2015 U.S. Stock Market Forecast: Climbing the Wall of Worry

2015 should be a thoroughly average year for stocks.  My macroeconomic models predict modest stock market growth through 2015, and see no reason the path during the year to be any smoother or more volatile than normal.  Negative market surprises, if they hit, will most probably be during the second half of the year.  A boring year would be wonderful!

The stock market, of course, will do what it 'wants', regardless of these predictions. That said, the model has performed well since 2007, so its forecasts may be worth paying attention to.

The tremendous multi-year stock market recovery from the depths of  "The Great Recession" is almost complete. More years of strong double-digit gains grow less and less probable.  On the other side of the coin,  serious action by the Federal Reserve to damp down the economy is still about two years away. Until then, a routine bumpy upward path for the U.S. stock market is the most probable future.

U.S. Market Forecast (based on the Value Line Arithmetic Index):
Probable stock market gain 1/1/2015 to 7/1/2015:  5% to 6%  (Avg. 6 months gain since 1984: 4.8%)
Probability of at least breaking even : 75%  (Average for all months since 1984: 73%)

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What drives this typical stock market prediction?

Regression to the Mean: The Value Line Arithmetic Index that my models follow includes over 90% of U.S. corporate activity, but because of the way companies are weighted, it is much less influenced by speculation than more popular indexes like the Standard & Poor's 500.  As a result, it follows a much steadier growth pattern than other indexes. The  Value Line Arithmetic Index is now near its long term trend making growth at normal rates very probable. The next 3-5 years should also yield typical market growth.

Continuing Moderate Economic Growth:  The 3rd quarter of 2014 produced surprisingly strong economic growth.  That may well be an exception caused, perhaps in part, by dramatically falling oil prices.  The longer term growth trend has been fairly slow and GDP remains below potential.  There is  room for economic growth.

Small Chance of Recession:  The stock market responds poorly to economic disruption. The metrics I track show few impending tornados on the economic horizon. Eventually, of course, the Federal Reserve will bring on the next recession by sharply raising interest rates. However, a large increase in rates is probably 2 - 4  years away.  Interest rates are still at historical lows and the Fed is only expected to make its first interest rate increase in mid-2015.  My expectation is that when the rate increases begin they will move very slowly.  So much long term money has been borrowed at current very low rates, a sudden increase would destabilize the economy much more than the traumatic shocks of of 2006-2008.  I wouldn't be surprised if mid-year the Governors of the Fed intentionally try to deflate markets a tad with some hawkish comments. Certainly they would rather do that than to cause actual serious disruption to the 'real' economy.

Plenty of Gray Swans Floating Around:  A true black swan can always appear on the world scene. But, that is a rare event (by definition).  Instead, there are plenty of major potential economic positive and negative possibilities.  The ones that I see developing do not appear likely to bring major disruption in the near future.  There are countless observers following each of today's gray swans.  As a result, major sudden surprises become less likely.

Speculation Has Not Exploded Yet:  Historically, margin debt has proven to be a reliable indicator of stock market speculation.  So far, it is nowhere near the level that typically flags collapse of a speculative bubble.

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Best wishes for a happy and prosperous New Year!

2014 Stock Market Forecast Results

Well, how far off were my model's stock market forecasts for 2014?

Not too shabby. During 2014 the forecasts from my macroeconomic stock market models matched reality pretty well. Overall, the stock market performed a bit better during the year than the model had expected. No complaints there.

During 2014 actual market performance could be checked for 12 monthly forecasts.  The first of these forecasts was made at the start of August, 2013 with a forecast for the end of January, 2014.  The last forecast that can be checked was made in July, 2014 with a forecast for stock market performance through the end of December, 2014.  A graph of the forecasts vs actual results appears below.

In statistical terms the comparison of actual and forecasted results showed an R-squared measure of 0.35.  That corresponds closely with the long term back-tested results for the model.

But, that doesn't mean that the model was "right" only 35% of the time.

