HOVZ Stock Market Forecasts

April 27, 2008
Upturn continues

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

HOVZ short term view of the stock market for the next few months looks good. After the current relief rally, longer term market weakness probably will set in.

It doesn't make us feel comfortable that a growing number of market prognosticators also think the current rally in stocks will be fairly short lived. Jim Jubak from MSN says Don't Trust This Market Rally. A Michael Sensit editorial at Bloomberg .com leans toward seeing a short lived rally in a bear market. Another MarketWatch.com story Talks about "5 Signs the stock market has bottomed". Steven Pearlstein at WashingtonPost.com sees this as " the latest sucker rally." Jon Markman at MSN MoneyCentral has been writing that "Stocks' wild ride isn't over ". We're getting worried by all this consensus -- everyone can't be right about the market.

Despite our reluctance to agree with others, our own Market Enthusiasm Indicator is pointing to the same significant but temporary rebound. Financial panic attacks always have a unique cause, but they all play out the same. Take a look at the long term history of the HOVZ Market Enthusiasm Indicator . Despite the relief rally, there are still major economic problems ahead. So what? For now things look very good.

Bottom line:  HOVZ Market Enthusiasm Indicator had been in free fall. It bottomed, rose, retested the lows and has risen again. We think many parts of the market are probably heading back up. Reinvesting for the next half-year is very attractive. Many stocks are still at sale prices! We now have a 110% 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 9% undervalued -- much improved from 15% a few weeks ago. Hopefully the market is completing a typical retesting of lows. 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 32% of stocks are above their 200-day average. A month it was 17%, probably a bottom. It is still VERY LOW. 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. For someone with a long term perspective, the market is 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 falls from a peak 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. For banks the nightmare scenario is when the short term rate they borrow money at climbs higher than the long term rate at which they lend money out. So it is little wonder that the banking world disintegrated in the past 2 years as the Fed cranked rates higher.

Now, the Fed has dramatically lowered short term lending rates and clearly intends to use this stimulus to keep the economy pumped up. Most economists ware predicting another quarter point rate cut next week. (MarketWatch.com forecast, bottom of linked page). 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. So far, that's exactly what the Fed has done.

Short Interest Ratio (from InvestmentTools.com) IGNORE THIS GRAPH -- It looks like incorrect weekly data 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. But it is WAY above that level now! 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.' 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. Margin debt on the NYSE actually rose a bit in February.

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.  Hasn't happened yet. Here is the NYSE data link.

Building Permits and Housing Starts (Major negative factor seldom worse than it is right now). 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. New home sales sank again in March to levels last seen in the 1990's. (NY Times) Here is a Wikipedia background piece on the U.S. Housing Bubble

U.S. Leading Economic Indicator  (See graph at bottom of link page.) It depends which leading indicator you are watching. (The eForecasting.com eLEI leading indicator dropped again in March -- some big surprise? ) The link is from e-Forecasting.com. . A competing and better known leading indicator, the Conference Board Leading Economic Indicator rose a tiny bit in March, but the moving average is still down. Here's a Bloomberg story on it.

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. 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.

Then they decided to refill the punch bowl to stimulate the economy. The deficit is going to go up again. The big 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 will not impact the economy for several months.

Effective Federal Funds Rate and Target Interest Rate (from St. Louis Federal Reserve) Negative The Fed has rushed like it never has before to drop short-term rates. At 2.25% there is not much further they can go. Eventually this will stimulate the economy. But, because of lag times, for now it is a major contrary signal showing just how worried they are at the Fed. 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.