HOVZ Stock Market Forecasts

February 3 , 2008
Good News: Chicken Little says the sky is falling!

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

For months now, there has been a din of news of multibillion dollar losses stemming from subprime loans, locked up credit markets, falling real estate prices, disappointing corporate earnings and probable recession. Unabated financial market hysteria has hit screeching level among commentators. Is there anyone left who doesn't know what a subprime loan was? Even our hapless Cheerleader in Chief did his part to curtail confidence, saying he sees "serious signs" the economy is weakening. Panic has been unmistakable even without watching the stock market nosedive. Which, of course, it has until last week.

In a contrary way, to HOVZ this Chicken Little display means the panic selling in the stock market is wrapping up. Most mobile rats scurried off the sinking ship months ago. We did. Only laggards and newbies remain to sell at the bottom. Soon they'll be gone too. Smart money left long ago and is already thinking of coming back. As noted a few weeks ago by Mark Hulbert of MarketWatch.com, company insiders are not sellers , they're buying. The HOVZ gage of fear peaked last week and is recovering, showing a selling capitulation.

(Over the coming multiyear bear market HOVZ anticipates that a stock market graph will look like the path of a ball bouncing down a flight of stairs -- think 2000 to 2003. But, that bad news is for later, not now. First, we will bounce up.)

The near term is encouraging. HOVZ statistical price gain forecasts for 6-weeks and 5-months out are generally outstanding. As far as we are concerned, stocks are on sale! Prices may not rise immediately -- panics most often have a double bottom. Most likely, though, prices will be going up over the next several months. A retest of market lows actually would be welcome and would increase our confidence a lot.

We track investor sentiment with the HOVZ Market Enthusiasm Indicator. Today's panic parallels other panics like 1929, 1987, 1998, 2001-9/11 and the 2002 final collapse of the Dot Com bubble. Take a look at the 20-year behavior of the HOVZ Market Enthusiasm Indicator -- Like a knife pointed at your gut, the comparable moments leap out at you. Panics are similar because they are guided by human nature more than objective realities.

Setting up our current panic, as early as 2004 numerous commentators identified impending problems in real estate valuations and bubbles of various sorts in other economies. They were generally ignored as alarmists. The party was just getting started. Low interest rates spiked the punch! Markets first tried to panic in the summer of 2006, after the Fed had been raising interest rates for roughly two years. But, it was only in July of 2007 with collapse of the housing market and the start of losses declared in the banking industry that the panic became severe and unmistakable.

Limitless concerns about the solvency of the whole financial system and the stock market have been front page news since July. Just about every market guru is on board stoking the great fear -- not just of price corrections, but of economic collapse. With all the publicity, economic fears have risen to the top of all headline-grabbing politicians' agendas. Innumerable save-the-day proposals are flying around. The Federal Reserve seems to be at DEFCON 5, with soothing speeches and cutting interest rates another half point this week, the second major rate cut in 10 days.

Among market commentators sweat drenched fear has reached especially high levels. This article from Paul Farrell at MarketWatch.com and this one from Bill Donoghue at MW both shriek panic. Jon Markman at MSN Money chimed in with his take of doom. Gallows humor is also common at this stage of things.

My favorite non-statistical sentiment capitulation indicator flashed this week when, independently, two friends who know little about the stock market asked fearfully what the market was going to do. (Reminds me of the last big signal when friends tried to interest me in condo flipping in late 2005.)

There is no denying that major economic problems exist. We did our best to scare BOTH or our readers with the gory details in last week's commentary, and the week before. The housing bubble here and the stock price and building bubbles in many other countries are huge asset inflations that may take years to clear up. Jim Jubak at MSN Money draws parallels with Japan's credit collapse in the early 1990's. But, unlike the underlying problems in the real economy that promise a bear market, the intense panic that's gripping the stock market today is likely to resolve itself quickly.

We have faith. Worse come to worst, there will be a bailout to avoid collapse of the financial house of cards. Because the alternative is an unthinkable financial collapse. According to the Washington Post, the U.S. Senate already is considering a bailout mechanism similar to the 1989 Resolution Trust Corporation. Bloomberg.com reports that the financial industry is already drooling. Seems their normal dread of government intervention doesn't apply today. RTC, of course, along with the Federal Savings and Loan Insurance Corporation, finally cleaned up the remains of the infamous savings and loan crisis (Wikipedia). Similar to today's meltdown, though smaller in scale, the S&L crisis also was brought on by stupid deregulated lending that capitalized a speculative building boom.

