Notes:
1. Terminology used in PI is listed below. Alternative terminology and abbreviations are in parentheses. For an example, check out the abbreviation for “GWSG”.
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401K Plan A defined contribution plan set up by a for-profit company for employee retirement. The savings are withheld through payroll deductions, and the employee’s income for tax purposes is reduced by the contributed amount. The company may choose to match a portion of the amount contributed. The money grows tax-deferred till retirement. There is an annual maximum cap which is set by Congress, and typically the money may be withdrawn after age 59-1/2.
403B Plan Is a defined contribution plan and which is sometimes called a tax-sheltered annuity (TSA) plan. It is set up by a public school, university, or non-profit organization for employee retirement. The savings are withheld through payroll deductions. The money grows tax-deferred till retirement. There is an annual maximum cap which is set by Congress, and typically the money may be withdrawn after age 59-1/2.
Annualized (Ann.) The process of converting weekly, monthly or quarterly data into its yearly or an “annualized” number. Weekly data is multiplied by 52, monthly by 12 and quarterly by 4.
Asset Allocation Deciding what fraction your investment portfolio should be in invested equities (stocks, or stock mutual funds), and how much in fixed income (bonds, bond funds, money market funds, or cash). The allocation depends on age and risk tolerance.
Bonds Are loans that you give to a company (Corporate bonds), a County or State (Municipal bonds), or to Uncle Sam (Treasury bonds). It is like a home Mortgage in reverse, where you loan the money and receive interest. It has a Face Value (amount you loaned), interest rate (that they pay you), and term or maturity date when they will return your money. Interest is paid monthly, quarterly or every six months, depending on the terms of the bond.
Bear Market Sustained, long period of falling stock prices.
Bearish Expecting the market to go lower. Persons who are bearish have either sold their stock holdings or bought Puts, and are counting on lower prices ahead.
Bull Market Sustained, long period of rising stock prices.
Bullish Expecting the market to go higher. Persons who are bullish have purchased stock or bought Calls, counting on higher prices ahead.
Budget Deficit Occurs when the government spends more money than the revenue it collects.
Budget Surplus Opposite situation from that of a deficit. The government is taking in more money than it spends.
Calls (Call options) A contract that gives the investor the right, but not the obligation, to buy a security at a specified price during a given period of time. For instance, the stock of XYZ Company trades at $55 per share. An investor buys a call option expiring in 3 months, at a strike price of $60 per share. If the price at the end of the expiration period of 3 months is greater than the strike price, say $63, the investor pockets the gain of $3 per share. It the price at the end of the 3 months is less than the strike price, say $59 per share, the call is worthless, and the investor gets nothing.
Certificate of Deposit (CD) Is a savings certificate issued by a commercial bank. It has a specified fixed interest rate and maturity date, and is insured by the FDIC in case the bank fails or is unable to pay. The principal and interest are guaranteed, up to a total combined amount of $100,000 per account.
Consumer Price Index (CPI) Is a method of measuring the rise in prices due to inflation. It is the change in price of a predefined basket of goods and services. The media usually calls it Headline CPI or Headline inflation.
Core CPI Headline CPI (inflation) number, minus the increase in prices of food and energy.
Core Inflation Same as Core CPI ,and used interchangeably.
Credit Risk The interest rate paid on a bond depends on many factors, one of which is the creditworthiness of the borrowing entity. The lowest credit risk bonds are issued by the US Treasury, which are backed by the full faith and credit of the US government. They therefore pay the lowest interest rates. At the other extreme are companies that are not financially sound, have large debts, and may not be able to pay the interest or repay (default on) the principal. The high credit risk means that they must pay very high interest rates to attract people to buy their bonds, which are called junk bonds.
Defined Benefit Plan Is a retirement plan set up with funds provided by the employer only. It is what we normally refer to as a “pension”, and on retirement, payments are made for the lifetime of the employee. This was the standard retirement plan before the mid-80’s, in the days when employees worked for one company for most of career. It has mostly been replaced by the defined contribution plan.
Defined Contribution Plan Is one where the employee contributes to their own retirement by saving periodically with payroll deductions. Examples of such plans are 401K, 403B, etc.
Dollar Cost Average (DCA) The process of gradually investing (or withdrawing) equal sums of money over a specified period of time. For example, for a one year DCA, divide the total investment capital by 12, and invest once each month for a year.
