April 2015 -- Below Average Stock Market Gains Coming

Following its normal pattern, the stock market had above average gains over the first part of the winter. Sadly, the stock market probably will have below-average gains over the next 6 months. Not horrible, just weak.

The chart below shows that for the past year or so the U.S. stock market has been tracking our forecasts rather closely.  In the last 6 month period, for example, the market rose 9.4% and our models had predicted an 8% rise -- close.

The fairly close match between our forecasts and the stock market is not much of a surprise. After all, the models are based statistically on how the stock market has responded to a number of key macroeconomic factors over the past 30 years. And, that is good news -- the market is responding normally to basic economic conditions. (measured based on the Value Line Arithmetic Index.) Nothing really unusual seems to be going on.

What's up in the next half year? Mild disappointment. Sorry, the market is now fairly pricey and statistically the summer months yield somewhat lower gains than the colder months.

U.S. Stock Market Forecast (Value Line Arithmetic Index):
Probable stock market gain 4/1/2015 to 10/1/2015: 3% (Avg. 6 mo. gain since 1984: 4.8%)
Probability of at least breaking even : 60% to 70%  (Average for all months since 1984: 73%

(Click on image to enlarge.)

Falling Margin Debt: Good or Bad Sign for the Stock Market?

Total Margin debt as reported monthly by the the New York Stock Exchange has fallen about 4% over the past 7 months.  Depending on how you want to look at the long term record, this could be a very bad omen, a pretty good one, or just a non-event.  I tend to see it as probably a positive sign, but nothing of immediate importance.

Margin debt is money that investors borrow from their brokers at fairly high interest rates in order to buy more stock than they otherwise could. As such it is a good indication of investor enthusiasm.  In a stock boom speculators buy all the stock they can and total margin debt shoots up. In a bear market those same speculators sell out in panic, the brokers get paid back, and margin debt levels plummet. Falling margin debt shows a drop in investor enthusiasm and optimism so it is hard to regard it as bullish.

Here's the scary view reported by Mark Hulbert at MarketWatch.com as a wake-up call on the bull market.   Since 2000, every time the level of margin debt has dropped below its 12 month moving average the stock market has been in a bear market. With the newly released January data, margin debt is now below the 12 month average -- and so that must be very bad news.  Right?

Taking the opposite view, the drop in margin debt may well be a very healthy sign for a continuing bull market.

Looking at the NYSE data going back to 1970 margin debt has shown an amazingly steady rate of growth.  Comparing actual margin debt to a constant rate of growth yields a pretty close fit. (Rsquared = 0.96)  That is not much of a surprise as the overall economy and the stock market have also had relatively steady long term growth. We all tend to focus on all the ups and downs, but overall the bumps of the economy and the stock market are dwarfed by long term, multi-decade growth trends. The same is true of the growth of total margin debt over time.

The graph below shows detrended margin debt over time -- relatively how much actual margin is above or below its historical growth pattern. The graph pattern is clear: in a boom the relative level of margin borrowing shoots up, perhaps 50% or more above the historic trend. Then the bubble pops and margin debt collapses even more quickly during any sort of market crash.  The dates of the margin spikes match the start of the most significant market disturbances over the past several decades.  The warning sign is clear -- when the relative level of margin debt shoots up to  roughly 50% above trend a market bubble is due to implode.

But what about now?  Margin debt has been growing in fits and starts since the catastrophic bottom of early 2009.  The rise doesn't resemble any sort of spike and is still well below its long term trend.   Rather than pointing to an imminent bear market, this chart of margin debt appears to indicate that the market is far from being in the middle of a speculative bubble. If history is to play out in a typical way, it may well be a few years before a speculative bubble shapes up.  If it does, the slow moving growth of margin debt should scream our a warning when it spikes up.

March, 2015 U.S. Stock Market Forecast

U.S. Market Forecast (Value Line Arithmetic Index):
Probable stock market gain 3/1/2015 to 9/1/2015: 3.5% (Avg. 6 mo. gain since 1984: 4.8%)
Probability of at least breaking even : 73%  (Average for all months since 1984: 73%

Coming off a strong 5% gain during February, the prospects for further stock market gains over the next half year are subdued: positive, but below average price gain of 3% to 4% and average probability  (73%) of at least breaking even. Looking at the progress graph below, the model would expect gains to continue for a few months followed by a bit of weakness during the summer months as is typically the case.

(Click on image to enlarge.)

The model has been anticipating the stock market pretty closely for the past year or so.  In the last completed 6 month period the model had predicted a gain of roughly approximately 6% and the actual gain turned out to be about 4%. Close enough.

The overall U.S. stock market situation has stayed roughly the same for a couple of years:

• U.S. stocks generally are somewhat over-priced.
• Historically low interest rates, however, prop up these high stock prices.
• Further real economic growth is necessary before stocks can rise much.
• Room for growth remains as the economy is still performing below its long term potential.
• Based on the amount of outstanding margin debt and continuing economic recovery a price bubble does not appear to exist.
• In the near term international economic disruptions do not seem likely to severely damage the U.S. economy. (e.g. Greek debt questions, low oil prices possibly unbalancing several countries)

Taking all of this into account, a major stock market decline does not appear to be likely for at least a year or so.