The “T” in Model “T” stands for transportation. The premise of the model is that certain factors in the freight transportation industry are leading indicators for the general economy and cycles in the S & P 500 index. In short, the model is designed to predict directional changes in the S & P 500 index months in advance.
The theory behind the model is that the freight transportation industry is a microcosm of the general economy, but it experiences the directional changes before other industries. Freight transportation is impacted by the movement of raw materials into production and the movement of finished goods out. It is impacted by imports since the goods must be redistributed from the ports. Manufactured export goods actually produce more freight since the finished goods need to be moved to a port. Services have minimal impact on the model.
The relationship between the transportation sector and the stock market is a very old concept. Charles Dow actually developed his Transportation Index 12 years before starting the Dow Jones Industrial Index. The classic “Dow Theory” is based on the Transportation Index confirming changes in the Industrial Index. So the Model “T” is a new extension of this old theory.
I first started to develop the theory behind the model at the beginning of this decade. I had discussed the theory several times with my boss at the time who was a very active stock trader. I remember going into his office in early 2001 and laying out the case that if the theory was correct, then we should sell all our stocks immediately. After the discussion, we both decided it made sense, but neither of us was willing to risk missing out on more profits if the market continued to go up and neither of us sold our stocks. Only four weeks after this discussion, the market started its deep descent.
Sometime after that I discovered another industry person had come up with a similar theory. After several discussions, I was able to identify the key transportation inputs and developed a predictive model, the Model “T”.
So Does It Work?
Unlike 2001 when I didn’t move my money, this time I did. I moved much of my money out of stocks in April of 2007. This turned out to be a bit premature, but still a very good move. I moved the rest of my money out of stocks in October 2007, two weeks after peak. The Model “T” is not this precise, it just happened that way. Both times I sold my stocks, my friends, co-workers and financial advisors thought I was crazy. And in the words of Billy Joel, “You may be right, I may be crazy” http://www.youtube.com/watch?v=hxNOCl7S7lU, but all of them lost big money after the market tanked.
The Model predicted in February 2008 that the S & P would hit 1000 (did it in October 2008). It predicted in October 2008 that the index would hit 850 (there in January 2009) and in November 2008 predicted 750 (February 2009). In 2008, I started sharing the Model’s predictions with a few financial people who follow the transportation industry. Of course they also thought I was crazy (cue Billy Joel again) but my phone started ringing in March (when the S&P dipped under 700 and the Model was at 680) with questions about whether the market had hit bottom.
When recalculated in March however, the Model indicated that the S & P 500 index would bottom out around 560. Surprisingly at the time, this gave the Model more credibility with some of my financial professional friends. You see, several very sophisticated models, developed by well respected PhDs, were also showing an S&P bottom between 500 and 600. I theorize that my less sophisticated model was picking up the same factors in a much more simplified calculation.
Time for an Acid Test
But as you know the S&P has gained around 60% from its low point in March bringing the credibility of the Model into question. Almost all of the economists forecasting a lower number for the S&P have abandoned their forecasts and have been very quiet lately. The notable exception is David Rosenberg who is still forecasting a large market correction.
The Model “T” now predicts a bottom at around 580. It would indicate that what we are experiencing is a huge “bear-market rally”. So bulls beware! Future posts will explore factors that could be impacting the accuracy of the Model.
I hope you will continue to follow this blog as we see how accurate the Model “T” turns out to be. Please pass this on to anyone who is interested in the stock market and ask them to e-mail me at firstname.lastname@example.org if they want to be put on the list to receive posting alerts. Again, anyone who wants to be removed from the alert list should also e-mail me now.
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