Diversified (diversification) Is a technique for reducing the risk in a portfolio, by including stocks from different market sectors, industries, and countries. bonds from a variety of issuers, both corporate and government, are also included. Risk is reduced since the portfolio is spread out over many different areas, and a decline in a given sector is often offset by an increase in another. Also, a decline in the overall stock market is often partly offset by a gain in bonds.
Discount Rate Is the interest rate that banks pay to borrow short-term money from the Federal Reserve Bank.
Dow Jones Industrial Average (Dow or DJIA) is a price-weighted Index of 30 large capitalization stocks traded on the New York Stock Exchange. The Dow is a very narrow index, and covers a very small group of very large stocks only. It is often (erroneously) referred to by the media as “the market”.
Earnings Estimate An estimate of how much profit a company will earn in the future. It is usually forecast by analysts.
Earnings Yield The yield equivalent of yearly corporate earnings. This is calculated as the inverse of the PE ratio (1.0 divided by PE ratio). So a PE ratio of 25 is equivalent to an Earnings Yield of 0.04 or 4%.
Equivalent bond PE ratio The “earnings equivalent” of the bond yield. This is calculated as the inverse of the bond yield. So it is 1.0 divided by the bond yield. For a bond yield of 5% the Equivalent Bond Yield is 1.0/0.05 which is 20.
Equities Is a synonym for stocks, which is a security that represents part ownership of a company.
Exchange Traded Fund (ETF) Is a “mutual fund-like” basket of stocks, that trade on an exchange like an individual stock. The collection of stocks may be from a sector, a country, or company size. Its value fluctuates with the prices of the stocks in the basket that it holds. ETF’s can be bought and sold at any time during trading hours, and they can also be margined or shorted.
Expense Ratio The percentage of the assets of a mutual fund that is spent annually to cover the fund management fees and operating expenses. This is paid out of the total assets, and therefore reduces the return of the fund.
Fairly Valued (Fully-Valued) The price of the stock fully reflects the value derived from the public information regarding the fundamentals and financials of the company. This task is performed by financial analysts, who use this information to project where the stock price could be in the future. If a stock is fully-valued, it is not likely to rise in price (assuming of course that investors are rational).
Federal Reserve (Fed) Is the “Central Bank” of the USA. The Fed controls and regulates the monetary (banking) system. Its two main objectives are to control inflation and to maximize employment.
Fed Funds Rate The overnight interest rate, set by the Fed, at which banks loan money to each other. They do this to meet the reserve requirements of the Fed, which mandates that a specified percentage of their assets must be on deposit at the Fed Reserve Bank at all times. If the deposit is lower than this requirement, they borrow from other banks that have excess deposits at the Fed bank.
Federal Reserve Open Market Committee (FOMC) Is the division of the Fed Reserve Board that deals with and sets monetary policy. The FOMC sets the Fed Funds interest rate, and buys or sells Treasury Bonds in the open market, to control the Money Supply.
Fees and Expenses See Expense Ratio.
Financial Advisor (Financial Planner, Certified Financial Planner-CFP) An investment professional, certified by the CFP Board of Standards, who assists clients to set up a plan to meet their long-term financial goals and objectives. Financial planners may be paid by commission on the amount of funds bought by the client, charge a fixed percentage of assets being managed, or on the amount of trades made in the account.. Other planners, preferred by persons managing their own money, are called “Fee only advisors”, who charge a flat-fee, a retainer, or by the hour consulting fees, and are registered members of the National Association of Personal Financial Advisors (NAPFA).
Fixed Income Is a general category of investments that pay a fixed amount of interest over a specified amount of time. This includes items like Certificates of Deposit (CD’s), Money Market Funds, Savings Accounts, Corporate, Municipal and Treasury bonds, etc.
Flat Yield Curve occurs when the interest rates are the same for long and short term Treasuries, specifically for the 20 year T-bond and the 3 month T-bill. Normally, higher interest rates are demanded by the market for tying up money for longer time periods. Flat yield curve is an unusual situation, and is often a precursor to significant economic slowdowns or an economic recession.
Forward PE ratio (Estimated PE ratio) Is the Price to Earnings ratio calculated using estimated or forecasted earnings. It is calculated as Current Stock price divided by the Estimated Earnings per share for the next 12 months.
