. 29.69 I7.I870 better S i t u a t i o n I I When the c r e d i t balance index expands beyond 150 m i l l i o n .dollars from the previous low since the l a s t s a l e , a buy i s in d i c a t e d . When i t contracts beyond a 150 m i l l i o n d o l l a r s from the previous high since the l a s t purchase, a s e l l i s i n d i c a t e d . 109 SITUATION I I (150 m i l l i o n on the upside and 150 m i l l i o n on the downside) A - Investment i n the Market (Dates are the end of month) Date Purchase + Commission Date Sales - Commission P r o f i t (Pts) Mar. 58 Dec. 60 J u l y 62 Feb. 64 Mar. 65 42.11 + .42 = 42.55 56.80 + .57 = 57-37 56.97 + .57 = 57.54 77-39 + -77 = 78.16 86.83 + .87 = 87.70 J u l y 59 Aug. 61 Sept.62 J u l y 64 Ju l y 66 59.74 - .60 = 59.14 56.51 - .57 = 55-94 58.00 - .58 = 57.42 83.22 - .83 = 82.39 85.84 - .86 = 84.98 Total 16.61 (1-43) (.12) 4.23 (2.72) 16.57 B - Investment i n Bonds Period out of Market Dec. 55 to March 58 Ju l y 59 to Dec. 60 Aug. 61 to Ju l y 62 Sept.62 to Feb. 64 Jul y 64 to March 65 Ju l y 66 to Dec. 66 Years 27/12 17/12 11/12 17/12 8/12 5/12 Amount Av.Int (Pts) 45-48 3.55 59.14 4.57 55.94 4.46 57.42 4.47 82.39 4.53 84.98 5.44 Av.Dividend (#) 5.70 5.56 5.78 3.35 2.93 3.77 Total p r o f i t from S i t u a t i o n i l i s A + B The performance of the control i s 15.64/35.85 X 100 than that of the investment Rate P r o f i t (Pts) ($) (.15) (.14) 1.21 1.01 .68 • 34 1.14 • 92 1.60 •91 I.67 .60 Total 3.64 19.01 43.62$ better 110 Conclus ion The r e s u l t s o f the two t e s t s i n d i c a t e that n e i t h e r s i t u a t i o n v/as s u i t a b l e f o r use i n the composite index, so t h i s i n d i c a t o r was e l i m i n a t e d . S t o c k P r i c e s and C r e d i t B a l a n c e s i n B r o k e r a g e A c c o u n t s CHART V I I I Stock P r i c e s and Credit Balances i n Brokerage Accounts CHART IX Credit Balances i n Brokers Accounts .(Customer Net Free i n B i l l i o n " D o l l a r s ) 1956 1959 1962 1965 January •905 1.226 1.225 1.207 February .913 1.196 1.190 1.254 march .960 1.257 1.154 1.264 A p r i l .896 1.205 1.110 1.207 May .870 1.188 1.205 1.20S June .836 1.094 1.374 1.297 J u l y .858 1.079 1.252 1.233 Augus t .872 1.035 1.150 1.193 September .866 1.039 1.091 1.369 October .835 .967 1.126 1-475 November .822 • 974 1.151 1-479 • December .880 .996 1.216 1.666 1957 I960 1963 1966 January .866 1.001 1.199 1.730 February .828 .981 1.191 1.765 March .820 .988 1.175 1.822 A p r i l .807 .940 1.201 1.744 May .817 .970 1.166 1.839 June .820 1.016 1.149 1.658 J u l y .829 1.018 1.126 1.595 August .816 1.021 1.120 1.595 September .838 1.059 1.180 1.528 October .879 I.O63 1.176 1.520 November .876 1.062 1.211 1.532 December .896 1.135 1.210 1.657 1958 • 1961 I964 1967 January .957 1.269 1.262 1.914 February .939 1.392 1.199 1.936 March .954 1.507 1.231 2.135 A p r i l • 985 1.508 1.165 2.078 May • 979 1.453 1.158 2.220 June 1.047 1.280 1.146 2.251 J u l y 1.080 1.207 1.114 2.341 August 1.103 1.208 1.077 2.281 September 1.119 1.227- 1.145 2.401 October 1.140 1.214 1.155 2.513 November 1.148 1.213 1.131 December 1.159 1.219 1.169 Data Source Federal Reserve B u l l e t i n 114 TEST IV; QUALITY OF ILARKET LEADERSHIP The i n d i c a t o r used i s the index formed from the d a i l y quotations of. the p r i c e of the ten most a c t i v e stocks on the N.Y.S.E. The index i s formed from monthly data v/hich are the monthly averages of the d a i l y s t a t i s t i c s . The monthly averages are subjected to a 5 month moving average, to smooth the s t a t i s t i c s . ^ ) The r e s u l t i n g index of the 5 month moving average i s then p l o t t e d as, "The Ten Host A c t i v e Stocks on the New York Stock Exchange". As W. J . Eiteman suggested that the when combined with volume of sales was more e f f e c t i v e , the w r i t e r decided to use the r a t i o of the volume of the ten most a c t i v e stocks to the volume of the N.Y.S.E. expressed i n a percentage, as another measure of "Quality of Liarket Leadership". (4) An inverse value r e l a t i o n s h i p e x i s t s between t h i s s t a t i s t i c and the p r i c e of the ten most a c t i v e stocks. For example: As the p r i c e of the ten most a c t i v e increase, the numerator of the Volume/Volume r e l a t i o n s h i p decreases, with a, lower r a t i o as the p r i c e increases. The percentage figu r e s f o r t h i s r a t i o a.re a v a i l a b l e i n Barron's Weekly, and are computed on a d a i l y b a s i s . -An index v/as formed from the monthly average of these s t a t i s t i c s , and was smoothed by a f i v e month moving- average . (5) The r e s u l t i n g data were then p l o t t e d as an index, "The Ratio of the Ten Most A c t i v e Stocks to the Volume of the Market". (3) w'The s t a t i s t i c s and p l o t t e d Index are r e s p e c t i v e l y i n Tables XVIII and XIX. (4) N 'Eiteman, W.J. o p . c i t . p. 420 w ' T h e s t a t i s t i c s and p l o t t e d Index are r e s p e c t i v e l y i n Tables XX and XXI and Charts X I I and X I I I . 115 R e c a p i t u l a t i n g , we are measuring the q u a l i t y of market leadership with two indexes: 1. Average Monthly P r i c e of the Ten Most Act i v e Stocks. 2. The Ratio of the Ten Most A c t i v e Stocks to the Volume of the Market. These indexes w i l l be tested separately to a s c e r t a i n t h e i r value f o r fo r e c a s t i n g and to e s t a b l i s h c r i t e r i a , f o r t h e i r best forecast. TEST IV-A: AVERAGE MONTHLY PRICE OP THE TEN MOST ACTIVE STOCKS By a v i s u a l comparison of t h i s index to the S. and P. 500 two s i t u a t i o n s were construed f o r t e s t i n g against the con t r o l that was established f o r the t e s t s , a buy and hold of the S. and P. 500 f o r the ten year period 1956 to I966. S i t u a t i o n IA When the value of the index on the upside reaches $53 the S. and P. 500 was bought. YJhen the value of the index on the downside reaches §37 the S. and P. 500 was sold . 116 SITUATION IA (Buy at $53 l e v e l end s e l l at $37 l e v e l ) A - Investment i n the Market (Dates are end of month) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Oct. 56 June 62 Aug. 66 46.24 + .46 = 46.70 55.63 + .56 = 56.19 80.65 + .81 = 81.46 Feb. 58 Nov. 65 Dec. 66 41.26 - .41 = 40.85 60.04 - .60 = 59.44 92.43 - .92 = 91.51 T o t a l (5.85) 5.25 10.05 7.45 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - Rate (%) P r o f i t (Pts) Dec. 55 to Oct. 56 Feb. 58 to June 62 Nov. 65 to Aug. 66 10/12 52/12 9/12 45-48 40.85 59-44 3.50 - 3.66 = 4.16 - 3.99 = 4.90 - 3.35 = (.16) • 17 1.55 Total (.16) .37 .72 • 93 Total p r o f i t from S i t u a t i o n IA i s A + B 8.38 points Control investment i s 35-85 The performance of the co n t r o l i s 27.47/35.85 X 100 = 76.6$ better than that of the investment. 117 S i t u a t i o n IIA When the value o f the index on the upside reaches &49> the S. and P. 500 i s bought, and when the value of the index on the downside reaches S39> the investment i n the S. and P. 500 i s s o l d . 