Stock Market Forecast December, 2017: Visions of Sugar-Plums Dancing

One Month Forecast December, 2017:  1.3% gain (above average)
6 Month Stock Market Forecast December thru May, 2018: 3% (somewhat below average)
Probability of at least Breaking Even:  0.94 (decidedly above average)

Parents of young kids know the dark humor of the classic poem Night Before Christmas. The line  'while visions of sugar-plums danced in their heads' sounds innocent and happy, but every parent knows that a real sugar high ends with the kid crashing fairly soon into an emotional wreck.  It is never a question of "if", just a question of "when" the child's blood sugars will drop and things turn dreadful for everyone.

It looks like the stock market is on the cusp of excessive optimism. That never ends well.  The guys behind the counter at my local UPS store were really excited about investing in BitCoins. Not good.

We will probably enjoy perhaps a year of continuing strong stock market returns.  My models say December should be excellent for the market and the following 5 months through May, 2018 should be OK, but not great.

However, the pieces are now in place for the next stock market crash. It won't be soon, but it is now rather certain.  The great bull market it coming to an end. Don't hold your breath.  As I just wrote, it probably won't happen soon. Hopefully my econometric models will give us plenty of warning.

As of today, it looks like the Republican Party's tax plan will be enacted in some form.  Much is unclear, but it is probably a sweet sugar-plum treat for many corporations and probably has not been fully priced into the stock market. Here comes a stronger sugar high, but the market has already been jazzed up on good news.

The economy is performing as good as can be expected. Literally.  The Congressional Budget Office, of course, is responsible for 'scoring' the costs and benefits of proposed legislation.  Many years ago as part of their scoring calculations CBO came up with a  remarkably accurate performance model for the U.S. economy. Here is a link to the long term CBO plot of that model going out to 2027.  The good news is that Real Gross Domestic Product has finally risen to the actual level of Real Potential U.S. GDP. The economy is actually doing quite well overall despite flat growth of wages and localized real problems in the Rust Belt and inner cities.  Real GDP may well go for years a bit over Potential GDP.  But, there is comparatively little upside room.  Possible GDP losses are now many times the level of near term potential gains.

Should the tax plan significantly spark the economy the Federal Reserve will almost certainly raise interest rates at a faster speed than their current course.  The Fed can, and will slow the economy to remove froth.  Unfortunately, for the past half century the Federal Reserve has not been able to bring the economy in for a "safe landing".  Sudden crashes are the norm.

Finally, the Leading Index for the U.S. economy as posted on the Federal Reserve data website has decidedly turned down. Every time the fall has reached today's level, the U.S. has gone into recession within a couple of years.

So, enjoy the good times while you can.  But, start preparing yourself for the letdown after the sugar high wears off.

Seasons Greetings.

(Click on image to enlarge.)

6 Month Stock Market Forecast: Strong start, then average performance

November 2017 through April 2018: 5% gains projected (about average)
November 2017: 2% one month expected increase (unusually strong)
Likelihood of at least breaking even: 80% to 95% (75% is average)

These stock market forecasting models remain bullish with surprisingly high projections for the coming month. The probability of at least breaking even is again considerably higher than average.  The Trump tax package could well falter and might take a bit of air out of the market. Beyond that the models still see no major mid-term threats to this bull market.

Personally, I expect November to be volatile since the GOP income tax bill is expected to be announced tomorrow. Whatever form it takes there will be possible winners and losers.  That should translate into stock market volatility.

I, however, will be a sure winner in the tax battle.  The flow of new lobbyists to Washington is going to be amazing.  There is nothing like the possibility of tax changes to get the K Street crowd hiring -- not just the lobbyists themselves with their money sacks.  They all get backed up with lawyers, accountants, analysts, consultants and IT staff.   The airlines, hotels, restaurants, and hookers all will do great business as all the greedy or scared interest groups come to town for "vital" meetings.  Once started, tax wars go on for years and years. The market value of my DC house is gong to take a great leap!  Thanks guys!

