The Forecast gets its name from the acronym of its components: economy, inflation, earnings, and interest rates = opportunity for stock market appreciation (E+I+E+I=O). Each factor is rated as positive (2 points), neutral (1 point), or negative (0 points) for stocks based upon historical relationships between that component's economic data and its likely effect on the Federal Reserve's monetary policy. The total points are added up to arrive at a score between 0 and 8. A score above 4 indicates a positive environment for stocks.
Economy - 2 Points
When the economy is growing slowly, the Federal Reserve's projected actions over the next 12 months should favor stocks. The Forecast score is positive when economic growth is less than the optimal, non-inflationary rate of economic growth of 3%.
The 2nd quarter GDP growth revised up to 2.5% was significantly better than the paltry 1.7% original number. However, the revision was mostly as a result of business spending readjustments with little change to consumer spending -- which is more important. The muddling economy is still not growing fast enough to warrant monetary policy tightening. Positive for stocks - 2 points.
Interest Rates - 2 pointsHistorically, the yield curve spread (difference between long-term and short-term interest rates) has been a predictor of the economic performance. The chart below shows the relationship between the yield curve spread (blue line) and the S&P 500 price (red line). As long as the spread remains positive, stock markets tend to rise. When it turns negative, that is a danger signal for stocks.
|Click to enlarge|
|Yield Curve Spread (3-Mo and 10 Yr U.S. Treasuries) and S&P 500 Since 1990|
Earnings - 0 points
Inflation - 2 points
Low inflation is currently the biggest argument against any substantial tapering of QE. Core inflation is 1.7%, which is well below the Federal Reserve's target of 2.5%. Minutes from the last Federal Open Market Committee (FOMC) meeting mentioned several members voicing concerns about the low level of inflation. While inflation levels remain low, the Fed will continue to support the economy going forward. Positive for stocks - 2 points.
= Opportunity for Stocks - 6 out of 8 (Positive)Adding each of the 4 factors totals a score of 6, which indicates conditions are favorable for stocks. Our Barnyard Forecast has historically done a good job of indicating the general trend of the market. While there are many unknowns surrounding Syria and the Federal Reserve's next moves, we agree with the Forecast's projection of continued positive returns for the market over the next 6 to 18 months.