Two days before the US presidential election, the forecasts for all the major market indexes are dead flat for at least the next month. For the S&P500 I now have 2 independent 1 month models. One expects 0.1% rise and the other 0.5% rise in the next month. (i.e. diddly squat) . My forecasts still cannot read the newspaper, so they do not have any idea of any crazy stuff that may happen.

As in the last several months, the stock market is priced to perfection — many forms of valuation see the stock market as overpriced. My GDP-based trend line sees the S&P 500 as 12% over valued, and an equal-weighted version of the same stock prices sees the market as 7% overvalued.

This situation of walking a Wall of Worry is likely to persist as long as interest rates do not rise again, and as long as US federal deficit spending remains at the unsustainable level of 6.11% of GDP. If congressional fireworks over deficit reduction do not occur next spring, we will almost certainly be in the midst of a true pricing bubble. Be careful what you wish for.

November forecast will come in a couple of days. This is just words.

If Republican election fraud claims have any credibility, the national network of Democratic election fraud collaborators must be astounding! Think of it, a vast conspiracy of operatives working in thousands of local government electoral precincts, but leaving no trace of their efforts. No emails. No letters. No witnesses willing to squeal for big chunks of money. But, especially, no telltale statistical evidence. Damn these guys are smart!

For context. In World War II the Allies managed to repeatedly break the German Enigma coding system. It is a fascinating story that is well worth the read. Suddenly, the Allies were able to instantly read all critical war communications – orders, troop movements, distribution plans, everything! But, they realized that if they took advantage of all of their intelligence, the Germans would realize that their code system had been compromised and would quickly change code systems thereby eliminating the Allied edge. So, consciously the Allies kept Enigma intelligence (Ultra) in a crucial but limited manner.

German statisticians would only be able to prove that the Allies were smart, maybe even lucky, but the Allies success was not much more than could be statistically random. There would be no statistical proof that the Allies results had surged unexpectedly. Allied moves would not betray the fact the code had been broken. Thousands of Allied soldiers died because their groups were not given critical code data that the Allies had gleaned. But, that was the price the Allies were willing to pay to keep their secret of having broken the Enigma code.

Back to today. The US election system is operated by the states and US territories. Within the states there are fixed rules for voter registration and voting. Voter registration occurs through state agencies, but actual voting occurs through hundreds or thousands of local precincts. Voting lists are public as are data on who voted in which elections. The only thing that is secret is how each voter actually voted. In nearly all precincts the voting data goes back for decades.

With all of this public voting data – going down to the level of which particular voter voted in which elections along with their party affiliation – it becomes a Statistics 101 class effort to identify voting irregularities. There is a laundry list of things to check first: Who died? Who moved, and are they voting twice? But, overall, the gross voting numbers would indicate if the results in any of thousands of voting places was unusual. Audits like this are routine in all states after each election.

In the modern era with voting data being public it probably still would not be too difficult to twist the voting outcome a bit in any single precinct.

But, today it would be an incredible effort for a group to significantly shift just a single state-level election. It would take hundreds of people and control of highly secured voting machines, all working in total secrecy for years at a time. But, for a political party to run such an effort in at least all the swing states would be an absolutely breathtaking effort.

If they are doing it, DAMN THOSE GUYS ARE GOOD!

d

(This is a boring digression and does not include stock forecasts.)

Over the past 2 years my stock market forecasting broadened its base to include vastly more data from a much broader set of sources. But, I have never included data from any ratings by established equity analysts. Thinking that maybe this was a terrible oversight, I now have taken a look at the possibility of including analyst ratings in my forecasting methodology. And found little of use.

With the cooperation of a friendly data broker I downloaded 127,000 distinct ratings produced by 303 rating companies from 2012 to the present concerning the 540 large capitalization stocks I now monitor.

A first caution flag in the data was that 50 analyst firms ended up with no score in my tabulations. Not all analysts use the same terminology, so by ‘Buy’, for example, I include: Buy, Strong-Buy, Highly Recommend, Outperform, Overweight, and Conviction Buy. Same story with variations on ‘Sell’. I lumped together ratings as best I could, but clearly I missed some, or just got confused. Afterall, what does “Peer Perform” mean? Even better term: Mixed! Either these firms with no final score were using quite different terminology, or else they produced very few actual ratings. This only amounts to skipping over a few percent of the ratings, and I don’t really care.