118 SITUATION HA (Buy at $49 l e v e l and s e l l at J37 l e v e l ) A - Investment i n the Market Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Aug. 56 June 62 Aug. 65 May 66 48.49 + .48 = 48.97 55.63 + .56 = 56.19 86.49 + .86 = 87.35 86.78 + .87 = 87.65 Apr. 57 Mar. 65 Oct. 65 Dec. 66 45.05 - .45 = 44.60 65.67 - .66 = 65.OI 91.59 - .91 = 90.48 92.45 - .92 = 91.51 Total (4-57) 9.82 5.13 3.86 11.44 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - ($) m Rate (#) P r o f i t (Pts) Dec. 55 to Aug. 56 Apr. 57 to June 62 Mar. 65 to Aug. 65 Oct. 65 to May 66 7/12 62/12 27/12 7/12 45-48 44-60 65.01 90.48 5.40 - 5.82 = 4.17 - 3.67 =• 4.51 - 3.08 = 4.90 - 3.27 - (-42) • 50 1.43 I.63 Total (.09) 1.12 . 2.08 .91 4.02 Total p r o f i t from S i t u a t i o n HA i s A + B 15.46 poin Control investment i s 35.85 The performance of the co n t r o l i s 20.39/35-85 X 100 = 56.9,0 bett than that of the investment Conclusion On the basis of the r e s u l t s of the t e s t s on these two s i t u a t i o n s t h i s index was not accepted. CHART x Average M o n t h l y P r i c e o f The tea most A c t i v e S t o c k s - B a r r o n ' s Weekly S t a t i s t i c s 1956 1957 1958 1959 I 9 6 0 1 9 6 1 1 9 6 2 CHART XI Average Monthly P r i c e of The Ten M©st A c t i v e Stoclcs-Barron's Weekly S t a t i s t i c s TABLE XVIII Average Monthly p r i c e of the Ten Most Act i v e Stocks on the Hew- York Stock Exchange (f i g u r e s are a 5 month moving average) 1956 1959 1962 1965 January February March A p r i l May June J u l y August September October November December 35.60 28.90 36.55 39.74 31.27 38.20 40.66 38.39 32.81 41.76 39.96 59-78 35-59 47.20 42.89 41.47 37.08 55-08 44.41 45-55 39.15 53.18 45.29 49-45 59-75 54.35 50.45 51.46 4O0O3 55.57 42.55 54-54 58.28 51.85 59.77 54.72 38.27 47.25 55.99 51.32 59.55 46.87 55.05 47.53 39-28 44.95 36.22 1957 i960 1965 1966 January 44.10 38.84 40.47 40.75 February 40.73 40.17 58-72 41.07 March 59-51 59-79 38.02 45.44 A p r i l 40.94 37.69 38.91 49-73 May 41-53 56.89 39.26 51.20 June 42.89 35.74 41.19 52.27 Ju l y 45-20 55-68 41.94 58.20 August 45-10 53-82 44.OO 61.58 September 41-50 34-23 47-36 60.10 October 59.41 52.79 49-33 59-01 November 58.45 55-96 49-65 55-04 December 38.00 33-77 50.15 46-70 1958 196I 1964 1967 January 57-31 32.47 48-39 41-50 February 56.82 31-84 44-81 39-81 March 35-53 32-71 42-58 58.17 A p r i l 34-15 33.46 41.32 38.26 May 33.04 35-37 41-05 58.10 June 30.94 36.95 41-44 38.07 Ju l y 30.39 38-31 41-84 57-86 August 29-61 38.89 41.55 38.19 September 28.14 38.04 40.71 40.31 October 27-55 37-02 - 40.31 41-13 November 28.60 37-63 39-84 42.11 December 28.63 36.43 40.23 42.05 jource: Barrons' Y/eekly TABLE XIX srage monthly P r i c e of the Ten Host Active Stocks _ on the Hew York Stock Exchange 1956 1959 1962 1965 January February March A p r i l May June J u l y August September October November December 36.23 36.90 35.41 39-46 45-98 43.15 45-39 55.68 58.95 54.17 58.55 46 .26 32.05 23.80 28.52 57.99 56.70 44 = 94 37.29 38.86 40.98 38.10 36.21 37.20 40.24 33-74 37.10 43-89 55-84 67-47 65.14 57-58 49-76 59-94 48.74 40.16 57.73 43.06 36.67 42.87 39.49 52.56 50.70 41.05 56.96 51.72 58.46 51.80 1957 I960 1965 1966 J anuary February March A p r i l May June July August September October November December 38.71 39-96 37.04 41.70 40 .16 45-86 42.92 45.82 43.27 39.67 37.86 32.45 44-28 40.62 55.91 42.84 35.06 54.05 56.62 50.16 52.54 55.76 36.09 29.42 35-75 40.17 57-55 40 .02 56.65 40.22 41.92 47-18 43-77 46.94 57.04 51.76 56.22 42.91 54.29 40.14 53.67 57.64 50.27 59.64 69.79 70.60 50.21 44.85 1958 1961 1964 1967 January February March A p r i l Hay June Ju l y August September October November December 39-01 37-58 57-20 51.41 31.03 33-54 52.06 26.71 28.65 27.13 26.17 29.00 36.01 31.59 29.27 32.95 33-73 59.76 41 .14 37.21 39-72' 36.62 55.51 56.06 48.75 46.30 38.15 39-15 40.59 42.47 44-96 40.07 41.14 59.11 58.27 42.99 59.76 57.06 35.65 41.75 56.67 59.20 56.28 55-48 40.68 38.34 50.79 40.38 Data Source: Barron's 'weekly 124 TEST IV-B: RATIO OP THE TEN HOST ACTIVE STOCKS TO THE VOLUJ.IS OP T E E MARKET By v i s u a l comparison to the S. and P. 500, two s i t u a t i o n s were constructed f o r t e s t i n g against the co n t r o l investment that was established f o r these t e s t s . S i t u a t i o n IB The S. and p. 500 i s bought when the volume index reaches 12.37° o n the downside. The S. and P. 500 i s sold when 14.97* i s reached on the upside. 125 SITUATION IB (Buy at 12.3$ on the downside and s e l l at 14 •9/o on the upside) A - Inves tment . in the Market (Dates are the end of month) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Oct . 56 • 4 6 . 2 4 + .46 = 4 6 . 7 0 Aug-. 59 59.4-0 - .59 = 59.8I i 5 . l l Apr . 62 68.05 + -68 = 68.73 Aug. 63 70.98 - .71 = 70.27 1.54 Tota l 14.65 B - Investment i n Bond Pe r iod out of market Years Amount A v . I n t . - Av .Div idend - Rate P r o f i t (Pts) (Pts) (#) (°/o) Dec. 55 to Oct . 56 10/12 45.48 3-50 - 3.56 = (.06) (.02) Aug. 59 to A p r . 62 20/12 59-81 4-58 - 3-48 = 1.10 1.08 Aug. 63 to Dec. 66 28/12 70.27 5.04 - 3.24 = 1.80 2.88 To ta l 3»94 T o t a l p r o f i t from S i t u a t i o n IB i s A + B 18.59 points Improvement i s 17.26/55-85 ( cont ro l ) X 100 = 48.1/> worse 126 S i t u a t i o n H E The S. and P. 500 averages are bought when the volume index reaches Y^.yfo on the downside, and the averages are sold when the index reaches 14.9fo on the upside. 127 SITUATION IIB (Buy at 13.3^ on the downside and s e l l at 14.9/ on the upside) A - Investment i n the Market Bate Purchase + Commission Date Sale - Commission P r o f i t (Pts) Aug. 57 Oct. 60 Jan. 65 45.84 + .46 = 46.3O 55-73 + .54 = 54.27 86.12 + .86 = 86.98 Aug. 59 Aug. 63 Oct. 65 59.40 - .59 = 59-81 70.98 - .71 = 70.27 91.59 - .91 = 90.48 Total 13.51 16.00 5.50 33.01 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - (#) (#) Rate (fo) P r o f i t (Pts) Dec. 55 to Aug. 57 19/12 Aug. 59 to Oct. 60 14/12 Aug. 65 to Jan. 65 17/12 Oct. 65 to Dec. 66 14/12 45-48 59-40 70.98 91.39 3.72 - 3.62 = 4.51 - 3.26 = 4-48 - 2.85 = 5.15 - 5.36 = .10 1.25 I.65 1.79 Total •07 .83 I.63 1.92 4-45 Total p r o f i t from S i t u a t i o n IIB i s A + B 37-46 points Improvement Is I.61/35.85 X 100 = 4.49/ better 128 Conclusion: S i t u a t i o n 113 improved the investment performance by 4.5$. I t was therefore decided to accept S i t u a t i o n IIB as c r i t e r i a , and also to use the i n d i c a t o r as such i n the composite Index. The c r i t e r i a f o r the use of the index are: 1. An i n d i c a t i o n to purchase i s given when the Index of the Ratio of the Ten Most A c t i v e Stocks to the Volume of the Market reaches 13.3% on the downside. 2. An i n d i c a t i o n to s e l l i s given when the index reaches I4.S/3 on the upside. Ratio of The Ten Most 'Active Stocks to The Volume of The Markets Barrows Weekly S t a t i s t i c s CHART • CHART XIII Ratio of The Ten Most Active Stocks to The Volume of The Market- Barron's Weekly S t a t i s t i c s TABLE XX E a t i o of the Volume of the Ten Most A c t i v e Stocks to the Daily Volume of Shares Traded on the Nev/ York Stock Exchange (f i g u r e s are a 5 month moving average of the monthly data) 1956 1959 1962 1965 J anuary 14.0 12.4 13.0 February 13.9 12.5 13.0 March 12.8 13.9 12.2 12.6 A p r i l 12.9 14.2 11.9 12.9 May 12.8 14.2 11.9 13.0 June 12.8 13.9 12.5 13.3 J u l y 12.8 14-3 12.9 13.8 August 12.8 15.3 13.2 14.7 September 12.3 I6.3 13.6 14.9 October 12.0 16.1 13.5 15.3 November 11.9 I6.5 13.5 15.4 December 12.3 16.9 13.4 15.1 1957 i960 1963 1966 January 12.7 16.0 13.5 14.5 February 13.5 15.0 13.4 14.4 March 13.7 15.0 . 