Note that the 1987 stock market crash actually happened fully two years after the S&L crisis splashed across newspaper headlines and the construction industry collapsed. The S&L crisis started in 1985 and was not entirely resolved for a full decade. By contrast, the entire 1987 stock market crash took just 2 weeks and was followed by a remarkably steady rebuilding.

HOVZ is convinced that non financial factors can play a major role in panics. The U.S. presidential elections, in particular, may be important over the next few months. Remember that the collapse of the Dot Com Bubble first began in April, 2000 just as the first opinion polls placed probable candidate Bush ahead of probable candidate Gore. Even then it was clear that much of world opinion -- and financial opinion in particular -- had doubts about a Bush presidency. If this MSNBC article is correct, the current signs are much more favorable. There seems a reasonable chance that financial trust of the United States will recover long before the bear market runs its course. If so, that could provide a major prolonged boost to the U.S. market.

With 'blood in the streets' HOVZ statistical stock price forecasts were never as favorable as they were last week. They remain very very high. However, we have an important disclaimer, and it's the reason this website is still experimental. A collapse in Market Enthusiasm like we have just seen does not happen very often. So our historical predictive data is limited and we can't validate our current statistical forecasts. They may be too optimistic. Most of our forecasts have been too optimistic since July. None the less, massive collapses of Market Enthusiasm are usually short lived.

Bottom line:  HOVZ Market Enthusiasm Indicator has been in free fall. Reinvesting is getting more tempting -- compared to October, many great stocks are now at 20% to 30% off sale prices! We have a 50% investment level, and fingers crossed.

.(This column is not investment advice, YOU need to figure out what's best for you.)

Links to Other Stock Market Indicators We tend to focus our market timing attention on the HOVZ Market Enthusiasm Indicator which follows a roughly annual cycle. Several other popular market indicators are listed below.  

Morningstar.Com Market Valuation graph  (Shows market to be 9% undervalued -- much improved from 14% undervalued last week. There may be a huge stock market bubble somewhere -- but it isn't in the bulk of U.S. stocks that Morningstar tracks.) This graph is a fundamental financial analysis / accounting calculation based on long-term projected returns for the 1,800 stocks Morningstar tracks.  Typically in the past couple of years the trend has gone from undervalued to somewhat overvalued at 5% to 10%. But a 20%+ under pricing as in 2001 and 2002 is quite possible. Our bet is that it's likely. The current trend is NOT up!

% Stocks Trading Above 200-Day Moving Average (The current value is shown at the very bottom of the link page. ) About 27% of stocks are above their 200-day average, after turning around from last week's 20% under valued.. As a general rule, when a stock's price is above its 200-day moving average, the stock is in a long-term price rise. So, an increasing percentage of stocks priced above their 200-day moving average is generally a good sign. However, when 80% to 90% of stocks are trading above their averages it is usually a signal that euphoria has gotten out of hand and a market correction is due. Similarly, when only 20% to 30% of stocks are trading above average (like now), a sharp bullish upswing becomes very likely It's your call as to whether the market will fall more. (Our bet is that for the next couple weeks the fall will continue. For someone with a longer term perspective, the market is already in buying territory.)

NYSE New Highs & New Lows  Now at what is typically a good level for buying. The graph of new lows tracks fairly closely with our HOVZ Market Enthusiasm Indicator.  A 'Buy' indicator occurs when the number of Low values peaks and a 'Sell' indicator occurs near when the number of new Highs heads past a peak. www .InvestmentTools.com. 

Long Treasury Bond versus Discount Rate  High and/or rising interest rates tend to be bad for corporate profits and stock market prices. The Fed has dramatically lowered short term lending rates and clearly intends to use this stimulus to keep the economy pumped up. Unfortunately, it takes time for this stimulus to start working through the real economy and there is a major concern that moving rates too low could cause the value of the U.S. dollar to go into free fall. The rate inversion that existed most of last year ended up being a good predictor of the market troubles that are occurring right now. The question now is whether the Fed will lower rates as fast as the market wants.

