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.

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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.

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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.

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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%.

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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).

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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.

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Stock Market Forecast: July through December,2017: Slightly above average

The forecasting models continue to predict a typical weak/flat stock market during the summer months followed by a good upturn in the fall.  The one month forecast is for a gain of just 0.1% for July and nearly a 6% gain following through the end of December.  The model gives the probability of at least breaking even over the period as slightly over 90% -- decidedly better than average.

The stock market started off this year strong -- much better than my models had predicted. More recently the actual and predicted market performance have been close.  The typical causes of a stock market crash seem to be taking the summer off.  Be grateful for small favors.

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Stock Market Forecast June through November, 2017: Looking Better

My 4 semi-independent six month stock market forecasting models are in general agreement.   The one-month forecast is for a negligible gain of just 0.1%.  Once the weather starts cooling, the outlook improves. The composite prediction is a gain of roughly 6% from June, 2017 through November, 2017.  That is better than the average gain of 4.8%.

The likelihood of at least breaking even over the next six months is around 90%.  Historically, stocks break even or rise about 70% of the time over all 6 month stretches since 1984.

My models still do not know how to read newspapers so they can't account for any of the political foibles are are now playing out in Washington. Wish I was so lucky.

Have a nice summer.  It doesn't look like anything really bad is on the horizon.

Stock Market Forecast May through October, 2017

The current six month stock market forecast for May through October, 2017 is nearly flat  -- a sub-normal 1% gain over the coming half-year, and no gains during May.  The likelihood of the market at least breaking even over the next half year is 0.71, slightly less than average. Meh.

According to MarketWatch.com the Dow Jones Industrial Average has had record gains (14%) from the election through President Trump's first 100 days in office -- best returns for the start of a president's first term since WWII.  My prediction models didn't see that coming.

The models anticipated flat market performance for most of the past half-year.  So, either my models were just plain wrong, or more probably the stock market was propelled not by economic data, but by hope of wonderous Trump-promised gains in corporate profits.  The 'Trump Bump, however, may have stalled -- for the past two months the market has been flat.  I would not be surprised if the stock market stumbles if the hopes of huge profit gains vanish as Trump's version of tax reform flounders in Congress.  Either way, the basic economic data does not presage a huge market move up or down.

Stock Market Forecast April through September, 2017: Start to worry

My U.S. stock market forecasting models expect a flat or weak stock market for the coming month and the next six months -- not too surprising as the second half of the year tends to be weaker than the first half.  For April, the model expects a minuscule gain of 0.2%.  The next 6 months are projected to yield a loss of 1%.  The models are just a rough estimate of future results, so the current forecast is an expectation of little market change.

Forecasts from all of my semi-autonomous models have been declining for  several months.  If that continues, my forecasts and the market will get even weaker over the summer.  (Read below chart.)

The next graph shows, beginning in 2007, the actual 6 month return of the market (black) along with the projected return rates forecast by my models.  (I use the Value Line Arithmetic Average as my market index.) The red line is the composite projected by combining the forecasts of several of my models.  For the past several months the composite forecast and all the semi-independent forecasts have trended down.So far, there is no reason for alarm.

Stock Market Forecast March through August, 2017: Weaker

The six month stock market forecasts from my models range from a possible gain of 6% to a loss of -2%. The composite prediction is for a loss of roughly -1% with a probability of at least breaking even of 0.70, which is slightly below average.  Generally, the models do not see a basis for the sharp stock market gains since the election. The forecast for just March, however, is positive.

About the chart:  Each data point was an actual U.S. stock market forecast made in real time starting in 2007.  Red points were predictions that the market will fall -5% or more over the six months following the forecast.  Green points were positive or neutral market expectations for the coming six months.

Stock Market Forecast February through July, 2017 -About Average

Through July, 2017 my forecasting models are expecting the U.S. stock market to rise about 6% to 8% . That is better than average.  The models see the probability of the market at least breaking even as somewhere between 66% and 85% -- roughly about average.

Besides my tested original model,  monthly market forecasts going forward will be derived from several additional, largely independent, econometric models. All of the models stem from business/economic fundamentals rather than Technical Analysis or other forms of trend projection.

What is interesting is that a new model largely based on corporate profits and a different model based mainly on various interest rates  'tell' basically the same story over several decades.  My hope is that with this broader base of economic variables, the net effect will be that the outputs will be less susceptible to bits of data that are unusual, and probably misleading, outliers.

As always, don't bet the farm on these models.  They now have a significant experience base, but reality will often be different from expectations.

For example - my models have no direct knowledge of the administration of Donald Trump.

On a personal side, I don't see that ending well.

There is far more downside potential than upside potential in the market at present. The Market Fair Value chart at morningstar.com reports that the market is currently estimated as 3% overvalued.  Go to the 'Max' time period view.  The market seldom rises much above the 3% value without a significant correction fairly soon thereafter.

Evaluating a Decade of Results from My Stock Market Forecasting Model

Each month since 2007 I have posted the 6-month predictions for the U.S. stock market generated by my econometric forecasting model. That amounts to 116 monthly forecasts that I can now evaluate. How well did my model perform?