13.5 14.14 A p r i l 13.7 15.O 13.2 14.12 May 13.9 14.5 15.2 14.59 June 13.2 14.2 13.4 14.60 J u l y 13.3 14.2 14.5 14.59 August 13.3 15.9 15.8 14.80 September 13.6 13.2 16.7 14.62 October 13.5 15.2 . 16.9 14.05 November 13.3 12.8 17.0 15.51 December 14.0 15.5 16.3 15.15 1958 1961 1964 1967 January 14.1 13 •3 15.4 12 .48 February 14.1 13 •7 15-1 11 • 99 March 14.4 13 • 5 16.5 12 .07 A p r i l 14.0 13 • 5 16.6 12 .40 May 15.9 13 •4 I6.5 12 • 44 June 13.9 13 •4 I6.5 12 • 44 J u l y 14.0 13 .6 16.4 12 •57 August 14.0 13 .6 15.0 12 • 57 September 14.7 13 .2 14.2 12 .58 October 14.8 13 •5 14.5 12 .45 November M .6 12 .8 14.I 12 .56 December 14.6 12 7 • 1 15.5 12 .52 TABLE XXI 152 Ratio of the Volume of the Ten Most Active Stocks to the Dai l y Volume of Shares Traded on the N evi York St 00k Exchar (Figures are the momhly averages of the d a l l y r t t i o s ) 1956 1959 1962 1965 , J anuary 13.4 12.5 15.2 12.5 February 15.8 14.6 15.1 12,6 March 12.0 14.6 11.0 15.2 A p r i l 12.7 . 15.1 11-7 12.46 May 12,1 15.0 12.2 12.3 • June 13.9 14*0 11.8 15.6 July 12.7 15.0 12.9 15.1 August 12.8 12.8 14.1 14.5 September 12.8 14.7 13.7 15.1 October 12.1 20,1 13.9 17.5 November 11.4 19.2 13.8 14.7 December 11.0 14.0 12.0 14.9 1957 I960 1965 1966 January 12.5 14.5 14.5 14.8 February 14.8 17.1 13.3 15.8 March 14.1 15.4 14.4 15.2 A p r i l 15.1 14.3 13.1 15.5 May 12.5 14.0 11.6 15.5 June 12.6 14.5 14.0 14.7 J u l y 14.2 13.5 13.2 15.2 Augus t 15.4 15.0 15.5 14.2 September H.7 14-5 17.7 14.5 October 12.7 12.6 19.1 15.5 November 14.5 11.0 18.4 13.8 December 15.4 13.3 14.4 12.5 1958 1961 1964 1967 January 14.8 13.0 15.7 11.5 February 14.8 13.7 15.9 12.7 March 13.5 15.8 14.7 12.8 A p r i l 14.3 12.9 16.8 11.4 May 14.8 12.5 21.7 12.7 June 13.0 15.0 16.5 15.2 J u l y 14.2 15.1 15.2 12.9 August 13.4 15.9. 14.5 12.2 September 14.7 15.7 16.2 12.0 October 17.7 12.5 14.8 12.7 November 13.7 10.9 12,2 13.2 December 14.7 15.8 14 • 8 12.3 H-7) , 12.8) Source: Barron'; Weekly Extrapolated TEST V: TOLU.JJ OF TRADING The index was c a l c u l a t e d from the monthly average of the d a i l y volume of shares traded on the New Yorr Stock Exchange (N.Y.S.E.). The monthly f i g u r e s were subjected to a f i v e month moving average to smooth the s e r i e s . The l a s t two months of the moving average data were extrapolated to the current period. The data f o r these averages i s located i n Tables XXII and X X I I I . The c o n t r o l measure i s a buy and hold of the S. and P. 500 from January 1, 1956 to December 51, I966. The p r o f i t on the co n t r o l i s : S. and P. 500 - December 31, 1966 81.55 pts l e s s S. and P. 500 - January 1, 1956 45-48 35-85 pts By the use of a v i s u a l comparison of the volume of shares traded, as r e l a t e d to the peaks and troughs of the S. and P. 500 index; two s i t u a t i o n s were formed f o r t e s t i n g the Volume of Trading Index. S i t u a t i o n I A purchase i s made when the volume of trading i s .6 m i l l i o n above the lowest observa,ble l e v e l since the l a s t s a l e . A sale i s made when the volume of traxling i s .6 m i l l i o n below the highest observable l e v e l since the l a s t purchase. 134 SITUATION I (.6 m i l l i o n d i f f e r e n t i a l ) A - Investment i n the Market (Dates are the end of month) Date Purchase -t- Commission Date Sale - Commission P r o f i t (Pts) June 58 Feb. 61 June 62 44.75 + -45 = 45.20 62.17 + .62 = 62.79 55-65 + .56 = 56.19 Aug. 59 Aug. 6l May. 66 59.40 - .59 = 58.81 67.79 - .68 = 67.ll 86.78 - .87 = 85.91 T o t a l 15.61 4.52 29.72 47.65 B - Investment In Bonds Period out of Market Yea.rs Amount (Pts) Av.Int. - Av.Dividend - (fo) (f) Rate (f) P r o f i t (Pts) Dec. 55 to June 58 Aug. 59 to Feb. 61 Aug. 6l to June 62 May 66 to Dec. 66 50/12 18/12 10/l2 7/12 45-4-8 58.81 67 . l l 85-91 5.51 - 5.50 = 4.60 - 5.08 = 4.55 - 5.55 = 5-57 - 5.68 =• .01 1.52 1.18 1.69 Total ( n e g l i g i b l e ) 1.29 .67 .86 2.82 Tot a l p r o f i t from S i t u a t i o n I i s A + B 50.47 points Control Investment i s 55.85 Improvement i s 14.62/55.85 X 100 = 40.78/S b e t t e r 133 S i t u a t i o n I I Same as S i t u a t i o n I with the exception that the d i f f e r e n t i a l i s .4 m i l l i o n shares rather than .6 m i l l i o n . 136 SITUATION I I (.4 m i l l i o n d i f f e r e n t i a l ) A - Investment i n the Market Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Dec. 57 J an . 6l Dec. 6l Jan . 63 J an . 65 40.33 + .40 = 40.73 57.92 + .60 = 58.52 71.74 + .72 = 72.46 65.O6 + .65 = 65.7I 86.12 + .86 = 86.99 June 59 J u l y 61 Oct . 62 J u l y 64 May 66 57.46 - .57 = 56.89 65.44 - .65 = 64.79 56.17 - .56 = 55.6I 85.22 - .83 = 82.39 86.78 - .87 = 85.92 • T o t a l 16.16 6.27 (16.85) 16.68 (1.07) 21.19 B - Investment i n Bonds P e r i o d out of Market Years Amount (Pts) A v . I n t . - Av .Div idend -w • m Rate P r o f i t (Pts) Dec. 55 to Dec. 57 June 59 to Jan . 61 J u l y 61 to Dec. 6l Oct . 62 to Jan . 65 J u l y 64 to J an . 65 24/12 19/12 5/12 3/12 6/12 45.85 56.89 64.79 55.61 82.59 5.68 - 4.03 = 4.55 - 3.16 = 4.58 - 3.20 = 4.42 - 3.45 = 4.55 - 2.93 = (.55) 1.59 1.59 .97 1.60 T o t a l • (.31) 1.25 .40 .11 .66 2.11 T o t a l p r o f i t from S i t u a t i o n I I . i s A + B 23.30 po in ts Improvement i s 12.55/55.85 X 100 = 55.0/i worse Conclusion: S i t u a t i o n I improved the investment performance by 38.4^0. I t was therefore decided to accept S i t u a t i o n I as c r i t e r i a , and also to use the i n d i c a t o r as such i n the Composite index. The c r i t e r i a , f o r use of the index are restated: 1. An i n d i c a t i o n to purchase i s given when the volume of trading i s .6 m i l l i o n above the lowest observable l e v e l since the l a s t s a l e . 2. An i n d i c a t i o n to s e l l i s given when the volume of trading i s ' .6 m i l l i o n below the highest observable l e v e l since the l a s t purchase. Stock P r i c e s and Volume of Trading Stock P r i c e s and Volume of Trading 1964 1965 1966 1967 1 9 6 § 1969 197CT 1971 P A B L E X X I I 140 AVERAGE DAILY VOLUIJB OE THE NEI/ YORK STOCK EXCHANGE 5 month moving average (OOO's shares) 1956 1959 1962 January February March A p r i l June J u l y August September October November December January February March A p r i l May June J u l y August September October November December 2,442 2,332 2,303 2,300 2,385 2,616 2,765 2,971 5,282 3,569 5,660 5,859 5,704 4,260 4,659 4,845 4,661 4,295 5,929 5,550 3,291 3,505 5,718 5,744 5,275 5,281 5,189 5,005 5,003 4,706 4,628 4,605 4,716 4,729 5,057 5,175 1965 5,866 5,801 5,290 5,824 5,761 5,459 2,492 5,690 5,641 5,555 5,595 2,455 5,721 5,670 2,569 5,433 3,940 5,299 2,180 5,585 5,949 5,206 2,057 3,086 4,001 5,552 1,925 2,944 4,009 6,011 2,005 2,826 5,685 6,318 2,059 2,920 5,692 7,245 2,063 2,955 5,796 8,039 2,109 5,087 4,057 ' 8,509 1957 i960 1965 - 1966 9,014 9,452 9,842 9,799 10,010 9,772 9,940 10,060 10,180 10,150 10,440) 10,510) January 2,115 3,144 4,209 8,413 February 2,102 5,157 4,256 8,803 March 2,126 3,051 4,529 8,698 A p r i l 2,115 5,049 ' 4,437 8,190 May June 2,125 5,106 4,427 7,638 2,165 5,040 4,287 7,586 J u l y 2,205 3,056 4,405 6,868 August 2,112 5,045 4,457 6,455 September 2,190 2,905 4,565 6,616 October ' 2,255 2,850 4,717 6,995 November 2,553 5,028 • 4,965 7,557 December 2,405 5,509 5,056 ' 8,571 1958 1961 1964 1967 xtra.polated Source: Federal Reserve B u l l e t i n TABLE XXIII AVERAGE DAILY VOLUME Oil TIE KB;? YORK STOCK EXCHANGE (OOO's shares) 1956 1959 1962 1965 J anuary February