In more descriptive terms, for most of the 6 month spans of the year the model expected the market to rise moderately and that is generally what the market actually did.  Four times during the year the model forecasted that the market would either be flat or fall less than 5%. One of these forecasts was spot on, but for the other three cases the market rose under 5%.

To my mind what matters is that the model did not make any really bad calls and mainly the stock market performed roughly as expected.  I'll call that a win.

Happy New Year!

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Incredibly Accurate, Incredibly Simple Multi-year Stock Market Forecast and Why That is Only Modestly Helpful

Forecasting the stock market 3 to 5 years into the future can be straightforward and fairly accurate if three basic concepts are followed:

1.  Long term multi-year forecasts are inherently more accurate than short-term forecasts.
2.  Estimating the collective future of thousands of companies gives more success than forecasting just a few.
3.  Avoid forecasting areas where speculative money is dominant.

In brief, trying to forecast the near term future of just a few companies that are the focus of huge piles of fast-moving hot money is just begging for failure.

This translates to a single rule: Do not attempt short-term or single year forecasts of the Dow Jones 30 Industrial Average, the S&P 500 or the NASDAQ composite, or at least, don't expect great accuracy if you do.  The calculation of each of these indexes is dominated by just a small number of huge companies.  Each is followed closely by millions of nervous investors all trying to beat the market and usually failing.  And speculation in each of these indexes is cheap and simple using exchange traded funds. All the makings of a frustrating forecast. Most market forecasters make their annual predictions using these popular averages, and not surprisingly, most of these annual forecasts end up being shown up as wildly inaccurate.

So what's left?  The rest of the stock market, all the thousands of other companies whose names are not household words and people really don't know or care much what they do.  Prices of these thousands of companies -- much of the rest of the economy -- collectively tend to move in a much more predictable way. They follow a path of constant moderate growth very closely over the span of several years. Not month-by-month, or year-to-year, but over a multi-year time span.

What explains this steady long term appreciation? The Law of large numbers. Millions upon millions of people work for these companies.  They go to work 5 days a week or so and they try pretty hard to do a good job regardless of whether the stock market is up or down.  Even in a severe recession most all of these workers are still plugging away at their jobs. The result is a rather predictable rate of overall corporate growth.

Like the more speculative parts of the stock market, prices of the less-speculative stocks go up and down with each bubble and recession.  Their collective price swings, however, are less dramatic and are more closely tied to economic fundamentals.

How predictable is 'the rest of the market'?  Statisticians use a measure called R-squared which evaluates how far, on average, forecast points differ from what actually occurs.  R-squared of 1.0 is a perfect match.  R-squared equal zero or negative means the model is essentially worthless.

Since 1984 the S&P 500 has followed a somewhat constant rate of growth with R-squared = .84, actually pretty good. Simply put, buy and hold investing makes sense: over the long haul the index grows at a somewhat steady pace -- except for all the speculative crashes and bubbles along the way.

I follow the Value Line Arithmetic Index  (VALUA) which focuses more on 'the rest of the market.' VALUA gives equal importance to each of the 1,700 or so stocks that the Value Line Investment Survey tracks. No company is treated as more important than any other in calculating the index.  VALUA  follows a constant growth rate with an R-squared value of .98.  Not perfect, but very good. An ETF near-equivalent is the Guggenheim S&P 500 Equal Weight ETF (RSP)

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Looking at the graph above it is obvious that neither VALUA nor the S&P 500 follow their long term steady growth trends exactly. But, even over just a 3 to 5 year time span, the growth of VALUA has matched the steady growth trend very well: R-squared = .96.

So what? -- stock indexes tend to follow their long term growth paths if you look from a multi-year perspective. Whoopie! Not news to anyone.

A more important and useful observation, however, is that VALUA has a very strong tendency to 'regress to its mean', to move back in line with the long term growth trend.  If the VALUA is above the long term growth trend the likelihood is that the next few years will show sub-par appreciation.  But, if the index is at or below trend, as is the case now, then average or somewhat better than average price appreciation is probable.  When the average is near the long term trend line a tremendous price gain becomes less likely. If prices do shoot up, a severe correction looms in the future.