Along a similar line, nearly half of the rating firms had produced less that 5 reports for any of the firms I care about. Generally, these are well known rating firms, so they must just be busy with other stocks. Some of these onsie-twosie ratings were spectacularly accurate and some ended up being incredibly bad. For my purposes they did not have enough of a track record for me to evaluate. I included them in the tabulation anyway, but there is not much of an impact.

A second and larger red flag in the ratings was that there were approximately 18 times as many ‘Buy’ recommendations versus ‘Sell’ recommendations. Nearly a third of all firms issued zero ‘Sell’ alerts. One firm racked up 206 ‘Buy’ recommendations and zero ‘Sell’ calls. Hmmmm…

Overall, I wanted to see if ‘Buy’ or ‘Sell’ recommendations actually translated into stock price gains or losses. Nope.

I looked at the ratings for the 540 stocks at one-week, one-month, and three month durations, with price performance measured from the day BEFORE the rating was published.

The average results show no correlation. Neither a Buy or Sell recommendation meant anything on average.

3-month performance 0.027 0 .030

I then plotted the 1-week, 1-month, and 3-month test results as shown below. The X-axis has a vertical line up for each stock. Up and down each vertical line are colored points. The Y height of a point reflects how much the stock moved up or down in the following week, month, quarter from when the rating was issued. The highest point would correspond to a gain of about 30%, while a low point would mean a price drop of about 30%. The color of the point indicates the nature of the rating: Green for Buy ratings and Red for Sell ratings. The other colors sprinkled in are for Hold or less common rating terms. The basic story is that green Buy ratings show little relationship to the resultant stock price rise or fall. The plots remind me of Christmas-time: lots of green combined with a random artistic sprinkling of red.

Several data vendors I had consulted acknowledged that a great bulk of analyst ratings were worthless, and for that reason they rate analysts and weight their recommendations in the process of developing ‘consensus’ ratings. So, I cut the data differently, scoring by rating firm rather than by stock. In the graph below, each vertical line corresponds to an individual rating firm. Some vertical lines for firms are nearly blank and some firms have hundreds of points. Green points again are Buy ratings and Red are Sell ratings. Height of each point again reflects how much that particular rated stock rose or fell. Just like the other graphs there is no obvious sign that some firms produce significantly more productive ratings than others. If you ever spot a large and reliable ratings firm, please send me a note!

OK, August turned out to be a bit more exciting than I had forecasted; the stock market flopped with a loud plop, down -7% at the start of the month. Stocks zoomed back up ,ending about 1% over where the month started.

Overall, as it has for months, the U.S. stock market continued to perform a bit better than my models have been expecting. And, that’s a good thing since the models are still mildly pessimistic. The basic economic situation is unchanged: the Federal Reserve is maintaining high interest rates with the goal of tamping down the economy. But, the U.S. Treasury is dumping new money into the economy through historically high deficit spending. Unemployment has crept up a bit. The housing sector has weakened a little. Corporate profits remain generally strong, and the probability of an actual recession stays fairly low. GDP is slightly above trend.

The Fed appears certain to change direction in September and to start lowering interest rates back down. The reality is that the Fed cannot cut rates much. The relentless Federal deficit will continue to push for inflation until at least next spring. Then, a new Congress and a new President will have no choice but to at least pretend to do something. I remain concerned for the stock market in late winter and early spring.

In the meantime the high flyers in the stock market have their backs against the “Wall of Worry”. New highs are occurring, and volatility will probably increase. The AI capital expenditure boom is real, and has further to run.

The S&P 500 is about 14% above its long-term trend line. That is a bit worrisome, and it could grow to become a bubble. The equal weighted Value Line Arithmetic Average is very near trend. Are we going to see something like the Dot Com Bubble as the next big market move? A populist President, a compliant Congress , and a castrated Federal Reserve could let it happen. That didn’t end well.

Emotionally, I keep wanting to issue a big controversial stock market forecast, but the numbers just won’t let me. The forecast for the next month is essentially flat, and the estimates in the months that follow are bland. There is no end of scary/exciting news in politics and we have seen distinctly higher volatility on Wall Street. My forecasts don’t care much. As far as they are concerned, the Immaculate Disinflation is still on-track. Higher interest rates are slowly damping down the economy, squeezing out inflation. Unemployment has inched up, but the current 4.1% unemployment rate is none-the-less historically quite good. Large cap stock profits are still fine overall. Financial liquidity (M2) is pretty stable. GDP remains a bit higher than the best long-term models expected. Main street is still pretending that workers are going to come back and fill the near-empty downtown office buildings. It is all like watching paint dry.

