The more advanced you become in stock and bond investing, the more familiar you'll become with a thing called a bond yield curve. This graph is probably one of the only tools you might find that can aide in predicting market trends. Since interest rates are ultimately controlled by the Federal Reserve (FED), tracking the way that the FED adjusts these rates can really help your investing approach.
The yield curve is broken down into two axis'. The x-axis is the term of the federal bill, note, and bond. While the y-axis is the corresponding yield for each of those securities. In order to show how all the investments are inter-related, a line is drawn between them on the graph. If you'd like to see what a yield curve looks like, simply google the term and you'll see a multitude of examples.
You see, the FED is completely reactionary. If the market goes down and jobless rates increase, they increase the supply of money so interest rates decrease. Inversely, if the market is booming and employment is very high, the FED gradually raises interest rates in order to prevent a future market bubble. This cycle, which some argue is the result of the FED itself (and I kind of agree), is something that will continue to occur in the future as long as we have a central bank for the country.
So how can you take advantage of this behavior as a stock and bond investor? Well for starters, let's talk about bonds. We know that the market value of a bond is directly related to interest rates. If we look at a current bond yield curve in 2012, you'll see a positively sloped graph that depicts the yield on long term bonds much higher than short term notes and bills. This is important because it's the FEDs way of saying, "Hey we don't think these low interest rates are going to last for a long period of time. In fact, over a 30 year period we think the average yield will be X (insert the yield from the intersection of the 30 year bond and line on the chart)" Knowing that the market value of a bond decreases when interest rates increase, we can rest assure that buying bonds in 2012 is probably a very poor financial decision.
With respect to stocks, we know when the yield curve is positively slopped, short term interest rates are low and it probably means it's a great time to be purchasing common shares.
Although this article only provides a very quick and ruff way to examine yield curves, active investors should really try to learn more about this wonderful tool.
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