Stock Market Forecast Update

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I have updated my Stock Market Forecast page with the latest systems I’m testing.  You can read the explanation there in detail.  The quick summary is that I’m doing two primary models (4-week and 13-week), both using a linear regression model (a statistical way of finding a straight-line relationship between a set of variables and a calculated outcome) that involves four different technical analysis data points.

I graph the stock market forecast for each model over the coming 4-week or 13-week period.

Lastly, I will issue two weighted combination forecasts each week in my update post, each of which makes only one “official” forecast for the record book.  One represents a weighted average between where the two models think the S&P 500 will close this upcoming week.  The weights are based on how sure each model is – that is, using the “standard error” for the regression analysis.  The other is a “Headline Adjusted” model, which tries to account for the fact that extreme and unforeseen events can throw off the models.  So, I remove data that seems affected by such effects and keep the more pure data.  But this model will only make a forecast one week in advance.

Performance of Last Week’s Forecast

(NOTE: The markets are experiencing tremendous upheaval from headlines out of Europe and possibilities for major interventions from central banks, which is extremely difficult to capture with 4-week or 13-week models.  An important caveat to the use of any model that forecasts out that far is that any game-changing event will cause significant deviations.)

Weekly Direction of the S&P 500

Correct: 4-week   /   Weight-Adjusted Combo   /   Headline-Adjusted

Incorrect:   13-week

Notes: The two combo models were very accurate and in the right direction, while the individual models weren’t very close in actual level.

Accuracy of the Weight-Adjusted Combination Models

Regular Weight-Adjusted Combination: 0.46 percent too optimistic

Headline-Adjusted Combination: 0.40 percent too optimistic

Notes: Great week – correct in direction and accuracy.

Accuracy of Individual Models

4-week Model:  3.07 percent too optimistic

Correct Prediction of S&P 500 Direction thru Last Week’s Close:  1 out of 4 predictions

Notes: It was consistently about 3.1 percent too optimistic in each of its four predictions.  The only reason it got the direction right on its last attempt was that the market had corrected so much.

13-week Model:  1.28 percent too pessimistic

Correct Prediction of S&P 500 Direction thru Last Week’s Close:  8 out of 13 predictions

Notes: The model was always too pessimistic, but it did improve slowly and actually made its best prediction on its final attempt.  Alas, it was still in the wrong direction at the time.

Buy-Sell Simulation

The simulated weekly trade using the weighted average of the two primary models can be found on the “Buy-Sell Simulation” tab of the spreadsheet

Weekly Profit/Loss vs S&P 500 buy-and-hold:  Gain of $16

Cumulative Profit/Loss vs S&P 500 buy-and-hold:  Loss of $909 (initial $10,000 investment, excluding costs of trading)

Notes: The slight gain was only because the market fell in the final five minutes of trading, when this model had already sold.

Stock Market Forecast Summary for Upcoming Week

Here’s the breakdown:

Forecast Change in S&P 500 This Week (Oct 22-Oct 26, 2012) 4-Week Model 13-Week Model Weighted Average
Standard down 0.63 pct down 1.32 pct down 1.04 pct
Headline Adjusted down 2.17 pct down 0.03 pct down 0.91 pct

The weighted average forecast for the two models says that on the close of October 26, 2012, the S&P 500 will be 1,418.29 – which translates to a 1.04 percent drop this week.  Adjusted for headlines, I would expect a level of 1,420.11 – which translates to a 0.91 percent drop this week.  Check out the Stock Market Forecast page for exact numbers and charts.

What Does Past Performance Tell Us About Upcoming Week?

My calculations show that there is a statistically significant correlation between how far off the Headline-Adjusted (HA) model is from the correct close one week and what happens to the S&P 500 in the following week.  That correlation is a positive one.  In other words, when the HA model is too optimistic, it has been more likely that the S&P 500 rises the following week, while the opposite is true if it was too pessimistic.

Last week, the HA model was 0.40 percent too optimistic.  Based on historical correlations, this would be associated with a 0.71 percent rise in the S&P the following week.  I am not suggesting that this overrides the forecasts above, but it does call into question the unanimous prediction by all the models above that the market will drop this week.

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EASY NOTE: I offer email newsletters documenting several portfolio simulations that apply a concept with solid backtesting and intuitively sound principles.  Click here to learn more about the newsletters or sign up to receive them.  If they’re not outperforming the S&P 500 … they’re free!

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Evolution of the Forecast

Basic Concept: We’ve had several forecasts for next week’s close from the 13-week and 4-week models.  The evolution of the forecast could give us a sense for whether the forecasts are too high or too low.

4-week Model: Very flat over all four weeks, so this forecast is probably about where it would be if we ran another round.

13-week Model: The forecast has barely risen the last couple of rounds, so it’s unlikely it would be much different if we ran another round.

Bottom Line of Forecast Evolution: There is no reason to suspect that either forecast would be different if we had more time.

You can see the “evolution” data on “Forecast Archive” section of the Stock Market Forecast page by clicking on the tabs at the bottom of the chart.

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