Ha.rch A p r i l May June J u l y August September October November December J anuary February March A p r i l June J u l y August September October November December January February March A p r i l May June J u l y Augus t September October November December 2,247 2,520 2,874 2,576 2,420 1,771 2,177 1,956 1,959 1,754 2,178 2,445 3,964 3,465 3,926 3,449 3,579 2,925 5,222 2,451 2,759 2,788 5,598 3,284 1957 i960 2,189 1,978 1,698 2,500 2,589 2,224 2,194 1,882 1,844 2,782 2,538 2,594 3,197 5,027 2,857 2,865 3,277 5,479 2,694 2,841 2,898 2,592 5,100 3,6 1958 1961 2,267 2,010 2,225 2,595 2,580 2,696 3,159 2,970 3,427 4,134 4.131 3,615 4,243 4,884 5,565 5,089 4,617 5,524 5,045 3,545 3,193 5,318 4.390 4,120 3,677 3,481 3,113 3,265 5,045 4,770 3,552 5,568 3,310 3,423 4,803 4,048 1963 4,575 4,168 5,561 5,072 4,781 4,528 5,467 4,154 5,551 5,516 5,294 4,701 1964 5,502 4,659 5,428 5,616 4,959 4,572 4,663 5,919 5,228 4,845 4,928 4,729 5,457 5,910 5,427 5,675 5,510 5,828 4,056 4,962 • 7,405 7,809 7,560 8,690 8,955 8,755 8,527 9,510 8,165 6,595 5,997 7,064 5,722 7,000 7,297 7,885 1967 9,885 9,788 10,217 9,589 9,933 9,666 10,854 9,057 10,251 10,225 10,578 Source: Federal Reserve B u l l e t i n 142 TEST VI: ODD LOT SALES TO ODD LOT PURCHASES A modified form of G. A. Drew's odd l o t sales to purchase r a t i o was ca l c u l a t e d . Drew used a ten day moving average of the d a i l y odd l o t sales to purchases. In t h i s a n a l y s i s , a three month moving average was cal c u l a t e d on the r a t i o formed from the monthly f i g u r e s of odd l o t sales and odd l o t purchases. The index thus formed was p l o t t e d on Charts XVI and XVII against the S. and P. 500, and i s recorded i n Table XXIV. As i n the method used f o r the other index s e r i e s , two s i t u a t i o n s are construed f o r t e s t i n g , to enable us to evaluate the worth of the index and i t s c r i t e r i a f o r our forecast. S i t u a t i o n I When the value of the index on the upside reaches .95 per cent, a. purchase i s i n d i c a t e d . When the value of the index on the downside reaches .90 per cent, a. sale i s Indicated. 145 SITUATION I A - Investment i n the Market (End of month dates) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Liar. 58 Dec. 60 J u l y 62 Oct. 66 42.11 + .42 = 42.55 56.80 + .56 = 57.56 56.97 + -57 = 57.54 77.15 + -77 = 77.90 Apr. 59 Feb. 62 Dec. 63 Dec. 66 57.10 - .57 = 57-67 70.22 - .70 = 70.92 91.75 - .92 = 92.65 81.55 - .81 = 82.14 Tot a l 15.14 15.56 35-11 4.24 68.05 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend -m Rate (#) P r o f i t (Pts) Dec. 55 to Mar. 58 Apr. 59 to Dec. 60 Feb. 62 to J u l y 62 Dec. 65 to Oct. 66 27/12 8/12 5/12 10/12 45-48 57.67 70.92 92.65 3.55 - 3.90 = - 4.45 - 3.26 = 4.54 - 3.34 = 5.21 - 3.35 = (.55) 1.19 1.20 1.86 Total (.56) .46 •55 1.48 1-95 Total p r o f i t from S i t u a t i o n I i s A + B 69.98 points Control investment i s 55.85 Improvement i s 54-15/55-85 X 100 = 95.2076 better Situation II When the value of the index on the upside reaches .95 per cent, purchase is indicated. When the value of the index on the downside reaches .87 per cent sale is indicated. 145 SITUATION I I A - Investment i n the Market (End of month dates) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Mar. 58 Dec. 60 J u l y 62 Oct. 66 42.11 + .42 = 42.55 56.80 + .56 = 57.56 56.97 + .57 = 57.54 77.15 + -77 = 77.90 May 59 Mar. 62 Jan. 66 Dec. 66 57.96 - .58 = 57-58 70.29 - .70 = 69.59 95.22 - .95 = 92.29 81.35 - .81 = 82.14 Total 14-85 12.25 54-75 4.24 66.07 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - $) (f°) Rate P r o f i t (Pts) Dec. 55 to Mar. 58 May 59 to Dec. 60 Mar. 62 to J u l y 62 Jan. 66 to Oct. 66 28/12 8/12 5/12 9/12 45-48 57-58 69.59 92.29 3-55 - 3.90 = 4.42 - 3-55 = 4.52 - 5.51 = 5.25 - 5-57 = (-25) 1.07 1.31 1.66 Total (.27) .40 • 35 • 65 1.12 Total p r o f i t from S i t u a t i o n I I i s A + B 67.19 points Control investment i s 55.85 Improvement i s 51.34/35-85 X 100 = 87.4I/0 better 1 4 6 Conclusion: As S i t u a t i o n I represented the best performance, i t v/as accepted as the i n d i c a t o r f o r Odd Lot Sales to Odd. Lot Purchases. The c r i t e r i a f o r use of the index are restated as follows: 1 . When the value of the index on the upside reaches .95 pe^ cent, a • purchase i s i n d i c a t e d . 2. When the value of the index on the downside reaches .90 per cent, a sale i s i n d i c a t e d . 149 TABLE XXIV ODD LOT SALES TO FurlCE ASE RATIO 1956 1959 1962 1965 - January 01-" 1.00 1.06 February • 95 .88 1.05 March .76 • 90 .87 1.07 A p r i l • 78 .88 • 91 1.07 May • 79 .86 .92 1.04 June • 78 .85 •94 •98 J u l y .75 .84 1.06 .98 August • 75 .82 1,08 .97 September .72 .82 1.12 .97 October • 71 .85 1.15 .95 November .71 .81 1.17 .94 December • 72 .80 1.18 .90 1957 I960 1965 1966 January .75 • 76 1.22 .87 February .77 .85 1.18 .86 March .80 .83 1.21 .90 A p r i l .82 .87 1.21 .95 May .82 • 90 1.20 .95 June • 78 •92 1.17 .92 J u l y .77 •93 1.22 .88 August .73 • 93 1.20 .84 September .69 • 93 1.16 .88 October .72 • 94 1.11 •99 November .72 •93 1.11 1.11 December .74 • 95 1.04 1.10 1958 1961 I964 1967 January •78 • 99 1.01 February .82 1.02 1.01 March .85 1.06 1.05 A p r i l .91 1.06 1.05 • May .96 1.01 1.07 June 1.00 1.00 1.05 J u l y 1.05 .95 1.04 August 1.04 .89 1.01 September 1.05 •94 1.05 October 1.05 .97 1.00 November 1.00 • 96 1.01 December .98 • 98 , 1.05 Data Source : Barrons 1 Y/eekly, Three month moving average 150 TEST VII: NET PURCHASES AND NET SALES ON ODD LOTS The index vms formed from the odd l o t s t a t i s t i c s of volume of purchases and sa.les that are recorded i n Barron's Weekly. Monthly net fi g u r e s of the algebraic t o t a l of purchases ana sales are the data p l o t t e d i n the index. The p o s i t i v e f i g u r e s represent purchases and the negative f i g u r e s represent s a l e s . A c e n t r a l l i n e v/as formed at the value of zero, and the p o s i t i v e data (net purchases) were p l o t t e d above, and the negative data (net sa.les) were p l o t t e d below. 'As stated i n Chapter IV, the l o g i c of forecast i s based on the f a c t that the odd l o t t e r u s u a l l y i s a c t i n g against the trend of the market at turning p o i n t s . He proportionately buys more at the top of the cyc l e , and proportionately l e s s at the bottom. To e s t a b l i s h c r i t e r i a f o r a forecast with t h i s index, two s i t u a t i o n s were formed and tested against the c o n t r o l , a. buy and hold d e c i s i o n . S i t u a t i o n 1 When the value of the index on the upside exceeds 1.8 m i l l i o n shares the S. & P. averages are sold . When the value of the index on the downside proceeds below .8 m i l l i o n shares, the averages are bought. SITUATION I A - Investment i n the Market (Dates are the end of month) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) A p r i l 57 Nov. 57 Apr. 60 J u l y 62 Ju l y 63 45.05 + .45 = 45.50 , 40.55 + .40 = 40.75 55-75 + .55 = 56.28 56.97 + .57 = 57.54 84.91 + .85 = 85.76 Oct. 57 Jan. 60 Apr. 62 June 65 Jan. 66 41.24 - .41 = 40.85 58.05 - .58 = 57-45 68.05 - .68 = 67.37 85.04 - .86 = 84.18 93.22 - .95 = 92.29 T o t a l (4.67) 16.70 11.09 26.64 6-55 56.29 B - Investment i n Bonds Period out of Market Dec. 55 to Apr. 57 Oct. 57 to Nov. 57 Jan. 60 to Apr. 60 Apr. 62 to J u l y 62 June 65 to J u l y 65 Jan. 66 to Dec. 66 Years j Amount (Pts) 16/12 1/12 5/12 5/12 1/12 11/12 45-48 40.83 57-45 67.37 84 .18 92.29 Av.Int. 5.57 4.55 4.67 4.49 4.60 5.24 Av.Dividend (#) 5.62 4.47 3.46 3.72 3.10 3.57 .05 .14 1.21 • 77 1.50 1.67 Total ( n e g l i g i b l e ) ( n e g l i g i b l e ) . .17 .14 .08 1.58 1.77 Total p r o f i t from S i t u a t i o n I i s A + B 58.06 points Control investment i s 55.85 = 6I.95/0 better Improvement i s 22.21/35.85 X 100 152 S i t u a t i o n I I When the value of the index on the upside exceeds 1 m i l l i o n shares, the S. and P. averages are so l d . When the value of the index on the dovmside proceeds below 200,000 shares, the S. and. P. averages are bought. 