HOVZ Stock Market Forecasts

October 19, 2008
Rebound underway? Probably.

All HOVZ Archived Commentary
Links to Other Stock Market Indicators .

Short term market prediction is foolhardy but I can't help myself at the moment.

Despite the rotten economy, a disparate collection of major signs point to a stock market rebound that, with fits and starts and heavy volatility, may already have started. Here's the list:

Stocks are cheap: Stocks have fallen so far so fast that many great companies are at incredible sale prices. Morningstar.Com Market Valuation graph says stocks are 33% undervalued. Can prices fall more? Of course.

Capitulation achieved: Last week's decades-high volatility certainly tried to pass as a significant market capitulation. Investors aren't just scared, they have thrown in the towel and are despondent.

Federal Intervention is incredible: Federal interest rates have been slashed and likely will be cut to just 1% next week. That amounts to interest free loans. The total scale of the financial interventions that have been anounced and are just starting to get underway are absolutely incredible. It is equally clear that Governments around the world are prepared to do more if necessary. There is no alternative course of action.

It's almost Halloween: The Halloween Indicator -- weird but incredibly reliable -- is turning positive. The "Sell in May, Buy Back on All Saints Day" market timing strategy has been around for a long time and sounds too simple and mechanical to be any good. Our research and the work of many others, however, shows that it does have validity. This MarketWatch column is an interesting variant on the approach that has been put forward and tested for years by Sy Harding of Street Smart Report.

The election appears settled: The presidential election now looks to be over so half of the population is relieved and the other half is at least glad to soon be rid of Bush. Here is Mark Hulbert's take from MarketWatch.com suggesting that election year anxiety tends to put a bit of extra spin on market gyrations in September and October.

Financial panic is easing for now. Panics have a fairly typical pattern and don't last forever. World wide financial market panic has gone on long enough so that it is losing its edge . Finally the infamous TED Spread which tracks inter-bank lending has edged down.

Buffet says so: Forget all the other signs if you wish. Warren Buffet now says that it is time to buy! Looking back from several years in the future the odds are very good that current prices will be seen as real buying opportunities.

It's not that any of the bad news has gone away.

There is near-complete agreement on the nature of the huge economic problem: the housing price bubble has been pricked. Now that people realize that the days of rapidly rising prices are kaput, house prices will revert back to normal. Until house prices have fallen to traditional valuation levels the economic picture will remain bleak. There is near universal agreement that this process will take years. It is half over at best.

Financial markets have been decimated over the past year, but the 'real economy' (with the big exception of construction) kept rolling along anyway. Now, though, the real economy is getting slammed -- unemployment rising, foreclosures and bankruptcies soaring, sales figures for just about everything slumping, new orders way down, construction in the sewer, transportation costs and demand well below normal, commodity prices for just about everything crashing. Not only has the financial system locked up in panic (TED Spread is still near an incredible high); consumer sentiment is gripped by panic; economists expect more recession (Anxious Index ), and the U.S. Leading Economic Indicator   points down. All of these are unmistakable signs of a severe and extended recession.

But, the stock market reflects anticipation, not the current status of the economy. To us and many market gurus signs are now pointing to a significant bear market rally that could last perhaps for 6 months. Things are so bad it seems like then can only get better from here.

Bottom line:  With 'blood in the streets' and normal stock market seasonality coming into play we are soon coming to an important decision point. Our hunch is that we are at the edge of a several-month market rebound. We started buying last week

(This column is not investment advice, YOU need to figure out what's best for you.)

A Few Stock Market Indicators

Morningstar.Com Market Valuation graph  (Shows market to be 33% undervalued, just a tad better than the ALL-TIME LOW reached two weeks ago. There may huge economic bubble in real estate -- but it isn't in the bulk of U.S. stocks that Morningstar tracks. Or, at least THEY don't think so. We read this graph as saying that stocks are at 'super-sale' prices. On the other hand, there is no sign this chart is trending up. ) 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.

% Stocks Trading Above 200-Day Moving Average (The current value is shown at the very bottom of the link page. ) Only a bout 7% of stocks are above their 200-day average. This is WAY BELOW a typical bottom. This indicator is in buying territory. But, the knife may still be falling! 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. For someone with a short term perspective it sure looks like the sky is falling. How low will it go?.

NYSE New Highs & New Lows If 'blood in the streets' is a good sign, then it is time for buying. There have not been this many new lows for at least 6 years! Of course, next week there might be plenty more. 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.

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. The odds of a bit more rate cutting have now crept up. (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 has been in an extended slide for years. Recent dollar strength is unlikely to last.) The rate inversion that existed during most of last year ended up being a good predictor of the extended market troubles we are feeling now.

TED Spread (Bloomberg) NEGATIVE This indicator tracks the difference between the 3-month Treasury rate and the 3-month LIBOR -- the interest rate at which banks loan to one another. A week ago, the TED spread had never higher. This past week due to incredibly large government intervention the rate finally began to fall!

Short Interest Ratio (from InvestmentTools.com) 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. Since the market has already fallen off a cliff, many speculators have closed their short positions, pocketed their winnings, and are waiting for the next round to begin.

Margin Debt  Dropped significantly in August giving another sign of market fear. Deleveraging as discussed in this Robert Samuelson article at WashingtonPost.com is possibly the best sign of a persistent bear market. Margin levels still are well below where they were last year, and the rate of change is down at recession levels. 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. Here is the NYSE data link.

Building Permits and Housing Starts (Major negative factor seldom worse than it is right now. It takes an optimist to take heart that things seldom appear to have been worse than 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. Here is a Wikipedia background piece on the U.S. Housing Bubble

U.S. Leading Economic Indicator   Slid down in September after rising in August. (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 reports a decline in August.

Anxious Index (xls file) (Negative. It was just a head fake when it seemed to be improving. This indicator is about as bad as it gets.) 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! Before last week's emergency Government intervention the deficit was headed toward $500 billion/year. But now with the Treasury seeking authority to buy up to $700 billion in bad mortgages? Who knows! 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, and the spending faucet has been turned on full, 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. A few weeks ago I wrote: "At 2% there is not much further they can go." Well, proving things are really very bad the Fed cut rates by another half point. The Fed now charges less interest than the rate of inflation. They are paying banks to borrow! 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 anticipates another half point cut on October 29.)

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. The way a graph is drawn makes a huge difference in the story it tells. First take a look at the graph linked at the start of this paragraph, then look at this longer term graph of the P/E of the SP-500 presented in the NY Times by David Leonhardt. Regardless of the view, I don't see all that much value in this as a short-term market indicator.

Halloween Indicator: Negative But, VERY NEAR A TURNING POINT The old saying "Sell in May and go away" and buy back after Halloween turns out to have statistical validity. This MarketWatch column by Sy Harding summarizes his variant on the approach. The adage was certainly right this year! Anyway, this one says to stay out of stocks until November 1 -- unless the market turns up a couple of weeks earlier. Hmm.. right near the presidential election. Hmm..Here is Mark Hulbert's take of the market timing impact of the presidential election.