The graph below shows the S&P 500 from 2007 with colored points overlaid to show the forecasts the models generated in real time.  Note that each point does NOT indicate what already happened in the market, rather each is the forecast for the 6 months that will follow the forecast. Look at the 6 months following each point to see if the forecast was on track.

Click on image to enlarge.

Boring, Boring, Boring, Crash

It has to be more fun writing for a stock market web site like MarketWatch.com.  Seems like every day they have a column suggesting  an imminent stock market crash, and at least one other column talking about likely explosive growth in stock prices.  Both can't be right, but you'll seldom see an article with a title like: "Wow, we were dead wrong 6 months ago! "

Stock market news sites also seem to carry few articles expecting the market to go up or down a measly few percent over the next half year -- even though that is what usually happens.

So, please give me a few 'pity points'  for posting quite boring ,mildly positive forecasts month after month.  They have been pretty accurate, but still boring. Add a few more pity points because the economic factors I look at suggest a couple more years of boringly positive stock market behavior.

Worse still, when these 6 month stock market forecasts eventually turn sharply negative, both of my loyal readers will almost certainly think I have gone nuts.  Most likely the stock market still will be surging up, but my six month forecasts will be screaming that the sky will soon be falling. Month after month.  I expect to appear quite foolish.

Then, thud.

Coming 6 months slightly better than average for stocks

October, 2017 expected gains 1.8%.
October, 2017 through March, 2018: Probable 5 percent gain.

The consensus of my forecasting models is that U.S. stock market will rise over the coming half year.  The likelihood of at least breaking even is about 97% -- That is significantly better than the long term market track record of breaking even 74% over all 6 month periods since 1984.  The projected 6 month market gain is about 5%. That's nice, but only slightly better than the long tern average gain over any 6 month period of 4.8%.

The models' forecast of very strong gains in the coming month (1.8%) is unusually positive.

The wild cards, however, are any changes to the U.S. tax code which may get pushed through the Republican-majority Congress.  These models cannot figure what, if any, positive or negative impacts tax changes could mean for business.  Passing major tax law changes isn't easy. The last major restructuring of tax law occurred in 1986.

(Click on image to enlarge.)

Without any major positive or negative catalyst, my models expect the stock market to just keep chugging along. Financial markets are generally calm. We are moving into the winter months which have historically been better for the market than summer months. Recession is unlikely soon.  Interest rates remain historically low. The Federal Reserve intends to raise interest rates only very, very slowly. Inflation is still steady and low.  All of these are positives for the stock market.  But, there is very little reason to expect any big jump in stock prices, as valuations are lofty.

6 Month Stock Forecast September, 2017 through February, 2018

(Note: The October market forecast will be a few days late.)

My models expect another month of weak results for the U.S. stock market, but then things should get back to normal.  For September, the models see a likely stumble of less than half a percent -- no big deal.  For the next half year the models predict a net gain of about 5% (slightly better than the average gain of 4.8% since 1984).  Surprisingly, the models see the probability of at least breaking even as 98%.

(Click on image to enlarge.)

The forecasting models have been very accurate so far this year. (Better than my long term testing would have expected.)  The graph below shows, month-by-month the actual gains of the Value Line Arithmetic Average (black) and the results for the same period that my models had predicted 6 months earlier (red).

(Click on image to enlarge.)

Why not forecast the Dow Jones Industrials or the S&P 500?

The Standard & Poor's 500 Index and the Dow Jones Industrial Average are the best known stock market indicators, but the way these averages are calculated make them hard to forecast accurately. So, I base my forecasts on the Value Line Arithmetic Average which is much more closely tied to the overall economy and business conditions.

Most of the time, most all stock market indexes give the same basic picture of the stock market. They go up and down at about the same time and by about the same amount as each other.  For general purposes most any stock market index will provide a reasonable view of where stocks have been heading. But, to get a more accurate understanding of market behavior, the exact way that the index is calculated makes a real difference.

Articles I spotted  this week in the New York Times and the Washington Post  show dramatically how just two stocks, Boeing and Apple, have caused much of the price rise in the Dow and the S&P 500 this year.  But, not in the same way.  The impact of Boeing has been about 15 times as big on the Dow as on the S&P 500.  Apple was responsible for about 14% of the rise in the S&P 500, but for only about 8% of the Dow's gain.  Why has Boeing dominated the Dow, but Apple has dominated the S&P 500?  Because of the way the indexes are calculated.

