(I will be on vacation for a couple of weeks, so I am posting this stock market forecast early. New data in the next few days might nudge the model’s  6 month stock market forecast a bit, but probably not by much.)

According to the econometric model I developed, the U.S. stock market from this April through September should perform a little worse than average. The model forecasts the market nervously ending up right where it is. Intuitively that seems reasonable for what is statistically the worst part of the year. The chance of the stock market at least breaking even is roughly 50% — distinctly worse that the normal 73% prospect of surviving intact.

For months and months, the good news for the stock market has been that the economy remains in tough straits, still needing a level of stimulus from the Federal Reserve that was unheard of before The Great Recession.  It got named The Great Recession for good reasons. As long as the economy is in tough shape it has room for improvement which is good for stock prices. Don’t fight the Fed!

The bad news for stock market gains is that the economy and the stock market have improved tremendously from the depths of March 2009 — so there is much less room for improvement than has been the case for the past several years. The net result is that the model expects the stock market to mark time or stall for a while.

Probable market gain from 4/1/2014 to 10/1/2014:    0%  (Average since 1984: 4.8%)
Probability of at least breaking even :    46% to 57%  ( Average since 1984: 73%).

This blog is about testing the econometric model in real time and in plain sight. So, how is the model faring? The forecast from October, 2013, the most recent 6 month period, was for a six month stock market gain of 11% which was almost exactly what occurred. (Measured using the Value Line Arithmetic Index as the standard.).  Sometimes the model just gets lucky. :o) For all forecast results since 2007 look at the graph below.

Recent articles such as this one or this one make the case that the level of  stock market margin debt today is at a dangerously high level. (Data on New York Stock Exchange Margin Debt is available with a two month delay here. )

The articles focus on a chart of NYSE Margin Debt like the one shown below.  The sharp peaks on the graph correspond to the Dot-Com crash of 2000 and the financial panic market collapse that got underway in 2007.  The graph gives the impression that the current spiking of margin debt must be pointing to another market crash coming sometime soon.  Or does it? Maybe the graph isn’t showing the real story.

(Click on image to enlarge)

Margin debt, like the stock market, has a long term trend of growing several percent year after year. Because of this fairly steady growth rate you can get a more helpful view by changing the vertical axis to a logarithmic scale, making the same data look somewhat less scary.

(Click on image to enlarge)

Look at a longer time period (since 1980) and add in a trend approximation line and an entirely different picture emerges — current margin debt is not outrageously high. It may even be a bit lower than the historical trend.

(Click on image to enlarge.)

Even this graph may be making margin debt levels appear more worrisome than they are. In 1987 at the time of the crash margin debt was 68% greater than the historical trend.  In June of 2000 margin reached 130% above trend! And in 2007 margin debt was 67% above trend.  Today, in sharp contrast, margin debt is about 3% BELOW trend.

There are countless things about investing that might be worth fretting. But, today’s level of margin debt doesn’t deserve to be very high on the list of worries. In a couple of years margin debt levels may be worth your attention.

U.S. Stocks stumbled in January, but came roaring back in February. I had forecast a strong 6 month gain of 8% last September, but the market more than doubled on my expectations with a 17% burst!  As far as my models are concerned I’ll still call that a win — the forecast was for the market to go up nicely and it did. The models are not expected to be accurate. The goal here is just to usually anticipate the market’s general direction.

The model’s forecasts from 3/1/2014 to 9/1/2014  are weak and falling.  The market, of course, will do what it wants.  But, factors that historically have affected the market are weak. Not bad, just anemic.

 Probable market gain from 3/1/2014 to 9/1/2014:    0%  (Average since 1984: 4.8%)
                    Probability of at least breaking even :  58%  ( Average since 1984: 73%).

Want to know if the U.S. stock market is too high or too low? Here is a free chart you can follow.

With more than a decade of published track record, the Market Valuation Graph at Morningstar.com gives Morningstar’s current calculations of  net present value of the stock market — what their analysts calculate the market is worth today based of expected dividends and growth over the next several years.

Here is the link.  I prefer using the “max” time period setting.
http://www.morningstar.com/market-valuation/market-fair-value-graph.aspx

There are probably worse investment strategies than to respond every couple of years to extremes in the net present value calculations that Morningstar compiles and presents here for a vast universe of stocks and then averages together.  Put another way, be careful if you think the stock market is valued far away from the Morningstar estimates — their track record has been amazingly good.

The strategy to using this measure is simple: 

Buy more stocks when Morningstar calculates that the market in undervalued by, say, 10% or more.
Sell some stocks when Morningstar views the market as overvalued by, say, 8% or more.