Genuine Wall Street Gibberish (GWSG). Ah, those fancy terms used by the Wall Street types, financial advisors, investment bankers and reporters. Used to fool the public into believing that the subject is very complex, that they add real value, and should be paid handsomely for mishandling your money!
Gross Domestic Product (GDP) The total dollar value of all the goods and services produced in a given country, during the last 12 months.
Real GDP is the GDP minus the rate of inflation.
Headline CPI (Headline Inflation) Total raw measured increase in the CPI. This is the YOY increase in the price of a fixed basket of goods and services. Details of the “basket” and measurement method can be found in the links section .
Hedge GWSG term for what normal folks call “insurance”. "Applying a hedge” or “hedging” your stock portfolio means “purchasing insurance to protect against a loss in the market”. One method for this is to “buy put options”. Like insurance, the premium is paid up front, and you get nothing back if the untoward event does not occur. Conversely, if the event happens, you get back the lost amount, less the equivalent of the deductible.
High Yield Bonds GWSG euphemism for junk bonds.
Index Is a hypothetical collection of stocks that represent a certain market or certain portion of a market. For instance, the S&P500 index is a collection of 500 of the largest US stocks as denoted by the Standard and Poors Corporation. The value of the index is the total dollar cost of all the stocks in the collection.
Index Fund Is a mutual fund that holds the same collection of stocks, in the same proportion as the underlying Index that it tracks. Its objective is to closely mirror the performance of the index.
Individual Retirement Accounts (IRA) Is a retirement vehicle that individuals can contribute up to the maximum yearly cap as set by Congress. Several types of IRA’s are available, Traditional, Roth, SIMPLE, and SEP. The earnings grow tax-deferred till retirement. Taxes paid on withdrawal depend on the IRS rules for the IRA type.
Indicator Is a parameter used in the PI model to forecast financial or economic trends, such as the CPI or GDP. It may also be a calculated or derived parameter such as Investor Sentiment or Slope of the Yield Curve.
Inflation Is the increase in price of a predefined basket of goods and services over a 12 month period. The media usually calls it Headline CPI or Headline inflation.
Inflation Indexed Bonds (I-bonds) Are bonds issued by the US Treasury that guarantee a rate of return that is higher than that of inflation. If the CPI increases, the interest rate paid increases by the same amount, and vice-versa.
Inverted Yield Curve Occurs when the yield on the long maturity 20 year T-bond is lower than that of the short 3 month T-bill. Banks profits disappear, and they stop lending money, since they borrow short-term, and loan the money to individuals and companies long-term. Inverted yield curves are often followed by a recession.
Investor Sentiment is a method of quantifying the levels of investor optimism or pessimism about the future prospect for the market. Some sentiment numbers are derived from the number of Investment Advisors that are Bullish versus Bearish, or the Put to Call volume ratio in the Chicago Options market.
Investment Grade Bonds issued by financially sound companies, that are rated BBB or higher, by Moody’s and Standard and Poor’s. Those rated below BBB are classified as high-yield bonds, also known as junk bonds.
Junk Bonds Are bonds issued by companies or municipalities with poor credit risk, meaning they are experiencing financial problems. These bonds have been rated below investment grade i.e. lower than BBB, by the credit rating companies Moody and S&P. Junk bonds are purchased for their higher yield, and the hope for capital gains, if the company circumstances (and hence the bond ratings) improve.
Long Term Trend Signal (LTTS) Is a proprietary PI technique, that tracks the direction of the stock market, and signals that a major change in direction is underway.
Margin (Margined) Securities in a portfolio can be used as collateral to borrow money to buy more securities, in a process called margining. Currently the Fed permits loans up to 50% of current value of the portfolio.
Markets The term “market” and the S&P500 Index, are used interchangeably in PI..
Market Timing The pseudo-science of determining when to buy equities, and when to sell them. Timing can range from short-term (hourly or daily), medium-term (weekly or monthly), or long-term (multi-year).
Money Market Funds A fixed income mutual fund that invests in very short duration bonds. The fund pays interest, and maintains a constant price of $1 per share. Usually used as a holding account for temporary funds, that pays higher interest than cash. Both taxable and non-taxable money market funds are available.
Money Supply Is the total amount of liquid assets in the economy of a given country, including coins, currency bills, credit, bank checking and savings accounts, etc.
