HOVZ Stock Market Forecasts

November 2 , 2008
Made it to Halloween! Phew!

All HOVZ Archived Commentary
Links to Other Stock Market Indicators .

October was the worst month in decades for the stock market and the economy. World-wide. Now, though, the probabilities have shifted and a good half-year for stock markets is very likely. Maybe even one of the best ever. It was a huge encouragement that October ended with one of the best weeks ever for stock markets world wide.

It would have been difficult for the first three weeks of October to have been much worse. But, without the massive interventions of governments across the world markets might have turned catastrophic.

The entire financial system of the U.S. and much of the world has been gripped by panic, freezing credit, leaving a rising number of financial companies bankrupt. Unemployment is way up. Consumer sentiment hit a 40-year low. Consumer spending had the worst monthly drop since 1980. Commodity prices suffered their worst monthly drop since 1956. Shipping levels (Baltic Dry Index ) have dropped incredibly fast -- a very bad sign. Home building went down the tubes long ago and shows no sign of recovery (Building Permits). According the the Case-Shiller survey housing prices have had their worst year ever. There is no longer much doubt that the U.S. is in recession and according to most commentators the prognosis for the next few years is pretty bleak. Professional economists ( Anxious Index ) are very negative. Oh, and stock markets around the world suffered historic drops -- until this past week which was one of the best ever. Volatility has been incredible. Mutual fund redemptions hit a new record. The first three weeks of October almost certainly will be called the Crash of 2008.

But, why did all of this happen in September and October? Why didn't it climax in, say, April? Or July? It turns out that there is something very strange and not well explained about market behavior in these two months. The Stock Market Crash of 1929 (October 24 - October 29) Crash of 1987 (October 19) were both late October events. Four of the seven worst stock market drops happened in either September or October. Our regression analyses demonstrate that statistically September and October are the worst months of the investing year. And other studies claim to prove that this seasonality of stock markets is a world wide phenomena that has existed for hundreds of years. The pattern is so well known that many investors follow it -- making it a self-fulfilling prophecy.

Here are our reasons for now buying fully into the stock market.

Halloween Indicator has just turned positive: 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! . But, as October wrapped up the trend may have reversed.

The election appears settled: Anxiety over the U.S. Presidential Election has risen to incredible levels. 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.

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 31% undervalued. That is much improved from last week's record 39% under valuation. Another investor service, Value Line has a similar market valuation tool. It's Value Line Median Appreciation Potential VLMAP, as discussed in this Mark Hulbert MarketWatch article also points to the best valuation potential since 1982. Can prices fall more? Of course.

Capitulation probably achieved: The decades-high volatility of the past two weeks could easily mark a significant market capitulation. The U.S. markets were scary enough, but emerging markets are the ones that showed the full extent of the panic and exhaustion. Investors aren't just scared, they have thrown in the towel and are despondent. Of course, that's what we thought two weeks ago before things really turned bad!

Federal Intervention has been fast, amazingly varied and tremendous in scale: Federal interest rates have been slashed to just 1%. That amounts to interest free loans. The total scale of the financial interventions that have been announced 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.

Financial panic easing? The infamous TED Spread which tracks inter-bank lending has edged down possibly indicating the start of a thaw in credit markets. This Jon Markman column at MSN Money Central, however, says: "I hate to be the one to break the news, but here it is: Despite everything you've heard about how massive infusions of hot new money printed by the Federal Reserve and other central banks have thawed the chill in inter bank lending, veteran credit analyst Brian Reynolds says credit markets have just experienced their worst two weeks of all time and show no signs of improvement. None."

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.

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 they have a good chance of getting better from here.

Bottom line:  With 'blood in the streets' and normal stock market seasonality coming into play we are now fully invested in the stock market. Our hunch is that we are at the edge of a several-month market rebound.

(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 29 % undervalued. Last week it hit 39% a NEW ALL-TIME LOW . There may huge economic bubble in somewhere -- 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. ) 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 8% of stocks are above their 200-day average. This is WAY BELOW a typical bottom, but a huge improvement from the 4% level of last week. This indicator is in buying territory. Has the knife may stopped 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. Did last week see the bottom or not?

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  The Fed has dramatically lowered short term lending rates creating a major stimulus to try to pump up the economy. The difference between the short and long rates is seldom greater than it is now. The futures markets rate an additional half percent rate cut next week as a certainty.(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 but improving 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. Two weeks ago, the TED spread had never higher. There has been some recent improvement but inter bank lending rates remain incredibly high by historic standards.

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. This may mean that we should not expect a huge short-covering rally at the market bottom.

Margin Debt  Remained below-trend in September 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.

This chart from www.InvestmentTools.com shows that for the past few years was a period of strongly rising margin. Deleveraging now is underway. 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.

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 modest increase in September -- the first rise in 6 months.

Anxious Index (xls file) (Negative. This indicator is about as bad as it gets. Big surprise: a big bunch of economists think we are in a recession!) 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) With the recession slamming the economy no one really cares about the deficit. Now, who knows! The U.S. Dollar had been falling for years. It has spiked recently, but that could well be less a sign of strength and more one of international financial panic. 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. Of course, for the last month of so we have been dead wrong.

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. 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 correctly anticipated the half point cut on October 29 to just 1%.)

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: Positive! 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.