The markets are playing along with the snooze-worthy scenario. The S&P 500 remains 9% above my long-term trend line. (No big deal.) The equal-weight Value Line Arithmetic Index is now a glorious 2% above its long-term trend, much improved from being a few points below trend. Be still, my heart!

If World War III doesn’t kick off in the meantime, my personal bet is that we will witness stock market fireworks in the late winter or early spring when a new Congress and new U.S. President will have no choice but to pretend to deal with the exploding Federal Deficit. (Scary picture at the end of this post. Well, I find it scary at least. The deficit truly is falling off a dangerous cliff.) They will try heartily to do absolutely nothing, but eventually will have to enact a tweak or two. In the process, the stock market will envision huge “what-if” gyrations if my guess is right.

Since November, the stock market has been performing somewhat better than these models have been forecasting. So, I wouldn’t be surprised if that positive over-achievement continues for a few more months, leading to fairly mild market gains overall. But, even my pessimistic models do not foresee anything really bad happening. The bad news should happen in 2025.

As I have written for months, the overall economy is performing well — actually it is performing slightly too well and that is the problem. The Federal Reserve feels forced to fight inflation by intentionally holding back the economy via high interest rates.

Actual Gross Domestic Product is running a bit higher than the long-term Real Potential GDP model run by the Congressional Budget Office. (See chart.) That is my personal definition of the famous “Wall of Worry”. Right now it much easier for the economy to quickly get worse than for the economy to sharply get much better. Looking at the graph, for years the actual GDP may run near or even slightly ahead of the GDP model. But, actual GDP seldom spurts high above the model, and typically the Wall of Worry period ends in some level of collapse.

The economy remains spurred by high Federal deficit spending, and simultaneously constrained by high interest rates — pressing simultaneously on the gas pedal and the brake. This may suddenly change next spring, but it will not change in the next few months.

The split continues to increase between a small number of high flying AI and tech stocks like Nvidia, versus the broader market reflected by the equal-weighted Value Line Arithmetic Average. At the moment the S&P 500 is 10% above my trend line and the Value Line Average is 5% below trend. All my models expect more of the same to come.

These models still have not learned how to read the news, so they are blessedly blind to the political world. Typically in the past, major movements in spending or interest rates lead to major lasting stock market movements. Political news, however, tends to produce sudden and sharp temporary stock price moves. Let’s hope that remains the case. (But, that is ‘hope’ speaking, not statistical experience.)

In May the market indexes popped back up nicely — which my forecasts were not expecting. That’s why my musings are free. It is only sometimes that they are right.

The model forecasts for June are flat to down a point or two. For the next 6 months the forecasts are mildly positive the the NASDAQ Composite and NASDAQ 100, essentially flat for the S&P 500 and down a few points for the broader market averages.

The primary reason these statistical models for the past half year have been pessimistic stems from the Federal Reserve’s interest rate increases that started just about two years ago. At no point in the past several decades has the Fed increased rates as much or as quickly as this round. Short-term interest rates are now higher than long-term rates, a so-called “rate inversion”; and there never has been a rate inversion as deep or as long-lasting as the present one.

In every other instance of a rate inversion there has been a major stock market decline. Typically, the stock market decline happens fairly soon after the Fed starts to reduce rates again, usually in response to negative economic data.

This time may well be different and maybe that explains why the models have been overly pessimistic. Even while raising interest rates, the Federal Reserve sent trillions of dollars to banks to temporarily prop up their reserves (“reverse repos”). A major bank crisis was largely averted. The Fed also has slowed the rate at which they are reducing their bond portfolio, another positive. And, perhaps most importantly, Federal deficit spending remains incredibly high, effectively providing a major economic stimulus.

Before the U.S. elections any significant Federal Reserve actions or Federal Government spending changes seem highly unlikely. Come the New Year, the picture will be entirely different as the Trump era income tax cuts are due to expire. At the very least, investor fears will skyrocket. But, that’s not now. For now the relevant economic news is not too bad.

Looking at the long-term trend lines, the S&P 500 is about 8% above the long term trend and the Value Line Arithmetic Average is 4% below trend.