HOVZ Stock Market Forecasts

February 17, 2008
HOVZ Market Enthusiasm Index is rising - Phew!

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

We're adding a NEW MARKET INDICATOR The "Anxious Index" gives one more indication of the economy falling into recession. David Leonhardt writes in the New York Times about what he calls the "Anxious Index" . Leonhardt says that since 1968 when this survey of professional forecasters was created, each time the Anxious Index reached its current level a recession has followed. Here's a link at the Philadelphia Federal Reserve to the chart (Excel spreadsheet). We'll track it in the future in our Links to Other Stock Market Indicators section. The Anxious Index is updated quarterly.

The real economy and the stock market are connected by complex relationships that function more like an elastic bunge cord rather than a steel chain. The lead and lag times and intensities for economic interactions are not fixed. (That's where the peculiar dynamics of herd behavior enter in.)

The risk and danger of predatory subprime lending, for example, was abundantly clear as early as 2003 as this New York Times op-ed by Eliot Spitzer makes clear. State Attorneys Generals from 50 states were trying to stop this damaging loan making, but were blocked by the Bush administration. Plenty of news print was devoted to the subject. It wasn't a secret. In the summer of 2006 there was a small but intense market scare that stemmed from subprime, but the fear left quickly. It took until the summer of 2007 for the greatly grown problem to cause the near collapse of the bond market and a panic in the stock market.

Generally the stock market looks ahead of the economy by about 1/2 year. That's why the stock market is a primary leading indicator for economists. Though the economy continues to slide, and there is a continuing stream of disturbing news from bond markets, we're convinced that the stock market already is looking ahead to further interest rate cuts and is therefore due for a rebound.

Chances for a rebound also increased because the panic that swept though all the markets has run its course -- just like chicken pox, the disease of market panic has a normal timeline and somewhat predictable development. (If the world doesn't end as feared, then things tend to get better.) Investors have started to calm down a bit and realize that the financial world did not entirely come to an end. Fixes, though possibly painful, are available. Life goes on. People are still hooked on iTunes, shopping at Wal-Mart and buying drinks like Coke and Pepsi.

That's how we read the HOVZ Market Enthusiasm Indicator. Over the past several months it fell like a knife. But in the past few weeks the Indicator bottomed out and is now rising. Odds remain good for another retest of market lows, but as far as our 5-month price gain forecasts are concerned, a significant stock market rebound is on the way. Check out our free EFT forecasts.

HOVZ forecasts only look 5-months into the future. However, qualitatively to us it seems that with a continuing unwinding of the credit bubble in the economy, a sustained bull market is unlikely. We continue to believe it probable that over the next several years the market will trend down -- like a ball bouncing down some stairs. But, all of that is way in the future!

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.

With 'blood in the streets' HOVZ statistical stock price forecasts were never as favorable as they were a few weeks ago. They remain very very high. (But, don't forget that our calculations are experimental.) 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 and begun a recovery. Reinvesting is very attractive. 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 90% investment level.

.(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 12% undervalued -- 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 22% 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 peaks. 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.

Anxious Index (xls file) (Long term negative) This article by David Leonhardt in the NY Times says the Index now points toward an economic recession. He notes this Survey of Professional Forecasters maintained by the Philadelphia Federal Reserve hasn't missed calling a recession or called a false positive in the years since 1968 when it was started. Updated quarterly.

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. This week they decided to refil the punch bowl. The deficit is going to go up again. The loser will be the value of the dollar. For the moment, the reduction in the deficit is a significant contributor to the slowing economy. The federal $170 billion stimulus package that became law this week will not impact the economy for several months.

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 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 reasonably 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.