HOVZ Stock Market Forecasts

June 8, 2008
Obama's Market Bounce?

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

Last week's high market volatility was unsettling. HOVZ had been anticipating some market consolidation because from March stocks had been rising too far too fast. So, the volatility wasn't unexpected. Some more bumps remain probable in the near future. Even so, the negative 3% U.S. market index trouncing of Friday, 13% rise in oil futures ("biggest gains ever") , and 20-year-record job loss statistics weren't fun at all.

HOVZ positive forecasts for 5 months from now haven't changed much. Actually, last week's minor market drop, provided more room on the upside, so our forecasts went up a bit. Despite the market setback HOVZ Market Enthusiasm Index inched up. We still predict a considerable amount of rebound for the next several months. Emotionally, though, it's hard to escape the gloom that hovers over the market and the economy. How about some cheering up!

Let's indulge in a bit of wishful Orphan Annie thinking. I'm outright partisan and here is my rosy hopeful view. The success of Barak Obama just might mean significant amounts of international money will flow back to the U.S. stock market. If this is indeed wishful thinking, that's OK also -- If enough others are feeling the same, then Market Enthusiasm will rise anyway. In the short run attitude is everything.

There is absolutely no question that the rest of the world is loudly shouting: Yay Obama! The U.S. finally may have a chance to come out of the dog house of world public perception. At least for a while. Traveling overseas you might not feel a need to pretend to be Canadian anymore. Eh? Maybe you will be able to say you're an American without being sneered at. How cool is that?!!

George Bush has been the lightening rod for anti-American sentiment around the world, and that negative sentiment could hardly get much worse. Here is a link to the Pew Foundation world opinion polls. They paint a sad picture. For example, in August, 2001 -- a month before 9/11 -- the Pew survey headline was: "Bush Unpopular in Europe, Seen as Unilateralist". That's before we and our limited 'coalition of the willing' invaded Afghanistan and Iraq. Things only went downhill from there. By 2003 the Pew headline said: "America's Image Further Erodes..." Just last month a commentary began: "Simply put, America's image in much of the Muslim world remains abysmal.".

Bush efforts to counter negative world opinion have come off as clownish. The much-hyped Karen Hughes, Bush-pushed, U.S. Department of State public diplomacy effort has been a dismal failure. Perception is so negative that George Bush has consistently been seen in much of the world as a greater threat to world peace than Osama bin Laden. That hasn't helped the U.S. stock market or U.S. corporations operating overseas.

World dislike of Bush II in the economic sphere is what counts to us. Major non-U.S. investors disliked George Bush Jr. from the start. They worried about what many saw as a stupid, short-sighted, inexperienced and shallow good-old-boy, ignoramus, phony-cowboy, evangelical, racist, isolationist, imperialist, privileged country club, defense-industrial-medical-oil-real estate profiteer bully complex that put Bush in power. Much of the world could not fathom the millions and millions of people who supported Bush. All the world could see were some really bad, ignorant, grasping, and corrupt folks very much in evidence at center stage. Much of the world really didn't like or trust the guy who they knew famously proclaimed that he'd "never be out-Jesused or out-Rednecked ever again!". They remembered when he wanted to launch a "Crusade". They didn't see it as a good sign when he was clearly proud to "mangle" the English language; and seemed to stumble reading sentences with more than 3 words, and words longer than 5 letters. They didn't have much confidence keeping their money in U.S. stocks.

It is no coincidence that the tipping point of the DotCom Bubble in April, 2000 was the moment when candidate George Bush began to seriously challenge candidate Al Gore in U.S. presidential preference polls. World investors had loved the Clinton-Gore administration causing the Dollar and the stock market to sail into the stratosphere during Clinton's years as President. (Heck, they gave Al Gore the Nobel Peace Prize a few years later.) Unfortunately the market sailed too high. That "irrational exuberance" unfortunately set the stage for a precipitous decline into fear and panic. Bush became a great rationale for pulling out. Once the market began to fall, the response of the Federal Reserve couldn't have been much slower -- no rate cuts were made until 8 months after the stock market collapse began. And President-elect Bush running around in late 2000 calling for a high level media-driven "Economic Summit" to save the economy couldn't have been more unsettling. International investors ran to the exits.

Now, we may see the opposite effect with the ascending candidacy of Barak Obama. Just maybe. Above all, to the rest of the world he personifies the appealing characteristic of being: "not George Bush." But, his appeal goes way beyond that. There is no question that most of the world is excited by Obama and see in him the potential for real change in U.S. relations with the rest of the world. (Impossible to get worse.) Just the fact that he has become the Democratic candidate is already a huge history making U.S. public relations gain. This article on WashingtonPost.com may be pointing to just the tip of the pro-U.S. emotion that may be liberated. Even John Mc Cain, though, will at least be seen as being "almost not George Bush", and Mc Cain's ties to the more detested parts of the Bush Southern Strategy coalition are perceived as weak and just temporarily opportunistic.

The major premise of the HOVZ statistical models is that market emotions and herd dynamics trump business fundamentals every time in moving the stock market. To see what we mean, take a look at the long term history of the HOVZ Market Enthusiasm Indicator . A truly rational and efficient stock market just wouldn't look like that! We are convinced that the huge, semi-periodic, somewhat predictable rises and crashes of investor emotion that we plot are pushed by herd psychology more than long term business basics. Economic fundamentals change from year to year, but the emotional swings of the investing herd are steadily characteristic. With Obama, Market Enthusiasm might grow a bit more than our models now predict, giving a nice surprise.

