HOVZ Stock Market Forecasts

August 17, 2008
Executing the Generals

All HOVZ Archived Commentary
Links to Other Stock Market Indicators

A truism on Wall Street is that in the capitulation stage of a bear market all the small soldiers are already dead, but finally at capitulations the generals -- the stocks that strongly led the previous bull market -- are executed. That seems to be what is happening now, All the financial stocks that seemed unbeatable for so long have been sliding relentlessly. As a climax, commodities across the board and resource rich foreign ETFs are also in free fall.

Bottom line:  In hindsight we chose poorly when we bought into the market in March. This was not a normal bounce of our Market Enthusiasm Indicator. The indicator is pointing to a longer lasting market recession. Results have been quite disappointing. The market is bouncing back up off a typical low point. Our forecasts point to more near-term gains -- but then probably to more bear market. Right now, our expectation is to sell the bounce.

(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 12% undervalued, up from -18 and now above the March lows. The 2002 all-time-worst was 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.) 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 33% of stocks are above their 200-day average up from 18% a few weeks ago. . In March it hit 17%, a typical bottom. A rebound seems to be underway and prices are again reasonably low. This is in buying territory 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 it is time 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 the stimulus of low rates 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 destruction 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. Maybe it is just wishful thinking on our part, but both of the linked charts show small recent upticks). 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. Here is a Wikipedia background piece on the U.S. Housing Bubble

U.S. Leading Economic Indicator  Took a dive In July! (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 but went down in June.

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 sent the economy into a 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 to roughly $500 billion/year. 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. Bloomberg appears to agree.

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 rate changes 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 statistical 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.