Monetary Base (M0) Is one component of the money supply. It consists of all physical currency (bank notes and coins), plus accounts at the Federal Reserve banks that can be exchanged for currency.
M1, M2, M3 These components are broader measures of the Money supply, in addition to the items in the Monetary Base M0. These include checking, savings and money market accounts, plus Certificate of Deposits (CD’s).
Mutual Fund Is a selected group of stocks or bonds managed by a for-profit mutual fund company. It gives investors a simple way to own and keep track of a well-diversified portfolio. Mutual funds are priced after the close of trading each day, and the price reflects the total value of the stocks in the portfolio, called the Net Asset Value (NAV). On any given day, mutual funds can only be bought or sold at the NAV for that day. Mutual funds may specialize in a market sector, market capitalization, or focus on a given industry or country. The fund is managed by a Portfolio Manager, who is compensated from the Expense Ratio paid by investors in the fund.
Nasdaq Is an all electronic stock exchange that actively provides quotes, and trades many thousands of stocks every day. There is no “trading-floor”, where buyers and sellers meet face to face, as at the New York or Chicago Stock Exchanges.
Nasdaq Composite Index (Nasdaq Comp) The Nasdaq Composite, an Index of 3000 stocks traded on the Nasdaq Stock exchange, and the exchange itself, are both referred to as “Nasdaq” (how very confusing !). However, the context in which they are used allows us to differentiate between the two. When we see a number quoted in the news, it refers to the value of the Nasdaq Composite Index.
Normal Yield Curve Is the expected case, where longer term bonds have higher yields than shorter term bonds. The yield curve is sloped upward, and is referred to as a “positive yield slope” or a “normal yield curve”.
Overheated Economy Is an economy that is growing at an unsustainably fast rate. Factory capacity utilization is high, labor shortages are rampant, and inflation is rising.
Overvalued Analysts determine the “fair value” of a stock by analyzing the future earnings and prospects for the company (see Fairly Valued). If the stock price is higher than the fair value, it is denoted as “overvalued”.
Par Is GWSG for the number “100”. So a stock or bond at par has a value of $100 per share.
Price to Earnings Ratio (PE or P/E) A measure of stock valuation. It is calculated as the current stock price divided by the Annual earnings.
PE(TTM) is the PE ratio using the actual earnings for the last 12 months. Forward PE is the PE ratio at the end of the upcoming year, and where estimated earnings for the next year are used.
Portfolio Is a collection of equities and fixed income securities. A portfolio may consist of individual or mutual funds of stocks and bonds and cash. Real estate and other assets are not included.
Productivity Is the output per worker over a specified time period. Higher productivity means that fewer workers are needed to do the same job. This reduces labor costs and improves the competitiveness of an enterprise or country.
Puts (Put options) A contract that gives the investor the right, but not the obligation, to sell a security at a specified price during a given period of time. For instance, the stock of XYZ Company trades at $55 per share. An investor buys a put option expiring in 3 months, at a strike price of $50 per share. If the price at the end of the expiration period of 3 months is less than the strike price, say $46, the investor pockets the gain of $4 per share. It the price at the end of the 3 months is greater than the strike price, say $51 per share, the put is worthless, and the investor gets nothing.
Put-Call Ratio (PCR) Is a PI indicator, and is defined as the volume of Puts divided by the volume of Calls on the Chicago Board of Options Exchange (CBOE). High PCR means investors are expecting a drop in the market, and vice-versa. But since most investors are usually wrong, this is used as a contrary indicator (meaning we do the opposite to what the “herd” is doing).
Real “xxxx” In economic jargon, “Real” in front of any parameter “xxxx”, means “adjusted for inflation”. That is, the inflation rate as measured by the CPI, has been subtracted from the parameter in question.
Real GDP Is the GDP less the rate of inflation.
Recession Is defined as 3 quarters of negative GDP growth.
Reward (Return) GWSG euphemism for making money.
Risk GWSG euphemism for losing money. High “risk” generally goes with high “reward”, but not always. In an advancing market, you can make more money than the market in a high risk stock or mutual fund. Conversely, when the market goes down, you can lose much more than the decline in the market.