153 SITUATION I I A - Investment i n the Market (Dates are end of month) Date Puroha: se + Commission Date Sale - Conmiission P r o f i t (Pts) May 58 45.70 + .44 = 44.14 Feb. 59 54.77 - .55 = 54-22 10.08 May 59 56.15 + .56 = 56.71 Apr. 59 57-10 - •57 = 56.55 (-18) Apr. 60 55-75 + .56 = 56.29 J u l y 60 55-84 - .56 = 55-28 (1.01) Dec. 60 56.80 + •57 = 57.57 Apr. 62 68.05 - .68 = 67.57 10.00 J u l y 62 56.97 + .57 = 57.54 June 65 85.04 - .85 = 84.19 26.65 Aug. 65 86.49 + .86 = 87.55 Jan. 66 95-22 - .95 = 92.29 4.94 Total • 50.48 B - Investment i n Bonds Period out of Market Years Amount Av.Int - Av.Dividend - Rate P r o f i t (Pts) (Pts) (#) C/) Dec. 55 to May '58 29/12 45-48 3.57 - 5-70 = (.13) (-14) Feb. 59 to Mar. 59 1/12 54-22 4.50 - 3.35 =- .05 ( n e g l i g i b l e ) Apr. 59 to Apr. 60 12/12 56.53 4.50 - 5.46 = 1.04 • 57 J u l y 60 to Dec. 60 5/12 55.28 4.60 - 5-59 = 1.21 .28 Apr. 62 to Ju l y 62 5/12 67.57 4-49 - 5.72 = • 77 .14 June 65 to Aug. 65 2/12 84.19 4.60 - 5-10 = 1.50 •17 Jan. 66 to Dec. 66 l l / l 2 92.29 5.24 - 3-57 = I.67 1.58 Total 2.40 — Total p r o f i t from S i t u a t i o n I I i s A + B 52.88 points Control investment i s 55-85 Improvement i s 52.88/55.85 X 100 = 47.50$ better Conclusion: The r e s u l t s of the tests i n d i c a t e that e i t h e r s i t u a t i o n represents b e t t e r r e s u l t s than the c o n t r o l . S i t u a t i o n I (61.95 V^T cent better) v/as chosen as the index c r i t e r i a , f o r Net Purchases and Net Sa.les of Odd Lots. The c r i t e r i a f o r use of the index are restated: 1. When the value of the index on the upside exceeds 1.8 m i l l i o n shares, the S. and P. averages are sold . 2. When the value of the index on the downside proceeds below .8 m i l l i o n shares, the averages are bought. TABLE XXV 157 ODD LOT NET PUHCEAS3S A2TD NET SALES (monthly data) Net purchases = + Net sales = - (OOO's) 1956 January February March A p r i l May June J u l y Augu.s t September October November December 1105 1185 1020 1470 1297 1068 768 1018 1117 1741 1541 1670 1957 J anuary February March A p r i l May June J u l y August September October November December 1994 1254 850 752 675 1225 1492 1780 1910 2444 '584 995 1958 1959 I652 191 1364 787 821 1065 1041 1022 2227 1297 1196 1525 I960 2525 1724 2284 214 46 578 1585 85 688 574 275 -975 1961 1962 165 '-258 565 2150 2717 1070 -177 -664 -870 -1744 -2125 -1061 1965 -1197 -1555 -1499 -1616 -1470 -684 -679 -1602 -1275 -825 -958 -128 I964 January 1048 398 -125 February 414 -168 -180 March 760 -227 -52 A p r i l 692 -379 . -127 May 92 -430 -590 June 87 +372 .  +127 J u l y -582 613 -270 Augu.s t -135 -362 -242 September -460 +546 -410 October -289 +6 +145 November -19 -857 -555 December + 103 451 -520 1965 215 -515 -804 -505 -544 1571 206 -932 -1103 -546 -77 +741 1966 1260 2151 1190 913 1260 870 826 2183 2099 1881 -266 -2243 1967 Data Source: Barrens 1 Weekly, End of Month 158 TEST VIII: THE ODL LOT SHORT SALES INDEX The index v/as calculated as a modification of G. A. Drew's method. Drew used a daily calculation of the ratio of odd lo t shorts to odd lo t sales, and then subjected this ratio to a ten day moving* average. The writer used the ra t i o of the odd l o t short sales to total odd l o t sales for the month, and then performed a three month moving average. This formed the index that i s plotted on Charts XX and XXI, and recorded i n Table XXVI. The index v/as then tested i n the same manner as the other indexes, and c r i t e r i a were established for i t s forecast. By visual comparison to the S. and p. 500 two situations were construed for testing against the control. Situation I Y/hen the value of the index on the upside reaches 1.5 per cent, a sale i s indicated. When the value of the index on the downside reaches 1.8 per cent, a purchase i s indicated. 159 SITUATION I A - Investment, i n the Market " ( D a t e s are the end of month) Date Purchase -1- Commission Date Sale - Commission P r o f i t (Pts) Apr. 58 - Nov. 62 42.54 + .42 = 42.76 60.04 + .60 = 6O.64 Apr. 62 Mar. 66 68.05 - .68 = 67.57 88.88 - .88 = 88.00 24.61 27.56 Total 51.97 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - w e%) Rate P r o f i t (Pts) Dec. 55 to Apr. 58 Apr. 62 to Nov. 62 Mar. 66 to Dec. 66 28/12 7/12 8/12 45-48 67.57 88.00 5.54 _ 3.70 = 4.45 - 5.15 = 5.34 - 5.68 = (.16) 1.28 1.66 Total (.14) • 54 .97 1.37 Total p r o f i t from S i t u a t i o n I i s A + B 55.54 points Control investment i s 35.85 Improvement i s 17.49/35-85 X 100 = 48.787b better 160 S i t u a t i o n I I When the value of the index on the upside reaches 1.3 per cent, a sale i s i n d i c a t e d . When the value of the index on the downside reaches 2 per cent, a purchase i s i n d i c a t e d . 161 SITUATION I I A - Investment i n the Market (Dates are the end of month) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Feb. 58 Dec. 62 41.26 + .41 = 41.67 62.64 + .65 = 65.27 Feb. 62 June 66 70.22 - .70 = 69.52 86.06 - .86 = 85.20 Total 27.85 21.95 49.78 B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. <f°) - Av.Dividend - Rate P r o f i t (Pts) Deo. 55 to Feb. 58 Feb. 62 to Dec. 62 June 66 to Dec. 66 26/12 10/12 6/12 45-48 69.52 85.20 5-54 4- 45 5- 45 - 5.70 .= -• 5.15 = - 5-68 = ' (.16) 1.28 1-77 (-14) -76 .77 Total 1.59 Total p r o f i t from S i t u a t i o n I I i s A + B 51.17 points Control investment i s 55-85 Improvement i s 15-52/55-85 X 100 = 42.73/ better 162 Conclusion: On the basis of the r e s u l t s of these t e s t s , S i t u a t i o n I was accepted as the i n d i c a t o r and c r i t e r i a selected f o r the Odd Lot Short Sales Index. The c r i t e r i a f o r use of the index are restated: 1. When the value of the index on the upside reaches 1.5 per cent, a sale i s i n d i c a t e d . 2. When the value of the index on the downside reaches 1.8 per cent, a purchase i s i n d i c a t e d . TABLE XXVI ODD LO' - SNORTS TO YCLU -E RATIO (Sale s) 5 month mov ing average 1956 195? 