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 also make only one forecast, one week in advance.

Performance of Last Week’s Forecast

Weekly Direction of the S&P 500

Correct:    Headline-Adjusted

Incorrect:   4-week   /   13-week   /   Weight-Adjusted Combo

Accuracy of the Weight-Adjusted Combination Models

Regular Weight-Adjusted Combination: 4.97 percent too pessimistic

Headline-Adjusted Combination: 0.02 percent too pessimistic

Accuracy of Individual Models

4-week Model:  1.44 percent too pessimistic

Correct Prediction of S&P 500 Direction thru Last Week’s Close:  3 out of 4 predictions

Notes: All four times it made a forecast, it was too pessimistic (by 0.4 to 1.5 percent).  It got the direction from that point through the forecast date correct on 3 out of 4 tries.

13-week Model:  8.05 percent too pessimistic

Correct Prediction of S&P 500 Direction thru Last Week’s Close:  0 out of 13 predictions

Notes: The model was always between 8.1 and 8.7 percent too pessimistic, and didn’t get all that much closer over time.  It got the direction wrong on every attempt.

Estimated Effect of Headlines on Current Market Value

NOTE: This is based on a calculation I do after running the current week’s headline-adjusted forecasts.

4-week ModelPositive effect of  1.5 percent   (down 0.4 percent from last week)

13-week Model: Positive effect of 8.7 percent   (up 0.9 percent from last week)

Notes: The headline effect went up an average of about 0.25 percent from last week, so headlines are artificially elevating the market by about 5.1 percent (average of the two models).

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:  Loss of $239

Cumulative Profit/Loss vs S&P 500 buy-and-hold:  Loss of $2,607 (initial $10,000 investment, excluding costs of trading)

Wins and Losses vs S&P 500 buy-and-hold (Win = $50 gain or more, Loss = $50 loss or worse, Tie = Anything in between): 38 pct

Notes: The model incorrectly sold for the week.  The system’s current streak stands at 3 losses (any weeks classified as a tie aren’t considered in streak).

Stock Market Forecast Summary for Upcoming Week

Here’s the breakdown:

Forecast Change in S&P 500 This Week (May 13 – May 17, 2013) 4-Week Model 13-Week Model Weighted Average
Standard down 4.26 pct down 8.11 pct down 6.25 pct
Headline Adjusted down 2.76 pct up 0.57 pct down 0.99 pct

The weighted average forecast for the two models says that on the close of May 17, 2013, the S&P 500 will be 1,531.58 – which translates to a 6.25 percent drop this week.  Adjusted for headlines, I would expect a level of 1,617.50 – which translates to a 0.99 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 a decent correlation for the Headline-Adjusted (HA) model (94 percent confidence).  That correlation is a positive one.  In other words, when the HA model is too optimistic, the S&P 500 performs better the following week than if the opposite were true, although it doesn’t necessarily mean the S&P 500 has dropped if the HA model was too pessimistic – just that did worse than when the model was too optimistic.

Last week, the HA model was 0.02 percent too pessimistic.  Based on historical correlations, this would be associated with a 0.5 percent rise in the S&P the following week.  In general, I am not suggesting that this overrides the forecasts above – just another thing to consider.

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EASY NOTE: I offer email newsletters documenting 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: The forecast has been mostly flat over the four-week period, so this forecast probably wouldn’t change if we had another round of forecasting.

13-week Model: The forecast has been very slowly rising since about 7 weeks ago, so this forecast might be higher if we had another round of forecasting.

Bottom Line of Forecast Evolution: The evolution of the forecasts suggests there could be slightly more optimistic forecasts if we had another round of forecasting.

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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