HOVZ Stock Market Forecasts

March 2, 2008
Problems remain but panic may be fading

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

Despite the sell-off on Friday, we feel the investor stampede of the past half year has nearly run its natural course. Credit market panic is dissolving, and credit-lock-up stories are starting to move off newspaper front pages. HOVZ Market Enthusiasm Indicator has risen considerably.

Some market commentators have also started to calm down (e.g. David Callaway from MarketWatch.com). The collapse of Market Enthusiasm came later than we originally projected and was worse than forecast. But, we'll stick with our commentary from last week -- looking ahead to a strong temporary market rebound over the next few months.

From last week: It's scary out there. You don't need the HOVZ Market Enthusiasm Indicator to know that financial markets are still in the grip of panic. The most conservative and boring part of the financial system -- long term asset-based lending -- has suffered a major loss of confidence. It had the potential to shut down the whole economy.

Every day it seems, potentially cataclysmic lending market news grabs the headlines. This week it was credit auction failures as Darrell Preston writes at Bloomberg.com. Financial writers covering the fixed income markets are having a field day. They've never been this well read -- sort of like being the TV weather reporter when a blizzard hits! They're getting giddy. Steve Goldstein at MarketWatch.com likens today's range of credit problems to a game of 'Whack-a-mole.' Economist Steven Pearlstein writes in his Washington Post column 'Time for Wall Street to Pay' that a "small voice" in his head repeats: "burn baby burn" . Jon Markman at MSN.com Money Central writes in 'Why Wall Street Rescues are Failing' of "a mess that will require hundreds of billions of dollars and global cooperation to fix."

It is pretty hard to miss their message. You 're not human if you don't get a sinking feeling in the pit of your stomach. That's how panics work.

But, HOVZ is increasingly convinced the entire financial world is probably not going to collapse this week. However much a cruel punishment may be deserved, the world economy can't afford to have the U.S. financial industry or the U.S. economy go down in flames -- at least not quickly. It really doesn't matter whether the ultimate price of the repair is $200 billion or $2 trillion. Considering that world stock markets have already lost several trillion dollars of value since October, there is incentive enough to somehow come up with some kind of a fix. That's especially true when most of the debt in question is just as solid as it has always been. The bad debt is not that large a share of the equation.

In the immediate future there will be stop-gap rescues and emergency actions like bailouts and more interest rate cuts. Financial vultures are already circling overhead ready to pounce on under priced assets. These articles from MarketWatch.com and the NY Times give outlines of how the solutions may develop. Then in a calmer situation we will see if longer term real corrections will be made -- or just ignored until the next bubble bursts.

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. The patterns that occur are not identical, but they generally are similar, (That's where the peculiar dynamics of herd behavior enter in.)

Last week's HOVZ column looked at the 1987 stock market crash in relation to the 1980's real estate boom and the subsequent savings and loan crisis. The parallels of that credit bubble with today are striking. The point here, though, is that the actual stock market Crash of 1987 went like lightning. It took only a couple of weeks to play out, eventually followed by a fairly slow rebuilding. The timing is worth noting: the Crash occurred fully two years after the S&L crisis began to unwind and almost a decade before the final residues of the S&L crisis were cleaned up. Take a look at the 20-year behavior of the HOVZ Market Enthusiasm Indicator. The pattern is gut-wrenchingly obvious.

Let's look at the bubble that followed the S&L Crisis. The asset / credit bubble of 1994 - 2002 played out on a somewhat similar timeline to the drama of the 1980's. Recovering from the S&L Crisis collapse, asset prices stagnated and then began fast appreciation around 1994. Again it was real estate that blossomed, but this time it was also emerging markets and the new "Dot Com" and high tech industries that inflated to incredible levels. By 1997 the first danger signs showed in the form of asian country currency crashes. The "Asian Tigers" flamed out. Too many risky loans had been made. By 1998 currency damage spread further to include the Russian Ruble. That, in turn, was partly responsible for the collapse of the trading pyramid Long Term Capital Management. Vast sums of unregulated currency were racing around the globe. It wasn't until 1998 with the LTCM collapse that real panic hit the U.S. stock market. Again, the panic itself was short lived.

Not all related asset bubbles collapse at the same time. Though many foreign markets were devastated by 1998, the U.S. Dot Com bubble still had not reached its glorious climax of April, 2000. Maybe it was even made worse because many other bubbles were already deflated. It became the only game left in town.

Well, except for real estate. Real estate was hardly damaged in the Dot Com bust thanks to the incredibly low interest rates that the Federal Reserve used as its primary rescue tool. (See Building Permits ) A good argument can be made that the Fed solved the stock bubble collapse by expanding an even bigger real estate bubble.

Take another look at the HOVZ Market Enthusiasm Indicator. Note that after the plunge of 1998 the indicator did not return to normal levels of optimism until 2003. The Dot Com Bubble was actually rather localized -- the broader market began going through a series of progressively weaker bounces from 1998 until the final bottom in 2002. That is probably the sort of thing we will be looking at over the next few years.

In the U.S. stock market we now feel that chances for a rebound -- a temporary rebound -- are fairly high. The panic that swept though all the markets has pretty much run its course. There is no one left to scare. 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. The subject of long term bonds will again become boring.

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 today. 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. Why? Because that is usually what happens after big panics. Look again at HOVZ Market Enthusiasm Indicator. We expect that over the next 5-months a significant stock market rebound will be 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!

With 'blood in the streets' HOVZ statistical stock price forecasts were never as favorable as they were a few weeks ago. They remain very high. (But, don't forget that our calculations are experimental. Don't bet the farm on what we say! We have already been falsely lured into buying back in this market too early. CD's aren't so bad.) 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 on a fairly short-term basis 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 13% 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) Back near an all-time high. This has proven to be a good short range market predictor over the past year -- doesn't look good for the next few weeks. 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 persistently 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 for the past few years 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. 

At the same time, it would probably be wrong to read too much into the predictive powers of margin debt levels according to this Mark Hulbert column from MarketWatch.com. Here is the NYSE data link.

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.) (The we3b site is unclear -- did it rise or fall??? Anyway, it's 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 in January for the fourth straight month.

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 refill 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.