1962 1965 January .48 • 85 .66 February •45 1.70 .48 March .56 .46 2.25 • 55 A p r i l • 58 •49 2.57 .81 May .60 •47 3.H .90 June .61 •54 3-27 1.08 J u l y .66 .69 5.24 1.17 August • 73 .92 3.59 1.19 September .79 .98 5.55 •97 October .83 1.00 2.79 .85 November .83 .94 2.54 • 79 December .90 •95 1.87 • 77 1957 I960 1965 1966 J anuary .95 .81 .96 .86 February .96 .85 .87 • 91 March .97 .87 .87 1.26 A p r i l .92 .88 • 85 1.45 May .84 .80 .86 1.81 June .96 • 74 .88 2.42 July- 1.19 .84 .94 5.67 August 1.50 1.13 1.06 4.03 September 1.88 1.25 1.18 3-97 October 1.99 1.24 1.12 3.68 November I.67 1.17 1.19 3.05 December 2.19 • 94 1.15 1.79 1958 1961 1964 1967 January 2.07 • 58 1.09 February 1.92 .41 1.07 March 1.96 .59 1.15 A p r i l 1.69 .42 1.15 May 1.59 • 54 1.09 June 1.12 .60 1.09 J u l y .87 • 78 1.00 August .66 .86 .87 September .60 • 851 .92 October- • 52 • 79 .90 November .48 ,8A .79 December .49 • 75 .73 Data Source: Barron's Weekly 166 PORIIATION OF THE COMPOSITE INDEX The Composite Index i s to be formed from the i n d i c a t o r series that - were tested and found to be s u i t a b l e f o r use i n t h i s a p p r a i s a l . The i n d i c a t o r s that tested favourably are: 1 The Advance-Decline Line 2. Ten Most A c t i v e Stocks to Market Volume 5. Volume of Trading 4- Odd Lot Net Purchases and Sales 5' Odd Lot Sales to Purchases 6. Odd Lot Shorts to Volume The f i r s t step that i s followed In the construction, i s the weighting of the i n d i c a t o r s on the basis of t h e i r performance i n the e a r l i e r t e s t s . (6) The process i s described and c a l c u l a t e d i n Appendix I l a . The weights are then assigned to the i n d i c a t o r s i n Appendix l i b . Each of the i n d i c a t o r s i s examined separately, and monthly s i g n a l s of + f o r favourable and - f o r unfavourable are assigned. The values f o r each month, as determined by the weights, are then summated to represent a monthly value f o r the composite. The composite index was p l o t t e d on Charts XXII and XXIII with the S. and P. 500. The mechanics of t a b u l a t i n g the i n d i c a t o r values i s represented i n Appendices I I and I I I . TESTING THE COMPOSITE INDEX The te s t applied to the other indicatox-s i s now applied to the Composite Index. The value of i t s performance, and the c r i t e r i a that o u t l i n e the process of the forecast are determined, so that the best s i t u a t i o n may be included i n the model. Two s i t u a t i o n s are construed f o r t e s t i n g . (^The method of weighting was described under "DESCRIPTION" i n the ea r l y part of t h i s Chapter. 16? S i t u a t i o n I \7hen the index value reaches 50 per cent on the upside, a purchase i s i n d i c a t e d . Y/hen the index value on the downside reaches 60 per cent, a sale i s i n d i c a t e d . 168 SITUATION I (Dates are the end of month) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Apr. 58 Dec. 60 Aug. 62 Aug. 65 42.M + .43 = 42.77 56.80 + .57 = 57-57 58.52 + .59 = 59.11 86.49 + .87 = 87.36 Sept.59 l i a r . 62 J u l y 65 Feb. 66 57.05 - .57 = 56.48 70.29 - .70 = 69.59 84.91 - .85 = 84.05 92.69 - .93 .= 91.76 T o t a l 13.71 12.22 24.94 4.40 55-27 — = _ - = ~ ^ = | B - Investment i n Bonds Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - (%) Rate P r o f i t (Pts) Dec. 55 to Apr. 58 Sept.59 to Dec. 60 Mar. 62 to Aug. 62 J u l y 65 to Aug. 65 Feb. 66 to Dec. 66 28/12 14/12 5/12 1/12 10/12 45-48 56.48 69.59 84.05 91-76 5.54 - 5.70 = 4.61 - 3.27 = 4.52 - 3.54 = 4.62 - 5.10 = 5.27 - 5-57 = (.16) 1-54 1.18 1.52 2.00 Total (.14) .90 • 55 .09 1.47 2.67 Total p r o f i t from S i t u a t i o n I i s A + B 57.94 point Control investment i s 55.85 Improvement i s 22.09/55-85 X 100 = 6I.6F/0 betti 169 S i t u a t i o n I I Y/hen the index value reaches 50 per cent on the upside, a purchase i s i n d i c a t e d . Y'/hen the index value reaches 50 per cent on the downside, a sale i s i n d i c a t e d . 170 SITUATION I I A - Investment i n the Market (Dates are the end of month) Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Apr. 58 Dec. 60 Aug. 62 42.54 + .43 = 42.77 56.80 + .57 = 57.57 50.52 + .59 = 59-11 Oct. 59 Apr. 62 Mar. 66 57-00 - .57 = 56.45 68.05 - .68 = 67.57 88.88 - .89 = 87.99 T o t a l 13.66 10.00 28.88 52.54 B - Investment i n Bonds Period out of Market Years Amount Av.Int. - Av.Dividend - Rate P r o f i t (Pts) ' (Pts) ($) (%) ($) Dec. 55 to Apr. 58 20/12 45-48 3-54 - 3-70 = (.16) (.14) Oct. 59 to Dec. 60 14/12 56.43 4.62 - 3-25 = 1.57 • 90 Apr. 62 to Aug. 62 4/12 67.57 4.48 - • 5-75 = .75 .20 Mar. 66 to Dec. 66 9/12 87-99 '5-57 - 5-56 = ' 1.81 1.14 Total 2.10 Total p r o f i t from S i t u a t i o n I I Is A + B 54.64 points Control investment i s 55-85 Improvement i s 18.79/55.85 X 100 = 52.41$ better 171 Conclusion: As the r e s u l t s of S i t u a t i o n I were superior, i t v/as chosen as the c r i t e r i a - f o r the i n d i c a t o r . The c r i t e r i a are rest a t e d as follo w s : 1. V/hen the index value reaches 50 per cent on the upside, a purchase i s i n d i c a t e d . 2. When the index value rea.ches 60 per cent on the downside, a sale i s i n d i c a t e d . 174 APPENDIX I I WEIGHTING THE INDICATORS 1956 through I966 P r o f i t i n S. and P. 500 - INDEX POINTS P r o f i t Source Benchmark Buy and Hold Index 1 Index 2 Index 3 Index 4 Index 5 Index 6 Stock Market Bonds 35.85 60.72 2.21 53.01 4-45 47.65 2.82 56 .29 1.77 68 .05 1.95 51.97 1.57 P r o f i t 55.85 62.95 37.46 50.47 58.06 69.98 55-54 Index P r o f i t as lp improvement of the Benchmark 55.85 = IQOji n=7 ^£ of Index c/o - 100 points or 526.75/o = 100 points P o i n t f o r i n d i c a t o r s Rounded 75.55 4.49 40.78 61.95 95.20 _ 48.78 25.12 1.57 12.48 18.96 29.14 14.95 24 1 12 19 29 15 Indexes #1 Advance-Decline Line #2 Ten Most Active Stocks to Volume #5 Volume of Trading #4 Odd Lot Net Purchases and-Sales #5 Odd Lot Sales to Purchases #6 Odd Lot Shorts to Volume APPENDIX I I I THE COMPOSITE INDEX + = Favourable - = Unfavourable I n d i c a t i o n Favourable dvance-Decline Line en Host Ac t i v e to Market Volume olume of Trading dd Lot Net Purchases and Sales dd Lot Sales to Purchases dd Lot Shorts to Volume In d i c a t i o n Favourable Y/eights 24 1 12 19 29 15 100 1956 J F A M J J A 0 N D 0 0 0 0 0 0 0 0 0 0 0 1958 Weights advance-Decline Line en Host Ac t i v e to Market Volume rolume of Trading dd Lot Not Purchases and Sales dd Lot Sales to Purchases dd Lot Shorts to Volume In d i c a t i o n Favourable dvance-Decline Line en Host Active to market Volume oluiie of Trading dd Lot Net Purchases and Sales dd Lot Sales to Purchases dd Lot Shorts to Y^olume 24 1 12 19 29 15 100 Weights 24 1 12 19 29 15 100 J F A K J J A 0 D 1957 M A Li J J S 0 N D 0 0 0 19 19 19 19 20 20 1 20 + + + + + - 1959 20 44 75 88 88 100 100 100 100 100 100 - + + + + + + + + + + + + + + + + + + + + - - - + + + + - - - - + + + + + + + + + + + + H- + + + + 4 - 4 - 4- + + + 4- I960 J F M A M J J A 0 N in S 0 N D 100 100 100 100 71 71 71 71 58 54 54 54 + + + + + + + + + + + + + + + + + -1- - _ + -1- + 4- 4- - _ + + + + + + - -+ + + + .1- + + + + + + + 1961 F M A M J J A S 0 N D 54 15 15 15 54 54 34 54 34 34 35 59 + - + + + + + + + + 88 88 100 100 100 100 100 100 88 88 88 88 + + + + + + + + + 4 - 4 - 4- + 4 - + 4- 4- + + 4- + + -1- + 4- 4- +• + + + 4- + - - - - 4- 4 - + 4 - + 4- 4 - 4 - + + + + + + -r 4. H- + + + + + + + 4- •V •f + - - 4 APPENDIX III THE COMPOSITE INDEX (cont) 1962 J F M A M J J A S O N D 88 88 59 35 1 1 47 85 85 85 85 100 + + "!