Shares: Liquidity

Buy on the up arrows, sell on the down arrows

This tool is intended to predict share prices based on government policies, using data on monetary policy available at the time, specifically interest rates or real effective exchange rates, as calculated by PIT for all countries in the database. For comparability stock market indexes have been rebased to set year-end 1994 at 100.

In each chart the stock market index is shown as the thick white line on the right hand axis. The main explanatory variables, interest rates (or real effective exchange rates in the case of the global perspective) uses the left hand axis, shown as the thin yellow line. Best Guesses as to the effect on markets are shown as red arrows embedded in the price index.

The selection of monetary variable depends on the choice of investment perspective. Interest rates are useful in predicting share prices in absolute terms, either in Local Currency or Dollars but tend to have an opposite effect on the exchange rate, so limiting their usefulness for global comparisons. Therefore for the Global Perspective only, real effective exchange rates are used instead. The series is expressed as a rate of change indicator.

This tool works on the assumption that governments rarely make a change in policy all at once, but spread out over a number of intermediate steps, so the effects of a change create a trend over time that investors can exploit. However, in times of crisis this is not the case. Buy signals for the Local Currency and Dollar are generated when interest rates begin to fall. Sell signals arise when the converse applies. Buy signals for the Global Perspective are generated when the real effective exchange rate accelerates and sell signals when it decelerates. Noise reduction methods have been employed to minimise the number of signals.

Back-tested past performance of this strategy shows that it can be an effective way both to raise returns and to reduce risks.

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