Short Interest Ratio (from InvestmentTools.com) Turned down from an all-time high. This has proven to be a good short range market predictor over the past year. This number derived from NYSE data is the dollar value of total outstanding short positions divided by the value of an average day of trading -- essentially, how many days would it take to close all short positions. The last time the ratio was anywhere near this high was at the broad stock market top of 1998-1999. Watch the moving average of this indicator for a very broad look at the anxiety level of the stock market.

Margin Debt  (The incredibly high level of margin debt is at least partially a sign of high leverage in the markets. The fact that the growth rate has fallen for months may be a sign of a longer term deleveraging. In the last bear market this was probably the BEST OVERALL INDICATOR for watching the bear run its course.) People who borrow money to buy stock (i.e. "buying on margin") fall into two groups. First, they might be optimists, convinced that the market is going up. On the other hand they can be hedgers, confident that they can borrow money to go long on 'winners' and short 'losers.' These people are arrogant. A rising level of margin is a good sign of a confident Bull market.  A falling margin level is a clear sign of a Bear market -- the optimists get frightened and the hedgers flee the scene. This chart from www.InvestmentTools.com shows that we have been is a very strong period of rising margin, possibly too strong. The total amount of margin borrowing has surpassed the historic high reached in 2000. Start to pay attention to the rate-of-change graph at the bottom of the linked page. When the rate of change turns negative it will almost certainly mean a serious bear market. 

Building Permits and Housing Starts (Major negative factor). Housing related activity -- not just construction, but including all factors such as new appliances -- constitutes roughly 20% to 25% of the U.S. economy, so it is much too big to ignore. These linked charts from the St. Louis Federal Reserve provide a way to watch the slow moving collapse unfold. Housing tends to lead the stock market by approximately one year. If so, that is very bad news. Each month the news just keeps getting worse.

U.S. Leading Economic Indicator  (See graph at bottom of link page.) (Fell in December and has been weak for months. ) The link is from e-Forecasting.com. Since the stock market is itself a big component of composite leading economic indicators, it's questionable how much this can really tell you about what is going to happen next in the market. A competing an better known leading indicator, the Conference Board Leading Economic Indicator fell sharply in November and again in December-- the fourth time in the last five months.

U.S. Federal Deficit (from St. Louis Federal Reserve) Be careful what you wish for! To recover from the Dot Com market crash and the 2001 recession the Federal Government spent lavishly. The deficit moved from a $200 B per year surplus to a $400+ B deficit -- a net difference of roughly 1/2 trillion dollars per year. Not chump change. This is the economic 800 pound gorilla that caused the U.S. dollar to plummet over the past few years. Now, in a major turn-around, the deficit is rapidly declining. It is already $200 B per year better than a couple of years ago. Wrapping up the Iraq war could make another huge cut in federal spending. That fiscal improvement bodes well eventually for strengthening the dollar, but in the meantime it is a huge amount of spending stimulus being removed from the economy. This week they decided not to take away this punch bowl. The deficit is going to go up again. The loser will be the value of the dollar. This reduction in the deficit is a significant contributor to the slowing economy. Not surprisingly the politicians are already calling for more stimulus spending to keep the party going.

Effective Federal Funds Rate and Target Interest Rate (from St. Louis Federal Reserve) Negative It was William McChesney Martin, a former Chairman of the Federal Reserve, who first said: "The Federal Reserve's job is to take away the punch bowl just when the party gets going." Right now the Fed has changed course and is lowering interest rates to spike the punch. Eventually this will stimulate the economy. But, because of lag times, for now it is a major contrary signal showing concern by the Fed that probably points to worse bad times ahead. The current MarketWatch.com forecast of interest rates points toward further rate cuts.

Price / Earnings Ratio of the SP-500  (To us this does not indicate a significantly overvalued market.) Except during short and intense recessions the composite P/E ratio of major corporations provides a general indication if the stock market is priced high or low. If this turns up, it probably will be a sign that earnings (right now at historically high levels) have gone to hell. That was much of the story in the 2002 rise of this indicator.

Big Mac Index Economist.com has a truly wonderful (though perhaps not statistically definitive) means to spot if various currencies are correctly valued against the U.S. dollar. It's based on the price of a Big Mac in each country. Right now the european countries appear to be overvalued. We're hoping this will tell us where we can afford to take our next foreign vacation.