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Summary

  • Market volatility is forecasted to rise over the 1-month and 3-month time horizon.
  • Negative outlooks dominate from S&P 500 companies by a ratio of 6.9 to 1 for the first quarter.
  • Beijing is expected to launch a series of policy measures to stabilize growth.
  • Russia’s stock market is very cheap at the moment, but may fall further as the algorithm is bearish.

There have been some recent changes in the market and the algorithm has recognized a trend that many might be unprepared for. Last year the S&P 500 (NYSEARCA:SPY) enjoyed a rise of about 30% but has plateaued since the New Year, only 0.15% YTD. On December 1st 2013, I shared I Know First's 2014 market prediction. The algorithm forecasted that the market would rise moderately by years-end but would likely also experience a drop at some point in the near future. Our analysis coincided with Goldman Sachs (NYSE:GS) chief US equity strategist, David Costin, who stated there is a 67% possibility the S&P 500 could endure a pull back of at least 10% as they projected more volatility in the markets. While we are no longer in a recession, the economy is still far from ideal. The market is becoming more vulnerable as the Federal Reserve begins to adjust the monetary policy. Federal Reserve Chair Janet Yellen proclaimed a tentative six-month time frame upon completion of the asset-purchase program that the Federal Reserve will begin increasing short-term interest rates. There is a risk that a bubble could form in the United States economy as the Federal Reserve tapers its monetary policy. James Bullard, president of the Federal Reserve Bank of St. Louis stated "I don't see an immediate bubble now, but maybe one would form as we are trying to remove policy accommodation in the years ahead, because that's what happened in the 2004-2006 period."

I Know First utilizes an advanced self-learning algorithm that utilizes Artificial Intelligence (AI), Machine Learning (ML) and incorporates elements of artificial neural networks and genetic algorithms in order to generate predictions for over 1,400 markets in six different time horizons. The current I Know First volatility index (NYSEARCA:VXX) forecast indicates that the market is becoming more volatile as can be seen in chart 1. Click here for the basic instructions on how to read the color-coded forecasts.

(click to enlarge)

This forecast indicates that volatility will escalate in the 1-month and 3-month time horizons. In the 1-month time horizon, the signal or predicted direction and magnitude (not a specific number or target price) is 7.88, indicating a rise in volatility. The signal increases to 13.66 for the 3-month time horizon, insinuating further uncertainty. The brighter green color indicates that there will be more of a drastic increase as the colors of the predictions reflect the signal. The algorithms certainty of this prediction is fair as the predictability indicator is 0.21 and 0.26 for the 1-month and 3-month time horizon respectively, which is usual for the algorithm as it inclines to be even more accurate for longer-term time frames.

U.S. Market

Last week's jobless report was better than expected. In the week ending March 22nd, new jobless claims dropped 10,000 to 311,000 from the previous week's revised figure of 321,000. The third estimate of Q4 GDP was revised to 2.6% up from 2.4%. The U.S. employment report for March is due on Friday. If hiring has picked up to a healthy pace after the mediocre gains in the prior three months, that could convince investors the economy's latest setbacks are only temporary and ready to pick up again after a winter-induced respite.

The most widely watched U.S. economic indicator, is expected to show that nonfarm payrolls added about 200,000 jobs in March. A gain of that magnitude would correspond to the monthly average in 2012 and 2013 and insinuate that the economy remains on a path of gradual improvement. In addition more economic data will be distributed this week as the Institute for Supply Management will release its national surveys for March on the manufacturing and services sectors, which are anticipated to show progress from the preceding month. Development in the manufacturing and services sectors plus improvement in the labor market could strengthen the case for the Federal Reserve's tapering of the easy money policies. However, another subpar month of job creation would propagate renewed anxiety that the pace of economic growth has slowed again in early 2014, making the Federal Reserve's job more difficult to end the huge bond-buying program.

Thomas Reuter's data showed that negative outlooks dominate from S&P 500 companies by a ratio of 6.9 to 1 for the first quarter. While that's still lower than the ratio for the fourth quarter, the S&P 500 first-quarter earnings growth is now expected to increase only 2.1%, down from a January 1st growth estimate of 7.6%. Chart 2 shows how increased volatility has affected the algorithmic outlook for the forecast of the S&P 500.

Over the past week or so, there has been a noticeable transition in the algorithm's prediction for the S&P 500 and general stock forecasts, aside from the enhancement of criteria installed in the most recent update of the algorithm. These predictions above come from our daily Top 10 Stock Picks and S&P 500 forecasts from the 26th of March through the 31st of March and are cropped from the full forecast. What should be noted in chart 2 is that the prediction for the S&P 500 is only barely hovering in the green (bullish forecast) and dips deeper into the red (bearish forecast) as we come to today's forecast.

