Thursday, August 8, 2013

Stock Market Analysis - The Bearish Case

As seen in the following charts, it would seem that I can predict the inflation adjusted S&P 500 index reasonably accurately if you tell me current nonfarm payrolls, weekly initial claims, and real disposable personal income. Yep, that's it. You don't even have to mention treasury yields. If you are curious, my model is fully described within the charts below. Enjoy!

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Well, would you look at that. Let's make a scatter chart.

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How's that for exciting? I'd say it is far better to invest near the lower left corner than the upper right corner, but perhaps that's just me. As seen in the chart, we're very close to where we were at the height of the stock market bubble (July 2007) just before the Great Recession. That's very exciting, but only in a gallows humor sort of way perhaps.

As if that chart isn't bad enough, I'm not done yet. There are three things that make up my model. Let's look at each one individually to see how we're doing. We'll do nonfarm payrolls first. I haven't updated the chart lately, but I'm sure it is close enough to get the idea.

April 6, 2013
40.9 Million Missing Jobs (Musical Tribute)

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Ouch. That trend failed in an epic way and there's just no getting back to it. It's not even remotely possible. Sorry. My model suggests that the lack of historic nonfarm payroll growth going forward will put a serious damper on long-term stock market performance going forward. Big shocker.

Let's look at the inverse of initial claims. That's part of my formula too. The more initial claims go down, the higher the stock market will go. Everyone knows it. This is hardly rocket science.

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Ouch. I can't speak for you, but that most certainly does not inspire confidence in me. We're near the very top of a declining trend channel. I'd even go so far as to call it cyclical growth within a secular bear market. I'd definitely err on the side of caution here.

Let's look at real disposable personal income, or more importantly its growth. That's the last piece of the puzzle. It is seemingly our only hope at this point, at least over the long-term. Since it is a noisy series and all we really care about is the long-term, let's look at the semiannual data (averaged) to smooth it out.

Click to enlarge.

Ouch. Now that's just painful. Guess what? Although I locked in long-term rates on TIPS and I-Bonds whenever I could, ZIRP is not actually enhancing my real disposable personal income. Further, if it isn't enhancing my income then think what it is doing to those who did not lock in rates (as they were repeatedly told not to do!). Once again, big shocker.

So let's summarize. My model says that the stock market should be high. The components of my model are mostly aligned in what looks to be a brand new era of prosperity. Unfortunately, my model also says that these components are only temporarily aligned more than likely. It's just an illusion of prosperity.

Welcome to my permabear world. The stock market may go higher from here, but I have absolutely no desire to put my nest egg anywhere near it. None. Nada. ZIRP.

This is not investment advice.

Source Data:
St. Louis Fed: Custom Chart
St. Louis Fed: Initial Claims Inverse
St. Louis Fed: Real Disposable Personal Income Growth


Stagflationary Mark said...

There's nothing that proves my model is correct. Correlation does not prove causation. It's just a theory.

That said, I think I've picked three different components that would seem to be fairly important for determining the desirability of investing in the stock market.

I thought this model up in one evening. I have no supercomputer.

Those who think they can go head to head trading against the investment banks of the world and actually win more than they lose are certifiably insane in my opinion.

I guarantee that "they" put more time into their models than I just did. And as an added bonus, their models work real time.

I would also add that very few can win a race to the "sell" button when competing against a supercomputer.

At some point there are going to be plenty of itchy trigger fingers hovered there though, especially if/when the music begins to stop again.

Just opinions!

Mr Slippery said...

Nice model. Lots to think about here. On the model itself, we've got NFP (a delta) / claims (a delta) X disposable income. There is no doubt that NFP moves stocks more than anything except Fed rumors. Disposable income (plus new credit) translates into corporate profits. The model seems close enough without adding in new credit. Does disposable income include transfer payments?

I think we can explain rising payrolls and shrinking income by the fact that most new jobs since 2008 have been part time jobs. Obamacare creates a strong incentive for hiring part time workers less than 30 hours/week.

ZIRP is creating extra disposable income for me (lower mortgage), but you have to have interest rate sensitive debt to benefit from it. Of course, I'd rather have no debt and not benefit from it. Most of that extra income goes into destroying the debt, so it doesn't help corporate profits in my case.

You update this once a quarter or something and see how it performs.

Troy said...

full-time jobs / population age 20-54

'Noninstitutional' excludes prison & military inmates I believe.

So 5 years into the recovery we're back to the worst of the dot com recession.

Our only hope is the boomers retiring and leaving their jobs to Gen Y.

If that doesn't happen, man.

Stagflationary Mark said...

Mr Slippery,

Does disposable income include transfer payments?

Yes, here's an interesting chart to show the effect.

ZIRP is creating extra disposable income for me (lower mortgage), but you have to have interest rate sensitive debt to benefit from it.

It is generating extra discretionary income for you since an expense has fallen, but it has not given you more disposable income (disposable income is just income after taxes).

Perhaps in general, that extra discretionary income you are getting is being completely offset by the extra expenses all of us have thanks to higher gasoline prices. Just a thought.

The model seems close enough without adding in new credit.

I believe it is probably in there, subtly tucked away inside the three components I used in the model. Similarly, oil didn't seem to matter much either, but its effects are probably in there too.

Extra credit and cheap oil temporarily led plentiful high paying jobs (especially in the tech and housing industries). Perhaps my model is capturing that to some degree.

Most of that extra income goes into destroying the debt, so it doesn't help corporate profits in my case.

Yeah. Similarly, ZIRP has given me fairly hefty paper gains on my TIPS holdings. Some would argue that I'm "wealthier" now but it is just not true.

I'm holding the bonds to maturity. I'm not earning any more interest than I was before ZIRP, and when my bonds mature I will have to reinvest at lower rates. ZIRP has not improved my personal financial situation at all, even with those paper gains. It's definitely made me poorer over the long-term and I doubt very much I'm alone.

It's all just one big frickin' illusion. ;)

Stagflationary Mark said...


Our only hope is the boomers retiring and leaving their jobs to Gen Y.

If that doesn't happen, man.

As the economy continues to stagnate over the long-term, thoughts of reentering the workforce appear in my head. Since I'm still burned out to some degree, I'd want a job that doesn't require me to take my work home with me and that doesn't require massive overtime.

You know, the kind of job that a younger worker in college might have. Stocking shelves at a grocery store? Working in a fast food restaurant?

I shouldn't need to do it, but there are other people who will. Picture my early retiree counterpart who did not invest in gold and silver from 2004 to 2006 and who also believed that all he had to do was sit in short-term fixed income until the economy returned interest rates to normal. If that had been me, I'd be looking for work right now. No doubt about it.

Sitting in cash for nearly 5 years of ZIRP would certainly be mighty discouraging to me about my long-term financial health. Glad I didn't go there!

Stagflationary Mark said...


That's not to say I don't keep a cash reserve for short-term living expenses of course. I do. It's earning a whopping 0.75%.

Tasukete! Tomaranai! ;)