Gazing Into A Hazy Crystal Ball

I'm not a fortune teller
Don't have crystal ball
I can't predict the future
Can't see nothing at all – (Maroon 5 – “Fortune Teller”)

When I started my “sabbatical” in early June the S&P 500 Index was two points higher than today’s close (1640) and nobody had a clue where the market was headed next.  So here we are almost three months later and …. uh.  Okay, so you have to give me credit for knowing when to take a break!

That’s not to say nothing happened this summer.  The market hit 1709 in early August (7% over the upper limit of the Model T forecast) and this peak (if it is in fact a peak) did happen in August (not May-June) which means the Model T failed to predict both the timing and the value of the market top this time.

Therefore it is time to speculate why the Model T forecast failed on this cycle.  Here are the reasons, not excuses, for the results:

1.   After writing for two years about how previously reliable economic models and indicators were being rendered inaccurate by the unusual economic circumstances, could I expect that the Model T to be immune to these same factors?  Score one (a negative one) for vanity.

2.   The Model T relies on forward looking data and forecasts.  Now it can be determined that this input information was not as accurate as it had been in the past.  Another victim of the economic environment.

3.   The stock market may be experiencing a “mini-bubble” (some would argue “major”).  Money flows where the return is greatest and with a weak economy and slow housing market, the stock market is the place to be.

4.   And that capital is cheap.  Ben (Master “B”) Bernanke has been pumping billions (around $80 billion a month) into the economy to keep it growing at around a whopping 2%.  Some of that cheap money is finding its way into the stock market.  Of course the last time people borrowed cheap money and inflated the stock market, was uh, 1929.  Oh boy!

The Market Is Jamming To “Master B”

Yes, the market loves “Master B” Bernanke and cheers him on as he pumps up the monetary jam.  He loves to raise the roof on the money supply.  The market hates it when he hints at cutting back the jam.  All the partiers in Club Wall Street shout:

Master "B" likes to pump it!

“No taper, no taper!

Just keep printing the paper!” 

But Master B’s arms are getting tired, so he is retiring.  He has done a good job of propping up, duct taping, and jerry-rigging the economy to this point.  He either should be commended as a genius or taken out behind the woodshed and shot.  We just don’t know which is appropriate yet.  If I were Master B, I would retire off-shore just in case, the Cayman Islands perhaps.

President Obama is having a difficult time selecting Bernanke’s replacement.  Let’s hope he doesn’t get this choice confused with other difficult decisions and appoints Larry Summers ambassador to Syria.

Still Have the Market/Economy Disconnect

The stock market is still smoking hot while the economy is tepid.  This situation can’t last much longer.  Either the economy starts to jump or the market tanks.  Despite the hopeful headlines, Wells Fargo is forecasting a 2013 GDP of 1.5%, improving to 2.1% in 2014.  The Model T Junior (based on consumer transportation) indicates the economy has been basically flat for the past 12 months (through June).  It says economic growth slowed starting in October 2012 and has not recovered much as of June.  This is now literally the “Hope & Change” economy.  Everyone is hoping, so hoping, that things will someday change.

What Does The Model T Say Now?

The quality of the data going into the Model T has not improved.  The Model T should show a very cyclical pattern and it is now producing a flat line.  I think this indicates that the economy is “sick”.  It is growing, but not generating many jobs. Nor is it able to gain much traction or momentum. This is not the new normal; it is an abnormal state that is not quickly resetting.

What About The Stock Market?

Respected analyst and investor John Hussman (Hussman Funds) is predicting a 40-55% drop in the market.  However there are other analysts forecasting continued gains the rest of the year.  The Model T says the market should be around 1350.  So if you jumped out (like me), I would stay out for now.  If you had the guts to stay in, set a floor (1550 perhaps) and be prepared to bail if needed. My crystal ball may not be broken, but I can’t even see it through the dense fog.