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.

(Click on image to enlarge.)