HOVZ Stock Market Forecasts

May 11, 2008
Minor speedbump, then upturn continues

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

Just like last week -- HOVZ statistics indicate that the stock market rally may have gotten a bit ahead of itself -- a little more pullback is likely. (Both SPY and DIA 6-week forecasts are mildly negative.) For the next 5 months, however, HOVZ view of the stock market remains very positive. We will buy any minor dip.

Come fall, after the current relief rally, longer term market weakness probably will set in. (Look at the relentless downward slope of the price boundary channel in the SP-500 animation.) There are only so many economic elephants and 800-lb. gorilla bubbles in the room that can be ignored. For now, though, the herd is just happy that the entire financial system did not collapse over the past few months.

(The powerful wildcard in this picture is the U.S. November election. If the foreign investors who soured on the Bush administration seven years ago get enthusiastic about the U.S. again, this might turn into a longer rally despite all the economic obstacles ahead. We'll see. It would be impossible for them to get more pessimistic about the U.S.)

It doesn't make us feel comfortable that a growing number of market prognosticators think, like us, that the current rally in stocks will be fairly short lived. Jim Jubak from MSN Money was talking bear market a few weeks ago, but now frets about a double-dip Downturn?

Longer term worries of Jubak include: home prices still falling, home building still in decline, more foreclosures, increasing problems in commercial mortgages, consumers falling behind on credit cards, some increase in unemployment, continued insolvency concerns among financial institutions.

To Jubak's concerns we add: U.S. balance of payments is still ghastly and not sustainable, meaning further decline in the dollar will be necessary. It's either that or do something about oil imports. Maybe when the U.S. isn't run by a President Texas oil man and a Vice President oilfield service / defense contractor that might even change.

Jubak and HOVZ are not alone in thinking the current market rally will be temporary. 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 ". This NYTimes.com market piece has a similar level of disbelief. 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 is heading back up after hitting a bottom and retesting. The rally for some stocks may have gotten ahead of itself, but the next several months should be good -- IF history is any sort of guide. Reinvesting for the next half-year is very attractive. Many stocks are still at sale prices! We now have a 120% 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. It appears that the market has completed a typical retesting of its 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%. A significant amount of upside remains.

% Stocks Trading Above 200-Day Moving Average (The current value is shown at the very bottom of the link page. ) About 35% of stocks are above their 200-day average. A month ago it was 17%, probably a bottom. It is still reasonably low and the direction is bullish. 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  Typically this is 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 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 creating a major stimulus to keep the economy pumped up. The difference between the short and long rates is seldom greater than it is now. Few economists are expecting another rate cut in the near future.(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. (Hey HOVZ, what do you mean, "could cause?" -- The dollar already is in a serious free-fall.) The rate inversion that existed during most of last year ended up being a good predictor of the market troubles that are occurring right now.

Short Interest Ratio (from InvestmentTools.com) This is really strange -- the ratio never seems to have dropped this far this fast before. We thought it was bad data, but apparently the data is correct. 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. Watch the moving average of this indicator for a very broad look at the anxiety level of the stock market.

Margin Debt  (Despite some deleveraging, margin debt remains above its 20 week moving average, meaning bull market optimism is still basically intact. 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.

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 rose a tiny bit in April -- finally! ) 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. In the meantime the U.S. dollar just keeps falling.

Checks to individual taxpayers that are part of the federal $170 billion stimulus package are just being sent out at the start of May.

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% there is not much further they can go. The quarter point reduction on 4/30 was a sign that rate cuts are near an end. Eventually rate cuts 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 no more cuts for while at least.)

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.