The vast majority of HOVZ 5-month forecasts remain excellent -- not as good as they were in February and March, of course, but still very favorable. The sharpness of the winter market panic, the depth of the fall, and the seriousness of Federal Reserve response to the panic all combine to make a continuing rebound very likely. 2% interest rates set by the Fed brewed pretty strong joy juice for an economic party. With inflation running at 3.9%, the Fed is effectively paying banks to borrow money. The Fed can't increase those rates too soon or else the financial panic of insolvent banks will blow up again and the recession will deepen. Interest rates will probably stay low and monetary liquidity high until at least November. For now, HOVZ forecasts the market will keep going up.

We aren't enthusiastic about longer term stock market prospects. Too many economic obstacles loom in front of us. The U.S. is probably in recession or at least in a low growth state. At the least, that means that corporate earnings will either fall more (down 14% in the first quarter) or stagnate. So far only earnings in the financial arena and construction have really been clobbered. But, earnings growth in other sectors has at least slowed, and that counts too. Slower earnings growth always leads sooner or later to lower stock valuations.

The litany of well known economic troubles is downright depressing. Interest rates will remain low and the money supply will continue its rapid expansion. That sounds good, but it also implies the dollar is still going to be in free-fall, and inflation will increase, discouraging just the sort of foreign investment in U.S. securities we are hoping for. Also, only about half of the likely decline in U.S. house prices has occurred. Housing news just keeps getting worse and worse. Already, 1 in 11 home mortgages (NY Times) are in trouble. The consensus seems to be that the housing decline is only about half over. Home equity withdrawals -- which powered much of the boom in 2003 to 2006 -- are already down an amount equivalent to the recent economic stimulus package. The home equity ATM is also petering out as it must sooner or later: total home equity has sunk (MSNBC) to levels last seen after World War II. That's down $400 billion last quarter alone, dwarfing the President's economic stimulus package. Despite the consumer equity well running dry, total consumer debt managed to rise $8.9 billion in May, but that's way down from the previous month. Completing the dreary picture, jobs are declining (Bloomberg) -- down 324,000 so far this year. That was the largest one-month drop since 1975, and the highest rate of drop since 1986. (Hmm. Didn't the stock market crash in 1987? Interesting.) .

The financial panic hasn't disappeared either. According to some estimates only a little over a third of the likely eventual banking sector destruction has been owned up to. UBS has estimated a total financial loss of roughly $945 billion of which only about $387 billion has been announced. (Only??? ) . More finance industry losses are coming. When Ben Bernanke tells banks to get more operating capital, as he did two weeks ago, there couldn't be any more obvious signal that more hard financial times lie ahead. Well, maybe the Government staffing up more agents to deal with a large number of anticipated bank failures qualifies as an even more obvious signal.

One of the few significant economic positives is that an important temporary break in commodity prices may be at hand. HOVZ forecasts for many energy related issues are still very high, but they may be due for a setback. The bubble in commodities was highlighted by the never-seen-before rise in oil prices last Friday. Admittedly, long range growth in consumption of all resources has ratcheted up with rapid economic growth in Asia. That long term demand pressure is not going away. But, a short term peak may be at hand. Recent price growth is not sustainable (chart) , U.S. gasoline consumption peaks in late summer, but because of time lags crude oil demand should drop soon. Likewise crop futures should also drop soon as the northern hemisphere harvests come in. By late summer, it seems to us that commodity prices may break down for a while.

The unwinding -- deleveraging -- of multiple asset bubbles probably will be prolonged. As the financial world of subprime finance began to collapse, and the magnitude of the housing mess became apparent, the Fed had a choice, either allow a sharp major recession or stretch the bad news out over several years. Clearly they chose the extended torture method. Margin Debt may be one of the best indicators to see if massive deleveraging that is occurring in bond markets will spread to the stock market as well. For the first time since 2000 that appears to be the case. For the long term view this is a terrible dark cloud.

But, like we said -- in the short run enthusiasm trumps business fundamentals every time. Recovering from the winter's financial panic, Market Enthusiasm has already been in an upswing in a predicted and completely typical way. With international optimism about Barak Obama, Enthusiasm just might pop higher and faster than we already forecast. (But, watch out in November if wishes are dashed, or next spring when any presidential honeymoon period is certain to be over. The next U.S. President, whoever he is, will be facing several difficult economic years.)

Bottom line:  HOVZ Market Enthusiasm Indicator is heading back up after hitting a bottom and retesting. It inched up last week as well. 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 . We may buy more if there is a little more of a dip.

.(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 negative 15% in March when the market 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. A significant amount of upside remains. Click on the 'Maximum' tab for the best view of the Morningstar chart. To us, the direction appears to be up.

% Stocks Trading Above 200-Day Moving Average (The current value is shown at the very bottom of the link page. ) About 37% of stocks are above their 200-day average. In March it hit 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.  We are at the brink!. 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  May be looking a little better. (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 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. For the past year or so, in a major turn-around, the deficit declined rapidly. It is already $200 B per year better than a couple of years ago. Not surprisingly, cutting back on Federal joy juice the economy started to slump.

Now, jumping to the rescue with fresh liquor for the punch bowl, the new economic stimulus plan is going to send the deficit way up. (Well, screw our kids and grandkids!) In the meantime the U.S. Dollar just keeps falling.

$58 billion in checks to individual taxpayers that are part of the federal $170 billion stimulus package have now been distributed. But, as Jon Markman at MSN MoneyCentral writes, higher food and fuel prices may suck all that stimulus up. It pales in comparison to the home equity lost in the same period and the companion drop in home equity borrowing.

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 McDonald's 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.