Then be patient.  It is difficult or impossible to predict exactly when the market will turn course, but this graph shows that year-to-year pricing of the stock market tends to revert toward the neutral “fair market value”.

The U.S. stock market forecasts coming out of my models for the coming 6 months are very weak — definitely worse than average.  Through January the stock market stumbled much like the model had forecasted.  If the market and the economy behave in a  fairly typical fashion, my forecasts over the next couple of months will continue to slide, and the market may well do worse than my models predict.  Sorry about that.

Probable Market Gain:                 1% to 2%         (Average since 1984 4.9%)
Probability of Breaking Even:    57% to 60%       (Average since 1984 73%)

My stock market price performance models forecast a weak first half of 2014 for the U.S. stock market (Value Line Arithmetic Index as proxy for the broad stock market):

Probable Market Gain:                 2% to 3%         (Average since 1984 4.9%)
Probability of Breaking Even:    60% to 65%       (Average since 1984 73%)

(Click on graph to enlarge)

The U.S. stock market partied hearty during the second half of 2013, and it may be time for sobering up.  My models had made a strong positive forecast back in July for an 8% gain through the end of 2013 — but the market rose a joyous 17%!  Many of the fears holding back the market simply evaporated:

Congress approved a budget and appears likely to avoid a debt default crisis.
The Federal Reserve ‘promised’ a very slow tapering of financial stimulus.
The economy continued to gradually improve.

Sadly, the stock market can’t keep growing at a 38% annual rate forever, or at least that is what my econometric models say. The stock market, of course, will do whatever it will, and the rush of the Bulls could keep running for months.  I have a gut feeling that the party will stop pretty soon, quite possibly in bone-chilling January or dreary February. I have a hunch that I wasn’t the only nervous investor who resisted selling in December in order to avoid paying 2013 income taxes on my 2013 gains.

Here is the short-term market indicator that I plan to watch: a plot at StockCharts.com of the relative performance of the S&P 500 versus a long-term bond fund:

http://stockcharts.com/h-sc/ui?s=IVV:IEF&p=W&b=5&g=0&id=p13375668178

When stocks start performing worse than bonds your worries are being confirmed.

Google includes an email subscription feature for this blogosphere, so this is a test…

(Click on the graph to enlarge.)

Starting in January 2014, I’ll post an updated performance forecast each month for the U.S. stock market that applies to the coming 6 months.  This is a big change for me — up to now I have posted just in October and May.  Hopefully, the shift to monthly forecast updates will give a better sense of where my forecasting models expect the stock market to go.

I will continue to base my forecasts on the Value Line Arithmetic Index  which tracks the approximately 1,700 stocks that the Value Line Investment Survey follows and weights each stock equally.  Because of the equal weighting, the Arithmetic Index has somewhat less variation than capitalization-weighted indexes like the Standard & Poor’s 500 or price-weighted averages like the Dow Jones Industrial Average.  Generally, the other market indexes move much like the Value Line Arithmetic Index, so the forecast given here should apply generally to most other market indexes as well.

The graph above is a sample of how the blog will appear going forward.  The December forecast is for an increase of  about 6% by the end of May, 2014.  Since the market has performed better than forecast for the past few months, a small and temporary pull-back in the next few months looks likely.

Please email me any thoughts or questions you may have.

Probability of at least breaking even: 73%
Probability of an 8%+ dip along the way: 9%.

1: Economic performance remains below potential – that leaves room for improvement – but, less room than before.
2: Leading economic indicators are slowly rising – but, they are wobbly, conflicted, and near-flat.
3: Recession probabilities remain low because the Federal Reserve continues to hold down interest rates – but, worry grows about what will happen when the current “extraordinary measures” of the Fed are scaled back or stopped.

 All that really matters, though, is that the models get the main story right:

Really big move up: not so likely now
Really big fall: very unlikely without a Black Swan
Bumpy normal with a positive tilt: my best guess

Probable market gain:  12%                 11%
Prob. of gaining:          83%                  ü
8%+ midcourse dip:     50%                  Hit  -5%

I ran my stock market forecasting models updated for the end of May.  Despite the strong performance of the U.S. market this month, the new forecast is even rosier than the numbers as of the end of April.

Probability of at least breaking even: 83%
Probability of an 8% dip along the way: 50%.

Statistically the stock market tends to be weak over the second half of the year, but my models say that probably will not be true this year. Why?

Here is a PDF of my full market report at scribd.com
http://www.scribd.com/doc/145298705/TomT-Stock-Market-Model-2013-05-31