For the 1-month time horizon on March 28th, the signal was -0.73, but negatively increased over the weekend to -1.16. The predictability or confidence in the prediction increased as well from 0.15 to 0.17. In the 3-month time horizon the signal negatively increased to -2.21 from -0.73 but the predictability stayed stagnant at 0.19. On March 26th, 43% of the 1,400 assets followed had a bullish signal, down from 49% in the previous forecast. As of the March 31st forecast, only 35% have a bullish signal. These four forecasts encapsulate the transition in the market that the algorithm has recognized. For quite some time before this, the algorithm has generally held a bullish prediction for the S&P 500 with some exception, especially in 2013. Another indication of this transition by the algorithm is the general color tone of the daily forecast.

When looking at the entire forecast, which also includes the top 10 most bullish picks and the top 10 bearish picks, the entire forecast has recently tended to become more reddish (bearish) in overall color, especially in the mid to long-term time horizons. This means that the markets will likely move south if it continues on this trend, however new data from the jobs report at the end of this week could have a positive impact. Either way, there are still market opportunities that can be taken advantage of.

China

Property markets in China (NYSEARCA:FXI) have reached disturbing levels as it has shown signs of losing steam since late 2013. On Monday, a preliminary private survey showed that the country's manufacturing contracted in the first quarter of 2014, raising anticipations of Beijing to launch a series of policy measures to stabilize growth and stop a loss of momentum in the world's second-largest economy. China's Purchasing Managers' Index (PMI), tracked by Markit Economics and HSBC Holdings plc, dropped from 48.5 in March to 48.1 in February, an eight-month low. A level below 50 signals an economic contraction. On Monday, Asian stocks crept higher in a cautious start for the week, as investors are hopeful that China will take steps towards stimulating growth. China's Premier Li Keqiang on Friday sought to reassure jittery global investors that Beijing was ready to support the cooling economy, saying the government had the necessary policies in place and would push ahead with infrastructure investment

Russia

Following the Russian invasion of the Crimea, foreigners have dumped the country's stocks, bonds, and the ruble. Russia's equity market (NYSEARCA:RSX) has fallen 18% YTD. Investors have withdrawn about $4.4 billion from stocks and about $4.1 billion from bonds over the last six months approximately. As predicted by the algorithm, the USD/RUB jumped 9.88% from December 19th's currency forecast as investors moved their money to a safe haven with the dollar and away from the ruble. Currently, the ruble is down almost 9% YTD. The central bank raised interest rates by 1.5% to curtail the ruble's fall. On February 21st 2014, right before ex-Ukrainian president Yanukovych was ousted, I Know First: Daily Market Forecast had a negative forecast for the Russia RTS Index (RTSI). In accordance with the algorithm, the index fell 8.11% in the 1-month time horizon. The Russia RTS Index consists of 51 leading Russian companies, 58% of which are based on energy and 13% are based on basic materials. While many are moving away from Russia, some view this as a buying opportunity. "Russia's stock market right now is one of the cheapest in the world, and probably one of the most hated," stated investor and commodities guru Jim Rogers, chairman of Rogers Holdings, in Singapore. "This is the time to buy Russia."

Those who share this stance should have a long-term horizon, as sanctions from the west are limited at the moment but can be extended further. Over the weekend, the United States sent its top general in Europe back to the region early from a trip to Washington, which the Pentagon described as a prudent step. U.S. Secretary of State John Kerry and Russian Foreign Minister Sergei Lavrov have convened in Paris to work out the framework of a deal to ease tensions over Russia's annexation of the Crimea region. Chart 3 contains our latest forecast for the Russia RTS Index from our World Indices Forecast.

This World Indices Forecast has been cropped and the top of the forecast including bullish forecasts is not visible. In total there are thirty-eight world indexes that the algorithm makes predictions for however, the overall forecast is red. The brighter red color visible at the bottom distinguishes the assets that are expected to drop more drastically. The Russian index is the fourth from the bottom, with a signal of -8.43 and a predictability of 0.31 for the 1-month time horizon. Interestingly enough, the forecast for the index is much more neutral but still bearish in the 3-month time horizon. The signal improves to -2.11 and the predictability increases to 0.32. So far, this insinuates that this may actually become a buying opportunity, but proceed with caution, as the forecast remains negative. It would not be recommended to buy without seeing a positive forecast trend for this asset first. Cathy Elmore, emerging market portfolio manager and senior sovereign debt analyst at Standish in Boston stated "We thought that whatever valuations we have in Russia, it's better to exercise some caution … we need to be aware of this political layer that has been driving valuations."

Conclusion

A bad start in January has seasonal implications for the rest of the year and this year's slow start was the worst since 2008. If the market does pullback, then this would correlate to our 2014 market forecast from the end of 2013. The algorithmic forecasts have been hinting that the market maybe reaching a tipping point soon and has recognized rising market volatility. Investors need confidence that the recent weakness in the market was due to severe winter-weather conditions. There is a lot of pressure on Friday's employment report as it may alleviate or increase investor anxiety.

Business disclosure: I Know First Research is the analytic branch of I Know First, a financial startup company that specializes in quantitatively predicting the stock market. Joshua Martin, one of our interns, wrote this article. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Algorithmic Market Outlook: Volatility On The Rise