Risk Tolerance Is a person’s ability to handle risk. This is very personal, varies a lot from person to person, and changes with age and circumstances. Some people take high risks in order to enjoy the high gains when the market is going up; they are comfortable with large losses on the way down, since the long-term market trend has an upward bias. Others cannot sleep when they lose even small amounts during normal market fluctuations. A person’s investment portfolio and asset allocation must match their risk tolerance, or else they are likely to make emotional and not well reasoned financial decisions.
Roth IRA A type of IRA account that is funded with after-tax money. It allows the normal tax-deferred growth, but also features tax-free income on retirement withdrawals. There are annual income limits on who can qualify for a Roth IRA.
Roth 401K An employer sponsored retirement plan, similar to the regular 401K, except that it is funded with after-tax money. Unlike the regular 401k plan, withdrawal after age 59.5 years is tax-free.
Sector A collection of stocks of companies that are in the same industry or market. For example the broad classification “technology sector” consists of stocks of companies that are engaged in computer hardware, computer software, design and manufacture of semiconductors and chips, etc. The general “technology sector” is also be subdivided into smaller sectors such as “computer software”, etc.
Sentiment (Investor Sentiment) is a method of quantifying the levels of investor optimism or pessimism about the future prospect for the market. Some widely reported sentiment numbers are the number of Investment Advisors that are Bullish versus Bearish, and the Put to Call volume ratio in the Options market.
Short Sale (shorting) A transaction where the investor borrows shares from a brokerage firm and sells them, in anticipation of a decline in the share price. The shares are then purchased back at the new (hopefully) lower price and returned to the brokerage house. The investor makes money since the purchase price is lower than the sell price, even though the transactions were performed in the reverse order (sell first, then buy).
Slope of the Treasury Yield Curve A Predictable Investing indicator, defined as the difference in the interest rates between the 20 year Treasury bond and the 3 month Treasury bill.
S&P500 (S&P500 Index) A collection of stocks of the 500 largest companies traded on the US stock exchanges. The list is set up and maintained by the Standard and Poor’s Corporation. Periodic re-balancing is done to remove poorly performing companies and those that are acquired, and replace them with growing and healthy companies.
SPY Is an exchange traded fund (ETF) that tracks the S&P500 Index. It is managed so that its performance closely matches that of the Index.
Stagflation A situation where there is the simultaneous occurrence of a Stagnating economy and high Inflation, as in the mid-1970’s. This is not the normal situation. During a slow economy or recession, companies do not have “pricing power” (the ability to raise prices). Prices stay the same or may even fall, leading to lower inflation..
Stocks (Equities) A security that represents part-ownership of a company.
Tax Deferred Income and profits in taxable accounts for individuals are taxed every calendar year. However, taxes on the gains in retirement accounts such as a 401k, 403b, and various IRA’s are postponed (deferred) to the future. The entire amount, principal plus gains, are allowed to compound and grow until retirement. The tax treatment after retirement depend on IRS the rules for each type of account.
Treasury Bonds (T-bonds) Are bonds issued by the US Treasury that are greater than 10 years in duration, and are used to finance the national debt. The treasury pays periodic interest to the purchaser of the bond, and these are taxable at the Federal level, but are State tax-free. Treasury Inflation Protected Securities (TIPS) see Inflation Indexed Bonds.
Treasury Notes (T-notes) Same as Treasury Bonds, but of duration 1 to 10 years.
Treasury Bills (T-bills) Same as Treasury Bonds, but of duration 6 months or less.
Trailing Twelve Months (TTM) The notation (TTM) after a financial or accounting term denotes that the value shown is for the last 12 months.
Undervalued Analysts determine the “fair value” of a stock by analyzing the future earnings and prospects for the company (see Fairly Valued). If the stock price is lower than the fair value, it is denoted as “undervalued”.
Unemployment Rate The number of persons seeking jobs divided by the total workforce is the unemployment rate. It s reported every week by the US Bureau of Labor Statistics (BLS).
Valuation Is the technique for calculating the value of a stock or index. Analysts use many methods of determining value. PI uses the Forward PE ratio, and compares it with its historical long-term value, to decide whether there is room for further price appreciation or not.
Yield Curve A graph of yield (interest rate, in percent) versus the duration of Treasury bond (in years). The curve can slope upward (called normal yield curve), be horizontal (flat yield curve), or slope downward (inverted yield curve). The shape of the yield curve is a key indication of future economic growth.
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