HOVZ Stock Market Forecasts

February 10, 2008
Doesn't it just make you sick to hear: "It's always darkest just before the dawn"?

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

Investors clobbered by severe losses are shell-shocked by relentless news of financial crisis, (editorial by F Willian Engdahl at FinancialSense.com), collapsing real estate markets, seized up credit markets, leveraged buyout loans that can't be sold (Bloomberg.com), mega-billion dollar surprise investment bank losses, rogue traders, declining retail sales, major layoffs, falling profits, stock market bubbles in emerging markets, and recession contagion. According to numerous economists such as Paul Krugman, poor economic conditions will probably drag on for years. If Little Orphan Annie started singing "The Sun Will Come Up Tomorrow", she'd probably be stoned to death by a crowd of foreclosure casualties!

Since July, more and more people have been dumping stocks and riskier bonds at a loss and scrambling for cover. The public now is more concerned about the economy than any time in the last 15 years according to a new Washington Post - ABC poll. Eight in ten people polled said the current economy is "not good" or "poor." Heavy stock selling on Tuesday showed that boundless fear has not left the market -- the Dow Jones Industrial Average does not drop 370 points a day very often!

The economic goblins just keep coming! It's like Nightmare on Elm Street part 12! Everyone now has learned more than they ever wanted to about subprime loans and probable 20% declines in housing prices. But, here is an even more frightening ticking time bomb -- half a trillion dollars of exploding option adjustable rate mortgages as reported by Bloomberg.com. They'll be resetting over the next few years and the prospects look bad. Notching things up, Jon Markman at MSN Money warns of $2.4 trillion dollars of municipal and corporate bonds that are threatened by possible collapse of monoline bond insurers. (How many investors had ever heard of monoline bond insurers before a month or so ago?) Not to be outdone Jim Jubak of MSN Money wrote a couple of weeks ago about the potential blow up of the credit default swap market -- some $450 trillion. (yes, $450 trillion)

"Smart money", on the other hand, sees opportunity in this worried frenzy. Warren Buffett, for example, is using the panic as a golden opportunity to set up a new monoline bond insurer. How could it be a better moment? All the potential competition is on the verge of collapse! For a while, at least, Buffett will be able to pick and choose whatever he insures and charge whatever he wants. He'll probably be praised as a Saint to boot!

Likewise, corporate insiders across the board are buying more of their company's shares than they have at any time since 1995. According to this Bloomgerg.com story the last 7 times that insider buying reached this level between 1988 and 1995, the stock market rallied an average of 21% in the next 12 months. According to Mark Hulbert at MarketWatch.com the last time insider buying was this strong was in 2002 near the bottom of the Dot Com bear market. Hulbert also notes that the high level of market volatility is typical of a market bottom.

We track and forecast investor sentiment with the HOVZ Market Enthusiasm Indicator. That sentiment is in pretty rough shape. Just 4% of stocks are performing in a way we would term 'euphoric'. Normally euphoria runs at 15% to 20%. Likewise, stocks behaving as 'despondent' are up to 45%. In a normal market the despondent share would be something like 7%.

The current market blow up 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 economic realities. Eventually. panic wears off and people turn numb to any more bad news. It's just human nature. Watch closely for the day when the stock market doesn't even flinch in response to a fresh dose of bad news. Perceptions change much faster than economic realities.

We doubt that the financial world is coming to an end just yet. Personally, I'd be more worried about bird flu. The media thrives on fear -- why else would people watch the news anyway?

Worse come to worst, there will be a bailout to avoid collapse of the financial house of cards. Why? Because the alternative is unthinkable. Besides the Fed's lower interest rates and the Government's $150+ billion spending stimulus, other solutions are forming. According to the Washington Post, the U.S. Senate already is considering a mortgage 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.

The infamous savings and loan crisis (Wikipedia) of the late 1980's is a good precedent to look at now. Similar to today's meltdown, though a bit smaller in scale, the S&L crisis also was brought on, in part, by short-sighted deregulated lending that capitalized a speculative building boom. The first bad scandals of savings institutions going belly up came in 1985. Thanks to the Federal Savings and Loan Insurance Corporation, millions of depositors in S&L's knew their money was insured and major runs on the banks were avoided. That was the first and most critical line of panic defense.

Many S&L's were still insolvent, though, since they had so many bad construction loans and mortgages on their books. As the news came out over months and months, it became clear that more and more -- hundreds and hundreds of S&L's and many thousands of building projects were in deep trouble. The Resolution Trust Corporation, set up by Congress, finally cleaned up the mess. An interesting note is that rather than being just a flood of federal give-away money, RTC bought loans at a tough discount and ended up making money by gradually selling the building projects into an improving market. To avoid having their heads lopped off, S&L investors and investors in the ill fated building projects found themselves happy to accept serious haircuts!

Timing is important. Note that the 1987 stock market crash actually happened fully two years after the S&L crisis first splashed across newspaper headlines and the construction industry collapse began. Just like today's crisis, it took a lot of time and relentless media attention to get the investment herd primed for a true stampede. 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.

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 -- this has been worse than a typical decline! None the less, massive collapses of Market Enthusiasm are usually short lived.

Bottom line:  HOVZ Market Enthusiasm Indicator had been in free fall until a couple of weeks ago. At least for now it has stabilized. Reinvesting is getting more and more tempting. Every day the odds keep improving. Compared to October, many great stocks are now at 20% to 30% off sale prices! We now have a 70% investment level. We're trying to sound brave too :o)

.(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 13 % undervalued -- worse than last week and near the worst recent level of 14% undervalued. 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.

% Stocks Trading Above 200-Day Moving Average (The current value is shown at the very bottom of the link page. ) About 23% of stocks are above their 200-day average. 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. ( For someone with a long 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.) (Rose in January after being 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.