Mark Hulbert: Is this glass half full or half empty?

[HenryTo]

Very good article from Mr. Hulbert, once again. This is why I don't believe that a blow off rally has started yet, as the current market conditions definitely do not support such a potential for the foreseeable future.
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Is the glass half full or half empty?

By Mark Hulbert, MarketWatch
Last Update: 12:10 AM ET July 12, 2005

ANNANDALE, Va. (MarketWatch) -- I have both good and bad news to report about a market timing model that I last wrote about 19 months ago.

The good news is that the model is not as bearish today as then.

The bad news is that it still suggests that stocks are overvalued.

(Read archived column from December 2003.)

The market timing model I'm referring to is based on a single number that is reported weekly in the Value Line Investment Survey, which is published by (VALU: news, chart, profile) Value Line, Inc. This number reflects the median of the projections made by Value Line's analysts of where the 1,700 stocks they closely follow will be trading in three to five years' time.

Followers refer to this number as the VLMAP, which stands for Value Line's Median Appreciation Potential.

Though Value Line itself does not believe that market timers should place undue weight on VLMAP, this has not stopped other advisers from doing just that. Dan Seiver, for example, a visiting finance professor at San Diego State University and editor of an investment newsletter called the PAD System Report, bases his newsletter's market timing model almost exclusively on the VLMAP.

Another eminent adviser who believes it behooves us to pay attention to the VLMAP is Peter Bernstein, editor of an institutional newsletter called Economics and Portfolio Strategy. Research he conducted in the 1980s and 1990s led him to conclude that the VLMAP has an "excellent" track record forecasting the stock market's level four years hence.

Both Seiver and Bernstein found that, on average, the stock market turned in significantly greater four-year returns following high VLMAP levels than low ones. (This also was the conclusion of an exhaustive study conducted in the summer of 2004 by Brandon Mills of Haverford College, who at the time was interning at the Hulbert Financial Digest. Those interested in a copy of Mills' econometric analysis should email me at mark.hulbert@dowjones.com.)

Currently, the VLMAP stands at 50%.

Is that high or low? The VLMAP's historical range has been from a low of 17, which was registered in late December 1968, to a high of 255, which came in late September, 1974. The median level is around 75.

In fact, fewer than 20 percent of VLMAP's historical readings have been lower than its current level.

It's for these reasons that I would classify the current VLMAP reading as more bearish than bullish. Seiver, for example, says he won't recommend his subscribers reinvesting their large cash positions until the VLMAP rises to 100.

The last time it was that high was in March 2003, just before the bull market took off in earnest.

Those inclined to see the glass as half full, however, can point to the fact that the current VLMAP reading is higher than it was in December 2003, when it stood at just 40.

One drawback to this VLMAP-based market timing model, at least in some short-term investors' eyes, is that it focuses on where the market will be in four years' time. A forecast of where the market will be in the summer of 2009, for example, tells us nothing about the path the market will take to get there.

It is partly for this reason that Value Line itself has de-emphasized the VLMAP, and instead devoted considerable energies to devising a market timing model with a good record at forecasting the market's level in six to 12 months' time. (Read archived column about Value Line's research.)

The model that Value Line came up with is currently bullish. The firm is recommending that subscribers allocate 80% of their equity portfolios to stocks and keep just 20% in cash.

Value Line does not divulge the factors that its econometric model takes into account in reaching this largely bullish forecast. But in its latest issue, Value Line writes that it considers it impressive that the stock market has been so resilient this year in the face of rising interest rates and skyrocketing oil.

"The stock market's ability to hold near breakeven, on average, in the first half was no small achievement," it writes. "Now, though, with the Fed likely to stop raising rates later this year, and with slower GDP growth making it likely that we'll see some stability return to the oil markets, it's logical to expect stocks to do better in the second half."