- + + + + +'+ + + + _ _ _ _ _ _ -|- + + + + + + + + + - - - + + + + + + + - - - - - + + + + + + + + • + - - - - - - - + 1964 J P M A M J J A S 0 N D 75 75 99 99 99 99 99 99'99 99 99 99 - - + + + + + + -i- 4 - 4 - 4 - + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + •+• + + + + -1- + 4 - 1966 J P M A M J J A S 0 N D 70 51 27 12 12 0 0 0 0 0 29 0 + + _ _ _ _ _ _ _ _ _ ' _ 4 - 4 - 4 - 4 - 4 - - - - - - - - + _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ + _ 4 - 4 - 4 - - - - - - - - - - + = Favourable - = Unfavourable 1965 Weights J M A J J 0 N D I n d i c a t i o n Favourable 100 100 100 100 100 100 100 100 99 99 75 75 vance-Decline Line n Most Active to Market Volume lume of Trading d Lot Net Purchases and Sales i d Lot Sales to Purchases d Lot Shorts to Volume 24 1 12 19 29 15 + + + + + + -h 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - + + H- + + -I- + 4 - -1- + - - 4 - 4- - - - -+ H- + + + -f 4- +• 4 . + 4- 4 - 4 - -1- + + + + 4 - I n d i c a t i o n Favourable Ivance-Decline Line n Most Act i v e to Market Volume: lume of Trading d Lot Net Purchases and Sale; d Lot Sa.les to Purchases id Lot Shorts to Volume I n d i c a t i o n Favourable 100 1965 Weights 24 1 J_ 12 19 29 15 100 Weights ivance-Decline Line n Host Active to Market Volume! lume of Trading ia Lot Het Purchases and Sales Lot Sales to Purchases d Lot Shorts to Volume 24 1 12 19 29 15 J F M A M J J A 0 'K D 99 100 100 71 71 71 71 100 100 loo 99 99 4- + 4 - + 4 - 4 - 4 - 4 - 4 - 4 - 4 - 4 - -1- 4 - -!- + + + 4- + + 4- 4 - + + + - - + 4 - 4- 4- 4 - 4- • 4 - + + - - 4- 4 - + 4- 4- 4 - + -r 4- 4- j~ 4 - 4- + + + -;- 4- H- + + 4- 4- 4- 4- 4 - 1967 M J J 0 H D 100 CHAPTER VI TESTING THE HYPOTHESIS AND THE CONCLUSION In t h i s Chapter we w i l l gather together the components that have been developed f o r the model to be used f o r the te s t of the n u l l hypothesis, that i t i s not pos s i b l e to make p r e d i c t i o n s about turning points i n the stock market averages, with a better than .50 p r o b a b i l i t y that t h i s would improve investment performance over what you would have achieved by a buy and hold d e c i s i o n of the averages. The components are then weighted, f o r i n c l u s i o n i n the model, on the basis of t h e i r past performance. C r i t e r i a are then developed f o r the for e c a s t , by the method of t e s t i n g that was used f o r the D i f f u s i o n Index and the Composite Index. The r e s u l t s of the te s t are used to develop c r i t e r i a f o r the model, and then In the te s t of the hypothesis. In the t e s t i n g of the indexes and the model, i n the period from 19156 to 1966 i n c l u s i v e , the w r i t e r r e a l i z e s that data f o r t e s t i n g the hypothesis was generated from the same period on which the hypothesis was developed. However, to support the use of t h i s method, i t may be argued that: 1. The period of the t e s t was s u f f i c i e n t l y long to j u s t i f y a te s t f o r consistency In the i n d i c a t o r s and the combinations that a.re used. 2. The indexes chosen are those from a group that are generally proposed f o r the task. 3. The D i f f u s i o n Index and i t s components have authority by the nature of economic theory. 178 DESCRIPTION OE TEE EODEL CONSTRUCTION The coraponerits of the model f o r the forecast are the D i f f u s i o n Index, the Composite Index, and c r i t e r i a f o r performance. The model i s formed b y combining the two indexes, i n t o one s e r i e s , by u t i l i z a t i o n of a system of weights . These weights are developed from the r e l a t i v e performance of each index as compared to the c o n t r o l measure that 'was used i n the t e s t i n g of the D i f f u s i o n Index and Composite Index i n Chapters I I I and V r e s p e c t i v e l y . The system, of weight ing the indexes and f o r combining them Into -a s i n g l e s e r i e s , i s descr ibed as f o l l o w s : An asstunption i s made, that when both indexes have a l l i n d i c a t o r s p o s i t i v e , t h i s value w i l l be represented by 100 per cent . To combine the monthly percentages of each I n d i c a t o r i n t o the one, an apportionment, on the b a s i s of t h e i r r e l a t i v e performance to the c o n t r o l measure over the e n t i r e t e s t p e r i o d , i s a p p l i e d to the monthly data, o f each i n d i c a t o r . The D i f f u s i o n Index performance i s 58.04 per cent b e t t e r than the c o n t r o l . The Composite Index performance Is 6l.6l per cent b e t t e r than the c o n t r o l . 58.O4 = 48.51% i s the monthly weight adjustment f o r the 58.04+61.61 ' D i f f u s i o n Index then 6l.6l = 51«49/^  i s the monthly weight adjustment f o r the 58.04 + 6l.6l Composite Index The monthly f i g u r e s f o r each index are adjusted by these weights, and the r e s u l t i n g percentages are combined to form monthly values f o r the s i n g l e ^ I n Chapter I I I , page 5 1 , the D i f f u s i o n Index tested as 58.04 ;b b e t t e r than the c o n t r o l . ( 2) ' I n Chapter V, page 168, the Composite Index tested as 6l.6l°/o b e t t e r than the c o n t r o l . 179 s e r i e s , which we w i l l r e f e r to as the Model Index. The c a l c u l a t i o n s and values f o r t h i s index are found i n appendix IV and the index i s p l o t t e d on Charts XXIV and XXV. TESTING THE MODEL INDEX The method of t e s t i n g i s the same at- that used f o r t e s t i n g the previous index s e r i e s . Hypothetical buy and s e l l decisions are made by the Model Index, on the basis of various s i t u a t i o n s of c r i t e r i a , and the best performance i s judged as that with the la r g e r p r o f i t over that of the c o n t r o l , a buy and hold investment i n the S. and P. 500 averages. In t h i s manner, i d e a l c r i t e r i a are established f o r the Model Index and are also included i n the t e s t of the hypothesis. S i t u a t i o n I When the index on the upside reaches 50 per cent, a buy i s i n d i c a t e d . When the index on the downside reaches 50 per cent, a sale i s i n d i c a t e d . SITUATION I A - Investment i n the market (Nates are at the end of month) Date Purcha.se + Commission Date Sale - Commission P r o f i t (Pts) Apr. 58 Dec. 60 J u l y 62 42.54 + -45 = 42.77 56.80 -i- .57 = 57-57 56.97 + -57 = 57-54 June 59 l i a r . 62 Mar. 66 57-46 - .58 = 56.88 70.29 - .70 = 69-59 88.88 - .89 = 87.99 Total 14.11 12.22 30.45 56.78 B - Investment Period out of Market Years Amount (Pts) Av.Int. - Av.Dividend - (%) $>) Rate P r o f i t (Pts) Dec. 55 to Apr. 58 June 59 to Dec. 60 Mar. 62 to J u l y 62 Mar. 66 to Dec. 66 28/12 18/12 4/12 9/12 45-48 56.88 69-59 87-99 5-54 - 3-70 = 4-55 - 3.25 = 4-52 - .3.31 = 5»57 - 5-56 = (.16) 1.30 1.21 1.81 Total (.14) 1.08 .28 1.14 2.36 Total p r o f i t from S i t u a t i o n I i s A + B 59-14 points Control investment i s 55-85 Improvement i s 25.29/55.85 X 100 = 64.96% better 181 S i t u a t i o n I I When the index on the upside reaches 50 per cent, a buy i s i n d i c a t e d . When the Index on the downside reaches 55 per cent, a sale i s in d i c a t e d . 182 SITUATION I I A - Investment i n the Market Date Purchase + Commission Date Sale - Commission P r o f i t (Pts) Apr. 58 Dec. 60 J u l y 62 42.J4 + -43 = 42.77 56.80 + .57 = 57.57 56.97 + .57 .