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Duelling Market Forecast Models at Trader’s Narrative

Duelling Market Forecast Models

Over the weekend, Mark Hulbert mentioned a market model that paints a gloomy forecast for the market. Although the exact formula isn’t disclosed, the variables are simple: the dividend yield, the rate on 90-day T-bills and the median of projections of Value Line, for how much the 1,700 stocks they monitor will appreciate over the next three to five years.

skinnypiggySmall.pngCurrently, the formula “projects that the total return of the Standard & Poor’s 500-stock index over the next six quarters will be one percentage point below that of riskless 90-day Treasury bills. Because those bills, at current rates, are to produce a 7.5 percent return over the next six quarters, that would mean a total S&P 500 return of around 6.5 percent — equal to about 4 percent, annualized.”

This is interesting as commentary but it isn’t really actionable - especially since the model missed the rise and fall of the bubble years. Throughout the 1990’s it projected a similarly poor performance for the market. And towards the end of 2000 it gave two thumbs up:

There were no headlines last week announcing it, so most stock-market bulls are unaware of the good news. But a market timing model with a good long-term record has flashed the all-clear signal to re-enter the market.

The model is based on a statistic reported each week in the Value Line Investment Survey. It is the median projection from Value Line’s analysts of how much the 1,700 stocks they monitor will appreciate over the next three to five years. After being cautious about the stock market for some time, the model based on this statistic is now forecasting healthy gains.

Source: NYT article (Nov 5, 2000)
(Use BugMeNot to access article)

So if you followed this model, not only would it keep you out of the whole run up, but it would have you enter long just as the vicious meltdown was starting. Ouch!

Personally, I prefer Bogle’s model for predicting the next decade’s market return. It has about an 80% correlation to the actual and in contrast to Reichenstein & Rich, Bogle’s formula is actually disclosed:

Take the initial dividend yield (S&P 500) at the beginning of the projected decade

+ (add it to)

The average annual earnings growth for the past 30 years (S&P 500)


… then calculate the rate of return (either positive or negative) that would be needed to occur - over the next 10 years - to get us to the 30 year average P/E ratio at the end of that decade.

Then add this number to the subtotal above. Ta-da!

For the decade spanning 1997 to 2006 Bogle’s formula gave a forecast average return of +4.6% a year for the S&P 500. I have no idea what the numbers are right now but if someone is willing to crunch them, I would be more than happy to put them up.

In any case, it is important to remember that all such formulas are very broad brush strokes. The job of the nimble and astute trader is to find opportunities to make money in any market.

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