Every day numerous bits of news items impact the market. A company’s earnings exceed expectations or disappoint investors. An economic release proves the economy is stronger than suspected – or weaker. The price of oil moves unexpected high, or plunges without warning. Multiply these surprises over a period of a month, and you have an incalculable number of news events that affect the market. None of these items enter into our monthly forecasts. Fortunately, fresh news items are not the only factors that move stock prices.
We have discovered that as much as 50% of the movement of stock prices are not due to incoming news items but are in fact predictable from past information. If only 50% of the change in market prices can be predicted on average, doesn’t it make our forecast merely equivalent to guessing a coin toss? No! As investors our first priority is to ascertain the direction of price movements, not their magnitude. Identifying the correct direction of market prices means that we are on the right side of the trade even if the forecast for the size of the change is less accurate.
While the Q&D Inflation Indicator can be easily calculated, our monthly forecasts use sophisticated computer and econometric techniques. This means that the hidden causal relationships that we uncover are not easily observed. Here we will only discuss one of the many factors that enter into the monthly forecasts: the VIX index. (VIX is the implied volatility calculated from S&P 500 options, available here.)
As the chart illustrates, there exists a pronounced negative correlation between the VIX index and the monthly returns on the S&P 500 index. This negative relationship can be transformed into forecasts by noting that spikes in the VIX index are excellent buying opportunities. Since the spikes do not always occur at the same level, it takes additional computer analysis incorporate the VIX into the monthly forecast.
What does it mean to follow our monthly forecasts?
First, remember that although the chart shows the most likely path for prices, it is only meant to project the monthly direction of the market. It is not a weekly forecast. Our monthly forecasts are updated weekly, but most of the time there is no change in the direction. An exception to that could occur in the event of a spike in the VIX or an extremely choppy market.
Our long-term market guidance, provided by the Q&D Inflation Indicator, shows the general market environment. The monthly forecasts should be interpreted in that context. The combined forecasts reveal whether a market increase is only a bear market rally or a long-term investment opportunity, and whether a market decline is a start of a bear market or merely a correction in a bull market.
Our current monthly forecast is presented at the bottom of our home page.
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