Stock Market Outlook

On Mondays, I will give a brief stock market outlook. I have started doing this for my own use and it takes very little additional effort to post the results here.

It is not a prediction. I didn’t predict the market crash in 2008 and I suffered through it. Almost no one is able to predict market movements, especially the most extreme ones. If a person invests for the long term, short-term fluctuations, including crashes, don’t matter, as long as the market eventually recovers. The only benefit to selling a falling market, then buying back in at the same level, is the psychological energy that is wasted worrying about a market crash.

I look at three things. It is customary to pay attention to interest rates and to consider the shape of the yield curve as an indicator of future economic activity. The stock market also moves in advance of the economy, so interest rates may not predict movements in the stock market. I also compare the relative momentum of stocks versus bonds. When bonds are performing better than stocks, it may indicate a coming bear market. This indicator can also present false positives. Finally, I look at the aggregate earnings of the stock market to determine a reasonable value. This model has trouble with unexpected changes in future earnings, such as during the credit crisis and recovery.

All together, these three aspects of markets give me an idea of the likely outlook. I try to take a long-term view, in an effort to balance the opinion or hysteria that is presented in other media. For example, newspapers may report three days of falling market values and predict a new bear market on that basis. I believe that’s rash, and I don’t feel that pushing the “fear” and “greed” buttons helps engender market stability.

How do you decide if the stock market is over or undervalued? How do you set your allocation between stocks, bonds and cash? Are there market commentators that you trust more than others?

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