HOVZ Stock Market Forecasts

May 25, 2008
Good news then bad. More gains for next few months. Then, who knows?

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

The stock market faces the same 'good news, bad news' situation that it has seen for two months. HOVZ models say the story is probably going to stay the same for months more. (Like the next half year or so.)

The Good news: The world financial system did not collapse in March as it easily could have! Yay! The panic overcame a lot of people and knocked stocks to great sale prices! Great news for buyers! We bought a little early but we aren't complaining.

The Bad news: It just keeps coming for investment banks, housing, and consummer spending. More huge financial industry losses are on the way. The investment banking world is borerline insolvent. Scary! Further "Worst since the Great Depression" decreases in housing prices and lame consumer spending are certain -- Boo! The dollar is still in a nosedive and isn't likely to pull out soon so inflation is a given. Boo! Stock sale prices aren't as good as in March. Boo! But, prices are still sort of attractive. Hmmm... watch the dip!

What happens to the economy and what happens to the stock market, however, are two distinct things. The stock market is always looking 6 months to a year ahead. HOVZ forecasting model sees a bit more stock market stumbling in the next few weeks, then significant market rebound for the several months, followed by a very uncertain and possibly quite grim longer term market deleveraging. HOVZ model is seeing a great deal in common between the 1998 to 2002 period and the current market.

From the lows of March, the SP-500 has regained 9.5%. That's roughly half of the total loss from October's high. It has been a very sharp rebound, and according to our model it is a bit faster than typical. A tad more small pause, stumbling, consolidation, or whatever, like we experienced last week is pretty likely. (Hey, that's just our guess as our models are rather lame in predictions for the very near future.) A favorite technical indicator for many speculators, the fast stochastic chart for the SP-500 shows the same story of immediate weakness. Is the weakness done? Don't know. (Both of the HOVZ SPY and DIA 6-week forecasts remain mildly negative, but the 5-month expectations are excellent.)

After the likely immediate-term market consolidation, the picture brightens up considerably. The vast majority of our 5-month forecasts remain excellent -- not as good as they were in March, of course, but still very favorable. The sharpness of the market panic, the depth of the fall, and the seriousness of Federal Reserve response all combine to make a continuing rebound very likely. Nothing is guaranteed, of course, but rebounds from major panics tend to be very similar in nature. To see what we mean, take a look at the long term history of the HOVZ Market Enthusiasm Indicator

The longer term market picture is what's foreboding. What happens after the euphoria dissipates from dodging world-wide financial collapse? The dollar is still going to be in free-fall, and increasing inflation will continue. Only about half of the likely decline in U.S. house prices has occurred. Housing news just keeps getting worse and worse. So, with this huge negative "wealth effect" consumer spending cannot return to the heady expansion of 2004 to 2006. And, according to some estimates only about a third of the eventual banking sector destruction has been owned up to. (UBS has estimated a total of roughly $945 billion.) That means the credit crunch is far from over and the U.S. financial industry is going to be largely foreign owned.

Bad economic news is not ending any time soon. As the financial world of subprime finance collapsed, the Fed had a choice, either allow a sharp major recession or stretch the bad news out over a longer period. Clearly they chose the Chinese Water Torture extended method. When Ben Bernanke tells banks to get more operating capital, as he did last week, there couldn't be any more obvious signal that more hard financial times lie ahead.

HOVZ forecasts just look 5-months into the future, so they really don't tell us too much about what the stock market is going to do when the current relief euphoria fades. There is a strong hint, though. Take a look at the animation of Market Enthusiasm at the top of the right column. If you pay attention to the forecast of Market Enthusiasm (magenta) you will notice that the end of the 5-month projection consistently stays near the 90% Bull/Bear line. That is not good at all. A real bull market rebound would have that prediction hitting the top of the graph. Also notice that the overall channel for our SP-500 forecast has turned down strongly and steadily. That only happens during a major market setback. Again, take a look at the long term history of the HOVZ Market Enthusiasm Indicator to see what we mean.

(The powerful wildcard in figuring what the investing herd will do 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 negative about the U.S. than they have been for the past several years.)

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 10% undervalued (8% last week) and much improved from 15% in March. 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 38% of stocks are above their 200-day average. A month ago it was 17%, a typical 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  (It looks like margin debt has sunk below its 20 week moving average -- first time since the last recession, and a rotten long term sign. 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. When the pundits use the phrase "... since the Great Depression..." it's not a really good omen). 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.) Both of the summary leading indicators we watch went up a weak 0.1% in April -- not much but at least it wasn't down. The eForecasting.com eLEI leading indicator rose a tiny bit in April. The link is from e-Forecasting.com. . A competing and better known leading indicator, the Conference Board Leading Economic Indicator also rose slightly in April. We aren't impressed.

Anxious Index (xls file) (Negative but it does seem to be improving) This article by David Leonhardt in the NY Times a couple of months ago said the Index now pointed toward an economic recession. He noted 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. But, jumping to the rescue the new economic stimulus plan is going to send the deficit way up. (Well, screw our kids and grandkids!) 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 in the short-term, but soon because of lag times it will become a positive factor. 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. Recent statements from Chairman Bernanke and other Fed members all point to a freeze on rates for now. 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. It has recently turned up -- a sign that earnings (still at very high levels) have headed 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.