San Juan Mountains

San Juan Mountains
San Juan Mountains: Grenadier Range

Tuesday, May 3, 2016

The Predictive Value of a Flat Stock Market

Apparently most everyone now believes that the current bull market in stocks is running out of steam and is doomed to fall into a prolonged bear market at any moment.   What is the reasoning behind such a pessimistic position?   One of the primary arguments used in support of this prediction for the future is the fact that the stock market, as measured by the S & P 500, has been basically flat for over a year.  The stock market closed at 2081 yesterday, the same place it closed on December 24, 2014 or almost 500 days ago.  Investment gurus who stupidly believe they have the ability to predict the future are making dire pronouncements about how this flat market is a harbinger of bad things to come.  Let's consider that for a moment today.
Go here, here and here for articles advancing this ridiculous prediction.  The first article pronounces the coming of a bear market because "with US growth slowing, central banks running out of ammunition, and a tumultuous presidential campaign likely, the signs aren't good for stocks."  The article then goes on to show that the stock market has not grown in over a year.  How the central bank managed to fire bullets into the economy, whatever that means, is not explained.  Perhaps, if the Fed is out of bullets, it could purchase some tanks and use them to jump start the economy?  Why central bank military activity would be a positive for the stock market is also not explained.  Of course I jest but we must acknowledge, if we are to have any economic integrity whatsoever, that the Federal Reserve never does anything good for the economy or the stock market.  If it has "run out of bullets" that must quite necessarily be a good thing. 
The second article declared that, "Lance Roberts, portfolio manager at STA Wealth, sees a lot of warning signs for the market, including high valuations, falling earnings and weak economic background, but contends that his technical analysis points to short-term bullishness.  'We have to respect the fact that the markets are breaking out to new highs, but this does not mean we should not pay attention to all the various risks out there,' Roberts said. 'Thinner volumes, tepid advances are historically associated with peaks. Thinner volumes do not mean people are not participating, indeed they are already fully allocated, there is just no new money coming in,' Roberts noted."  The current bull market, which began in March of 2009, has tripled the value of stocks and most of those gains have been realized during periods of thin trading volumes.  Furthermore, P/E ratios are non-predictive.  The current forward P/E on the S & P 500 is a little bit under 17.  The P/E ratio of the S & P 500 was 46 on 1-1-02 and the market continued to rise for the next eight years. The bull market can easily continue with a P/E ratio of 17.
The third article provided three technical indicators allegedly proving the stock market is running out of steam and soon to fall.  Technical indicators always fascinate me.  They are utterly meaningless but thousands of people spend thousands of hours pouring over them in the hope that they will find something magical which will allow them to predict the future.  Shall we all confess to a universal human weakness?  None of us is able to predict the future.  Nobody.  Never.  The ability to predict the future requires omniscience, a characteristic attributed only to the God of the Bible and the career politicians and bureaucrats of the Socialist Democracy of Amerika who rule over us. 
There is something unnerving about a stock market that hovers in the same range for a long period of time.  Investors begin to get a bit twitchy when stocks trade in a narrow range for over a year.  There is something about human nature that would rather have the stock market go either up or down than simply stay flat for a year.  Indeed, a long term flat market seems to work on the psyche of many investors, convincing them that the next move must be down.  If the market has been flat for so long, they reason to themselves, then there must be no reason for it to continue to go up and the next move must be bearish.  Acting on their bearish feelings they sell their stocks and then have the most unpleasant experience of being on the sidelines as the stock market starts another move upward.  It never occurs to them that the exact same reasoning could be applied to a bull market.  Since the market has not gone down for so long the next move must be up.  But that sort of reasoning never takes place in the minds of stock market investors because investors feel stock market loses far more powerfully then they feel the gains.  When a market is flat it must be a sign of some sort of coming weakness.
Fortunately I came across a chart, found here, that actually records the historical facts about prolonged flat stock markets.  I have copied that chart and present it here:

Note that the average rate of total return in stocks for the one year period immediately following all 9 flat stock markets since 1933 is 24%.  A year and a half after an average of a year and a half of no stock market movement sees stocks up an average of 32%.  Two years after the last 9 flat stock markets, defined as a period where the market was stagnant for at least 300 days, we find that the stock market was up an average of 39%.  Only one two year period saw stocks down after a flat market and that was in 1935.  No one year period saw stocks with negative returns after a prolonged period of no returns.  So much for the popular wisdom.  Once again the greatest enemy of stock investors is their own inability to control their emotions and the way their emotions color their expectations for the future.  Don't let that happen to you.

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