HOVZ Stock Market Forecasts

July 20, 2008
A bounce would be nice. But, we aren't expecting too much.

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

A number of stock market indicators say a stock market bounce of some sort is due:

Up on bad news: Last week Citigroup announced that it wrote down $7.2 billion last quarter and Merrill reported another $4.65 billion loss. In normal times that would be enough to send the market into a major tailspin, but on Friday, both stocks rose in trading along with the financial index as a whole.

Stocks below 200-day moving average: Currently, only about 20% of NYSE stocks are above their 200-Day Moving Average . Things can always get worse, but this is a typical rebound point.

Stocks undervalued: According to the Morningstar.Com Market Valuation graph stocks are roughly 18% undervalued -- a typical turn-around point.

HOVZ optimism bands: For a large number of ETFs that we track price has now fallen to the lower bound of what we calculate to be "normal behavior'. Unless the world ends (which always remains possible, and with the Bush administration, somewhat probable) this is a routine rebound point. As shown in the SP-500 graph in the right column, the HOVZ models still point to a near-term rebound. Unfortunately the sort of rebound we expect has not happened over recent weeks. The opposite has occured! Bigtime!

The problem, of course, is that because of the Bush administration allowing the housing boom to overshoot, the U.S. economy is now in dire straits- we have spent money we didn't really have. We are seeing bank runs of the sort we have not seen since the Great Deperssion --- and you never really want to go through a period in history that is titled in capital letters! (Sort of like having your daughter marry a guy who only has a one-word name. Not good.)

Most signs in the financial and real estate markets in the U.S. point to major extended problems remaining ahead. Of $1.3 trillion in subprime damage forecast for the financial industry by UBS, only about $400 has been confessed to. A new forecast was released from another group that saw losses possibly in the range of $3 trillion. Also, the huge bubble of inflated commodity prices (especially oil) remains to be popped. Oil prices took an encouraging hit last week, but plenty of bubble inflation remains.

When oil crashes, the stock market can rebound. There is an old stock market saying that at the end of a stock market decline even the 'Generals' -- the top solid performers -- get killed. For this stock market the Generals for the past several years have been in the oil and commodities arena. They are now lined up as prime targets.

We are not witnessing a normal correction in a healthy economy, but rather a correction happening in the course of the collapse of a major asset price bubble. There is more to come and no reason to think the downward path will not continue for years. The Fed had a choice at the start of this year -- either allow a major implosion that could plunge the U.S. and maybe the world into a major Depression,( see, there is that Capital Letter thing again!) or do everything possible to choreograph an orderly unravelling, hoping that future growth could be used to lessen the damage.

Margin Debt  probably will give the best view of the market multi-year deleveraging progress as it unfolds. This is an indicator that does not change very often and solidly defines bad and good stock market conditions. The simple message today is: BAD NEWS!

So, scared and shaking, we'll try to grab a little solace from our calculations that still point to many stock prices going up over the next few months. Our focus is on stocks that have little to do with the problems in U.S. finance, but that were knocked down anyway in the market panics.

Bottom line:  HOVZ Market Enthusiasm Indicator has been hurting for weeks. The good side of that is that many stocks are back at sale prices! Last week we dialed back to 80% investment.

(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 18% undervalued, below the March lows of 15%, and getting near to the 2002 all-time-worst of 22% undervalued. There may be a huge stock market bubble somewhere -- but it isn't in the bulk of U.S. stocks that Morningstar tracks. We read this graph as saying that stocks are at 'sale' prices. But, the knife of lower prices has not stopped falling!) 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. 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 19% of stocks are above their 200-day average. In March it hit 17%, a typical bottom. It is again reasonably low, but while prices are falling, the direction is bearish. This is getting near a buying point again. 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 If 'blood in the streets' is a good sign, then this must be betting near a good point 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, the flip side of this is that low rates like this are a direct statement that the Fed is really worried about the economy. 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  (THIS IS SCARY. 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. Pay close attention to the rate-of-change graph at the bottom of the linked page. It has now turned negative, almost certainly meaning a serious bear market.  We have just stepped over 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  Took a dive In June! (See graph at bottom of link page.) The eLEI did well in April and May, but jumped off a cliff in June! A competing and better known indicator, the Conference Board Leading Economic Indicator rose slightly in April and May. 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 cut taxes and 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!) The U.S. Dollar has been falling for years. It has looked better recently, but as long at the U.S. balance of payments is so terrible, we just can't believe that the Dollar will jump up too high.

$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  (Rising P/E because of falling profits is bad news.) The P/E ratio has spiked up in recent months, a sign of earnings going down sharply, especially in the previously profitable financial sector. This is a sign of bad economic news.

Halloween Indicator: Negative The old saying "Sell in May and go away" and buy back after Halloween turns out to have a lot of validity. We will add some links here in coming weeks. The addage was certainly right this year! Anyway, this one says to stay out of stocks until November 1. Hmmm... right near the presidential election. Hmmm...

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.