= 57-54 June 59 Jon. 62 Feb. 66 57.46 - .58 = 56.88 69.07 - .69 = 68.38 92.69 - .93 = 91.76 Total i 4 . l l 11.01 34-22 59-54 B - Investment i n Bonds Period out of Market Years Amount Av.Int. - Av.Dividend - Rate P r o f i t (Pts) (Pts) $ ) Dec. 55 to Apr. 58 28/12 45-48 5-54 - 5.70 = (.16) '(•14) June 59 "to Dec. 60 18/12 56.88 4-55 - 5.25 = 1.50 1.08 Jan. 62 to J u l y 62 6/12 68.58 4-51 - 5.34 = 1.17 •27 Feb. 66 to Dec. 66 10/12 91.76 5-27 - 5.57 = 1.70 1.29 Total 2.50 Total p r o f i t from S i t u a t i o n I I i s A + B 61.84 points The c o n t r o l investment i s 35«85 The improvement i s 25.99/35.85 X 100 = 72.49;/ better Conclusion: As s i t u a t i o n I I provides the most favourable r e s u l t s , i t was selected as the t e s t f o r the hypothesis. APPENDIX IV TEE MODEL INDEX 1956 Weights J F •A 1.1 J J A s 0 N D D i f f u s i o n Index + Composite Index 48.5 51-5 0 0 0 16.0 0 8.5 0 8.5 27.7 0 o- 44-1 0 44.1 0 44.1 0 52.5 0 16.0 "0 = THE HODEL IHDEX 100.0 0 0 0 16 8 8 28 44 44 44 33 16 1957 Weights J F M A M J J A s 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 0 0 8.5 0 7.3 0 14.1 0 14.1 9.8 20.8 14.1 9.8 9.8 7-5 9.8 7.5 10.5 7-3 10.3 0 • 5 0 10.3 = THE MODEL INDEX 100.0 0 8 7 14 14 21 24 17 18 18 1 10 1958 Weights J F M A M J J A S 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 0 10.5 14.1 22.7 8.3 22.7 37.8 43-2 37.6 45.5 48.5 48.5 45-5 51.5 48.5 51.5 57.8 56.4 48.5 51.5 51.5 51.5 36.4 51.5 r THE MODEL INDEX 100.0 10 57 51 75 89 94- 100 100 100 88 100 88 1959 Weights J F M A M J J A S 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 50.6 51.5 50.6 51.5 56.4 51.5 24.3 51.5 24.5 56/6 12.1 12.1 7-3 12.1 16.0 36.6 36.6 56.6 29.9 17.5 17.9 17.5 24-3 17.5 = THE MODEL INDEX 100.0 82 82 82 76 61 49 49 44 42 54 55 42 I960 Weights J F M A M J J A s 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 17.9 17.5 21.3 7-7 5-5 7-7 4-9 7-7 10.7 17.5 9-8 4.9 17.5 17.5 4.9 17.5 9.8 17.5 9.8 17.5 24-5 18.0 24-3 30.4 = THE MODEL INDEX 100.0 55 29 15 15 28 27 22 22 27 27 42 35 1961 V/eights J F M A M J J A s 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 52.5 45.5 38.8 45-5 58.8 51.5 34o0 51.5 54-0 51-5 34-0 29.1 51.5 51.5 48.5 51.5 38.8 45-3 24-3 45-3 29.1 45-3 24.5 ^5-5 = THE MODEL INDEX 100.0 78 84 90 8 6 8 6 86 81 100 8 4 00 74 70 13? APPENDIX IV THE MODEL INDEX (cont) 1962 Y/eights J P M A M J J A S 0 N 1) D i f f u s i o n Index + Composite Index 48.5 51 -5 19.4 45-5 19.4 '45-3 19.4 5O.4 19.4 18.0 11.2 • 5 11.2 29.1 •5 24.2 29.1 45-8 I9.4 43-8 54.0 43.8 29.1 43-8 54-0 51.5 = THE MODEL INDEX 100.0 65 65 50 57 12 12 55 63 78 73 86 1963 — • — _ Weights J E M A M J J A S 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 21.5 51-5 29.5 51.5 57-8 51.5 34.0 51.5 21.8 51.5 29.I 24.3 51.5 51.5 24.3 51.5 38.8 51.0 38.8 51.0 24.3 38.6 24-3 58.6 .= THE MODEL INDEX 100.0 73 81 89 86 73 81 76 76 90 90 63 65 1964 Weights J F M A M J J A S 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 19.4 58.6 54.0 58.6 29.1 51.0 24.3 51.0 29.1 51.0 24.5 29.1 51.0 51.0 21.5 51.0 38.8 51.0 29.1 51.0 29.1 51.0 19-4 51.0 = THE MODEL INDEX 100.0 58 75 80 75 80 75 80 72 90 • 80 80 70 1965 Weights J P M A M J J A s 0 N D D i f f u s i o n Index + Composite Index 48.5 51.5 29.I 51.0 24.5 51.5 54-0 51.5 54.0 56.6 34-0 "29.1 I9.4 36.6 36.6 36.6 29.1 51.5 52.0 51.5 58.8 51.5 29.1 51.0 34-0 51.0 = THE MODEL INDEX 100.0 80 76 86 71 71 66 56 81 84 90 80 84 1966 V/eights J P M A M J J A S 0 N D D i f f u s i o n Index + Composite Index - 48.5 5I.5 29.1 56.1 24.5 26.5 16.0 13.9 14.6 6.2 9-7 6.2 14.6 5.5 0 0 14.6 0 4-9 0 14.6 0 14 • 6 14.9 24-3 0 r THE MODEL INDEX 100.0 65 51 50 21 •' 16 15 5 15 5 15 29 24 188 TESTING THE HIPOTEESIS The hypothesis to he tested i s restated from Chapter I: "It i s not possible to make predictions about turning points of prices i n the stock market averages with a better than .50 probability that would improve investment performance over what you would have achieved by a buy and hold decision of the averages". This hypothesis i s to be tested by the model formed from, the Diffusion Index of economic indicators, the Composite Index of technical indicators, and suitable c r i t e r i a that are developed for the performance of the model. The structure of the model v/as developed i n this Chapter, as one, the Model Index, and two, c r i t e r i a that were selected from the test of the index. For the s t a t i s t i c a l data to substantiate a statement concerning the v a l i d i t y of the n u l l hypothesis, the writer refers to the f i n a l tests, which were made on the Model Index.(^ The control investment, represents the buy and hold decision of the averages, and i t i s the benchmark against which we test whether there i s a better than .50 probability of improving investment results by timing stock market purchases and sales. I f , over the eleven years being tested, the investment decisions performed with the Model Index of this appraisal are sign i f i c a n t l y better than the control, the rejection of the n u l l hypothesis w i l l be substantiated.(4) In the test of the Model Index, Situation II was the performance selected. (^Refer to Testing the Model Index i n this Chapter. (4)_he writer makes the assumption that the degree of significance i s 10 per cent. 189 The c r i t e r i a are: when the index on the upside reaches 50 per cent, a buy i s i n d i c a t e d . Y/htn the index on the downside reaches 55 per cent, a sale i s in d i c a t e d . The performance i s : that the p r o f i t from the investment decisions of timing purchases and sales i s 72.49$ better than the buy end hold d e c i s i o n . CONCLUSION The r e s u l t s of the t e s t of the hypothesis i n d i c a t e a, r e j e c t i o n of the n u l l hypothesis, and substantiate the statement that: " I t i s possible to make p r e d i c t i o n s , about turning points of pr i c e s i n the stock market with a. bet t e r than .50 p r o b a b i l i t y , that would improve investment performance over what you would have achieved by a buy and hold d e c i s i o n of the averages". BIBLIOGRAPHICAL ENTRIES A. BOOKS Cohen, Jerome B. and Zinbarg, Edward D. Investment Analysis and Portfolio management. Horaewood I l l i n o i s : Richard D. Irwin Inc., I967• Edwards, Robert D. and Magee, John. Teclinical Analysis of Stock Trends. Springfield, Massachusettss John Magee, 1966. Katona, George. The Mass ConjunipjWori Society. New York: KcGraw H i l l Co., I 9 6 4 . * Hansen, Alvin Harvey. Business Cycles and National Jj\come. New York: W.W. Norton and Co. Inc., 1951- Bolton, Arthur Hamilton. Mojne.v; and Investment P r o f i t s . Homev/ood, I l l i n o i s : Bow Jones - Irwin, 19&7- Drew, Garfield A. New f f e t l i c ^ - S for P r o f i t i n the Stock Market. Wells, Vermont: Eraser Publishing, I966. Eiteman, W.J., Dice, Charles A., and Elteman, D.K. The Stock Market - 4th edition. New York: McGraw H i l l , 1966. Sprinkel, Beryl V/. Money and Stock Prices. Homewood, I l l i n o i s : Richard D. Irwin Inc., 1964. B. ARTICLES Gartley, H.i.i. "Volume of Trading - A Forecasting Factor". A Treasury of Wall, Street Wisdom, Hand Shultz, Coslow S. New York: Investors Press, 1965. Lempert, L.N. "Do the leading Business Indicators Lead?" The Financial Analyst Journal, Nov/Dec, 1967 - Moore, G.H. "Analyzing Business Cycles". The American S t a t i s t i c i a n , p. 15. April/May 1954- Mueller, Eva. "Ten Years of Consumer Attitude Surveys". Journal of the American S t a t i s t i c a l Association, 196}. Freeman, G.K. "Advance-Decline Line". Elements of Investments, A.J. Zakon et a l . I965: Holt Rhinehart and V/inston. "Is the Odd L o t t e r Alwasy Y/rong?". Business Week, '<-ray 6 1967. ' C. PAPERS S h i s k i n , J u l i u s . "The Knovrn and the Unknown". Business Cycle Developments. September 1965: U.S. Departiaent of Commerce. Moore, G.H. and S h i s k i n , J . N.B.E.R. Occasional Paper Ho. 105. D. PUBLICATIONS Business Cycle Developments published monthly by the U.S. Department of Commerce, Bureau of the Census. 

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