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Now before you run and check the long bond as an indicator for the stock market, I must mention that this relationship doesn't always hold true. Stocks and bonds are sensitive financial instruments, and their movements depend on a variety of economic and social conditions - for instance, the threat of inflation. Sometimes both markets move up and down together. Alas, there is no magic formula that can precisely forecast these markets, only possibilities. One must always consider these indicators in the context of other conditions. Can investors shift their money to other investments besides stocks and bonds? Sure. There are numerous other investments out there: gold, real estate, or just plain cash (money market), just to name a few. There are myriad choices out there for investors, but unfortunately I can't cover them all here as they go beyond the scope of this book.

The Inflation Factor

During our discussion of bonds, I gave special attention to inflation and how it affects bonds. Stocks as a whole are pretty much affected the same way by inflation. The reason I say "as a whole" is because inflation affects individual stocks in various degrees. Some companies (e.g., banks) are more sensitive to interest rates than others, and therefore inflation affects them in a more pronounced way than it does others. But in general they are all affected, and for the most part they don't respond well to the threat of inflation. Thus inflationary data can become another tool in the investor's arsenal to forecast a possible direction for the stock market. For instance, whenever CPI and PPI (consumer and producer price indices) or jobless claims numbers are released by the Department of Labor, there is a spike in stocks trading volume as these numbers are significant inflation indicators.

How does inflation (or the threat of inflation) adversely affect stocks? Remember that as the threat of inflation sets in, the Fed may react by …