Predictive Model Output - Dec 30, 2005

[nodoodahs]

The explanation of the S&P 500 52-week model, along with my stock picks for the year 2006, are now online at MarketThoughts and Safehaven. I wrote the piece and finalized the stocks for the selections over the course of last weekend, and so, I am tracking them from the close of Dec 23, 2005. This actually works to my detriment, since a couple of the "potential value shorts" picks had considerable momentum and edged up last week, while the indices went down. That's OK, it really is the tortoise vs. the hare, and I expect the momentum effects have potential to possibly carry the "value shorts" higher than the "value longs" for a month, maybe two, as a portfolio.

The EPCR model has moved from the 3rd decile two weeks ago, to the 5th decile last week, and although it crossed into the 6th decile on Tuesday's close, it ends the week in the high end of the 5th decile. Not particularly bullish but certainly suggestive that we'll pull up soon. The biggest thing I see in the short term technicals is how oversold the index is. I have been saying all week that this is a buying opportunity, and I still think so. Don't call me a Pollyanna on this! I report what the models suggest, along with interpretation. The real Pollyannas were excited in the last week of November, while I was busy saying stuff like "Output for this model remains in the 2nd decile, which is bearish for the next 21 sessions, suggesting average to flat returns." Nyah.

The 13-week model for the S&P 500 has fallen to the 6th decile, after racking up a 7th decile reading for five consecutive weeks. A 6th decile reading would suggest median and average returns of 2.3% for the next quarter, with greater than 65% chance of gains, 43% chance of above-average gains, and 5% chance of ending the quarter down more than 10% from where we are today. 1280 for the end of January is about 50/50.

The 52-week model for the S&P 500 is still in the 6th decile, and it has been for five of the last six weeks. The 6th decile is neutral in the sense that it suggests an average 52-week return. Median and average returns for this reading are 13.4% and 11.7% vs. standard median and average returns of 12.4% and 11.8%. The 6th decile implies a 79% chance of gains, with about a 52% chance of above-average gains, and a still-hefty 13% chance of ending the year down more than 10% from where we are today. 1415 for the end of 2006 is about 50/50.

Still looking like a slow stock market beginning to January, with action picking up shortly thereafter, and overall returns for the year being better than 2005 by year-end.

The 13-week model for the 10YT is back into the 1st decile. It had moved up into the 2nd decile after being way down in the 1st decile for seven of the previous eight weeks including six in a row. This suggests a 95% chance that yields on the 10YT will be lower come the end of March.

The 52-week model for the 10YT is still in the 3rd decile, and has been for twelve weeks in a row. Implication is 93% chance that yields decline. Output for both of these models was defined as an additive function of yield, so I really doubt that the suggested output (yields well below 4%) will happen - the average 10YT over the life of the database was over 7%, so while the existing yield is this low, I will probably express the output in terms of general odds of decline or increase instead of a target yield.

The implication is rates will stay low - per my Safehaven forum post, if rates stay low on the 10YT until the Fed capitulates and starts to lower the FFR, the homebuilding stocks will be screaming buys late in 2006. They are already heavily discounted as "peaking cyclicals" but if they stay relatively healthy financially, the boost from resumed lowering of rates will most likely precede investor reaction on their stocks.

The 13-week model for the USDX has is in the 5th decile for the fourth consecutive week.

The 52-week model for the USDX is in the 7th decile for a third week, but it has flip-flopped between the 5th, 6th, and 7th deciles for a few weeks now.

The models suggest about a 65% chance the USDX will be lower in March than it is now, and about the same 65% chance that the USDX will be higher in December than it is now. This doesn't jibe with my macro views that USDX will likely peak early and roll over, based on timing of the remaining FFR move(s?), opening of the Iranian Oil Bourse, and the end of tax benefits for corporations bringing foreign dollars home.

One possible scenario is that demand for dollars tanks due to the above; most likely so would demand for 10YT. Ben "Bag Man" Bernanke responds by having the Fed buy bonds with digitally created money, money that is not immediately traceable due to the elimination of M3 and RPs from data releases. Further, the Fed-low-interest-rates misallocations of capital are already starting to unwind (one sign of this is the yield curve inversion); while the damage is already done, the Fed will most likely not realize this until Spring, and they will respond with lower FFR. This scenario could be bullish for U.S. stocks, since foreigners could be short the dollar and long the stock market as a hedge, or vice versa, and still be bullish (or at least not very bearish) for bonds because the Fed will be told to support demand for treasuries to keep the "government's" borrowing costs low.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.