The U.S. stock market suffered major pullbacks in 1987,
1990, 1998, 2001, and 2007. This post
looks subjectively at how well my forecasting models previewed those market traumas and the
subsequent market recoveries. They did surprisingly well with the possible exception of the brief 1990 decline.
(Note that the model forecasts for 2007-2009 were made in real
time, but earlier dates are evaluated with back-testing data. Also, the market
data below refers to market prices at the start of the month and may not match
exact market highs and lows that appear in daily market data.)
1987 Crash – A big
win for the model
On “Black Monday” October 10, 1987, world stock markets
crashed. The Dow Jones Industrial Average lost 22% in one day. Though most of the crash happened in a few
days during mid-October, markets had started to roll over as early as August and
damage continued into November. All
told, the S&P 500 lost 24% from August through November and the Value Line
Arithmetic Index (VALUA) lost 31%.
As shown in the chart below, my stock market forecasting model
turned sharply negative in March 1987 – seven months before the main crash. During
those spring months of 1987, markets were soaring, reaching one new high after
another, but the model, correctly, saw major storm clouds forming. Then, with the market still crashing in the darkest days of October and
November, the 6-month forecasting model turned strongly positive, correctly foretelling the market rebound.
(Click on image to enlarge.)
1990 – Missed the
correction, caught the rebound
From May through October, 1990 the S&P 500 lost 15% and
VALUA lost 24%. The forecasting model
was issuing weak forecasts prior to the sharp correction, but it did not
foresee the scale of the correction. On
the other hand, the models did accurately forecast the remarkably rapid market
recovery.
1998 correction
During the short lived market correction from April through
August 1998, the S&P 500 lost 15% and VALUA lost 24%. The models issued
forecasts in March and April of 7% to 8% losses in the months ahead. The actual losses that followed were
approximately twice as bad as forecasted.
The models got the timing of the subsequent market correction correct,
but underestimated the 6-month market gains.
(Click on image to enlarge.)
2000 – 2002 Dot Com
Bubble
The DotCom Bubble was a speculative buying binge focused on
technology stocks – not the entire market.
In total the NASDAQ Composite fell by 78%, the S&P 500 by 46%, but
the VALUA suffered only a 20% drop initially.
While the NASDAQ drop was nearly continuous from 2000 to 2002, the VALUA
had a rebound through 2001 followed by another 26% drop in 2002 as the U.S.
real economy fell into recession.
As shown in the chart above, the models’ forecasts generally matched the timing of the double-decline of VALUA during the period. The model did not expect
the 2001 rebound to be as strong as it was and did not expect the second dip in
2002 to be as bad as it turned out to be. Overall, the model predicted the
timing and direction of the VALUA fairly well.
2007-2009 The Great
Recession
Stock markets worldwide were traumatized by a series of
financial panics and steep recessions.
Between October, 2007 and February, 2009 both the S&P 500 and VALUA
lost 52%. The collapse started slowly with the bulk of the market destruction
occurring in late 2008 and very early 2009. Overall, the model forecasted the
market well. It issued weak
forecasts through 2007, but by April 2008 it was forecasting a massive 25%
decline in the market, well before the steep part of the decline actually
began. Likewise, in early 2009 while the market was in the steepest part of the crash, the model issued dramatic positive forecasts for the coming months,
forecasts that accurately predicted the subsequent rebound of the market.
(Click on image to enlarge.)
Summary
Though the stock market models’ forecasts of these major market disruptions were far from
perfect, except for the correction of 1990, they did anticipate the correct timing and general
magnitude of the severe market corrections and their following
recoveries.
A lesson to learn from this review, however, is that the models truly are future oriented. They do not have much value in assessing how the stock market will behave in the next few weeks. (In August you know that the weather is going to get cold by January, but that is no reason to put on your winter coat in August.) In general, the models start warning of market disasters months before actual destruction occurs, and they get highly optimistic months before markets finish their crash phase.