There are several ways to judge performance. Cumulative return on investment, however, ends up being the best measure of success or failure. Based on cumulative returns, following my models would have produced about three times the return of a Buy-and-Hold strategy.

Not that Buy-and-Hold is a bad idea. If you followed a Buy-and-Hold strategy from 2007 through July, 2016, simply holding an S&P 500 index fund, your holdings would have grown 51% plus dividends. Pretty good for a portfolio set on autopilot.  Especially considering that shortly after the test period started the stock market crashed horribly and took years to fully recover. You still would have come out OK.

Acting upon the 6-month forecasts from my model would have been somewhat better than just following a Buy-and-Hold strategy. (i.e. Buy when the six-month forecast was positive and sell when the 6 month forecast turned negative.)  But, while the 6-month forecasts were surprisingly accurate, they really didn't say much about what the market was likely to do in the month immediately following a forecast.   In the end, they didn't do very well at picking the best buy and sell points. For example, my model was generating fantastically positive  6-month performance forecasts while the stock market was still crashing down in 2008-2009.  The market did, indeed, climb over the following 6 months, very nearly as expected. But, in the meantime the stock market was still falling like a rock. Buying when the 6-month forecasts first turn positive or first turn down ends up not being such a good idea.

 A while ago I learned that I could apply different weights to several of my 6-month forecasts from previous months to give a better decision on buy and sell points.

An investment in the SP 500 index that followed the forecasts generated by the weighted predictions from my model would have largely missed the market crash of 2007-2009 and would have gained 169% -- over three times the return from a Buy-and-Hold strategy.

An important caveat is on order.  The calculation above does not consider dividends. Dividends would have been somewhat less for the trading strategy since the strategy would have taken you out of the market for over a year.  Also, the net gain would be significantly less for the trading approach for stocks held in a taxable brokerage account due to taxes levied on profits from sales of stocks.

That said, being able to dodge a major market crash can significantly beat a Buy-and-Hold strategy -- especially in a tax-favored account such as an IRA. It looks like my forecasting model is doing what it is supposed to do.

The Next Market Crash Will Look Like...

If my stock market prediction models do their jobs they should start screaming loud warnings several months or even a year ahead of any major stock market crash -- or at least warn of those crashes that have an economic basis. (The models inherently will miss any market crash that comes from a sudden geopolitical shock.)

We are in a bull market that has been charging along since early 2009. Most traditional stock valuation metrics say prices are already pretty high.  So, sooner or later, rightly or wrongly, my models are going to start shouting out danger. It might not happen for years. It could happen later this year.  But, at some point the models will be waving big red flags.

So, what evidence can you look at to judge if the dire warnings coming from the models should be listened to?  What is the moment before the crash going to look like?  The answer is glaringly simple.

Just before the next stock market crash my forecasts should appear to be totally wrong, even crazy.

Most market busts come as the sudden collapse of an optimistic market boom. If there isn't a lot of hot air in stock prices, there isn't much much of a bubble that can suddenly deflate.  The next market crash is most likely to hit when optimism and 'animal spirits' run high.

At MarketWatch.com this week Jeff Reeves came out with a New Year's  "9 reasons the stock market is optimistic about 2017".    In a nutshell, the article points to strong numbers and high confidence for investors, consumers, manufacturing, home building and small business. For most people and the economy as a whole, times are actually pretty good.  When the market bust finally comes, there should be plenty more optimistic articles appearing and the majority of investors will be really proud of how well their investments have performed.

That's when you need to worry. By the time the next market crash hits, peoples' optimism will probably have become euphoria. People will be hating the Federal Reserve for having raised interest rates by about 3 percentage points from today's level. The economy will seem unbeatable.  And my models' forecasts should seem to be totally wrong.  If they don't seem crazy, then my forecasts are probably not right.

Happy New Year.

Stock Market Forecast January 2017 through June 2017: Negative

Over the second half of 2016 my stock market forecasting models had expected the U.S. stock market to go nowhere.  Instead, the market staged a strong 11% increase.  I was pretty far off base. (Sam E. -- You won this round!)

What's going to happen now?  My models still see disappointment coming -- roughly a 5% market decline over the first half of 2017.

The econometric models don't know anything about what the Trump administration will try to do for the U.S. economy, or what Congress will actually vote for.   All the models say is that compared to the last three decades of market behavior, stock prices are pretty high.  Some unrealistic economic hopes are likely to evaporate.

For the first half of 2017 the market is not expected to make a huge move either up or down. Calling any major market move is all that my models are actually trying to accomplish.  Precise prediction is beyond the forecasting models' scope. So, on that score my models do not see things aligned to force prices into a huge and lasting move either up or down.  If, however, the market does shoot up or crash down over the next few months, the models will expect the market to retrace its steps.

If long term economic factors exert their normal force on stock prices, most probably U.S. stocks will be about 5 percent lower come summer.  The probability of breaking even is only about 40% -- much lower than the long term record of the market at least breaking even 73% of the time.

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