The original  Dow Jones Composite was based on a simple calculation -- add up the closing prices of 30 great big companies, and follow that sum day by day. Over time the calculation has become more complicated to account for a changing mix of companies, but it remains totally based on price.   Boeing at $237 per share today is a very expensive stock. Entirely because of its high price Boeing, up 50% for the year, is responsible for 25% of the rise in the Dow.  But, here's the magic -- if Boeing were to authorize a 2-for-1 stock split, its price would be cut in half and its impact on the Dow Jones Industrial Average would be sliced in half.  A stock split of Boeing at the start of the year would have significantly reduced the Dow's gains this year. Crazy!

The S&P 500, in contrast, is calculated based on the total market capitalization of each stock in the average: multiply the stock price by the number of shares of the company.  The idea of following market capitalization is that what happens to huge companies is more important to investors and the economy than what happens to a smaller company.  In the S&P 500, Apple Inc. is about 260 times more important than, for example, Chesapeake Energy Corporation.

Reliance on market capitalization makes the S&P 500 and similar averages like the NASDAQ Composite, prone to bubbles.  As the Dot.Com bubble showed dramatically, soaring prices of a relatively small number of stocks does two things -- besides raising the index price directly, the increased prices raise the market capitalization of those stocks and therefore increase the amount that each bubbling stock counts in calculating the index.

The Value Line Arithmetic Average is calculated differently, and that makes a huge difference in predictability.  The Value Line Arithmetic Average tracks the average percentage gain day-by-day of about 1700 very large U.S. companies.  Changes in Boeing, Apple, Chesapeake Energy and many smaller companies all count equally.

Since 1984 the S&P 500 Average has matched a steady rate of growth about 86%.  Yes, despite all the bumps and bubbles, the S&P 500 shows a "relatively" steady long term growth rate.  But, the Value Line Arithmetic Average matched a steady growth rate with about 98% accuracy -- it gives a much less bumpy investment ride. (The Value Line Arithmetic Average is not available as an investment fund, but RSP, the Guggenheim S&P 500 Equal Weight ETF, has very similar performance.)

By using the Value Line Arithmetic Average as the basis of my forecasts, the predictions are much less vulnerable to the somewhat random  price movements of a very few huge companies. It would hardly budge, for example, if simultaneously Boeing and Apple had major product flops.  The Dow and S&P 500 would be tanking post haste.

For most purposes, most of the time, my forecasts for the Value Line Arithmetic Average will apply fairly well to other indexes like the S&P 500 and the Dow Jones Industrial Average.

As always, even though my forecasts for the past decade have been pretty good, at most, they should be only one of the factors an investor considers.

Stock Market Forecast August, 2017 through January, 2018: Weak start, good finish

Out of the  countless economic statistics available, relatively few factors actually foretell stock market changes.  Usually, the hyper-sensitive stock market is a much better leading indicator for other economic variables rather than the other way around.

Fortunately, most of the time-tested leading statistics don't  usually change quickly. So, not surprisingly, the my models' expectations for the U.S. stock market have not changed much from last month.

The models say that the summer is likely to show relatively weak performance for the next month -- maybe a slight loss of about half a percent.  But, for the rest of 2017 stock prices should strengthen, ending with a net gain of slightly below 6% by the end of January 2018.

Long term, the U.S. stock market has risen about 73% of all 6-month periods. Pretty good!  For the coming 6 months the prospect of at least breaking even is well above average as a bit above 90%.

Enjoy your summer!

For now, I suggest you save your worries for something other than the market.  My models don't see huge and avoidable problems cropping up in the near future.  That doesn't mean that Earth won't be hit by some huge asteroid tomorrow destroying nearly everything.  It just means that my models that match U.S. stock market performance pretty well over the past 35 years don't see huge storm clouds on the near horizon.  Never put all your eggs in one basket.  But, f you need to carry some eggs, put them in a basket that is fairly trustworthy.

(Click on image to enlarge.)