What Now for the U.S. Stock Market?

 |  Includes: IUSV, IWV, SPY
by: Todd Feldman

In previous articles written for SeekingAlpha we have suggested that the US stock market will be up and down with no direction for some time. Up to now our suggestion has been correct. Recently, the US stock market has fallen significantly. What does this mean? Is the stock market ready to head lower or will it rebound again?

In our past articles we wrote that our behavioral indicators appear to behave similarly to three periods in the past 40 years of our history. Those years are 1976, 1994, and 2004. Let us take a closer to look to see how the behavioral indicators from 2004 compare with 2011.

At BFIA we create several indicators for major global financial markets. The two most important are a long-term and a short-term indicator. The long-term indicator reflects a long-term outlook such as one to two years. The short-term indicator reflects a one- to three-month outlook. We rank the level of these indicators relative to all other markets evaluated including Latin America, Asia, Europe, Australia etc.

Figure 1 displays our long indicators. The y-axis label is missing do to the proprietary nature of the data. The x-axis represents the month in both 2004 and 2011. The figure represents the evolution of our long indicator since the beginning of 2011 and compares it to how our indicator evolved during 2004. A rising indicator represents bearishness and a falling indicator represents bullishness. We have extended the 2004 indicator out until October in order to predict how the US market will evolve until then.

Figure 1: US BFIA Long Indicators: 2004 vs. 2011

It is evident that the indicator from both years have been evolving in a similar pattern. However, during the month of June the indicators did diverge. Even so, the indicators are now again on similar paths.

What do we find? At the end of July, beginning of August, both measures made significant upward movement which is bearish. However, the 2004 measure falls during the month of August and then increases again. If 2011 is going to follow 2004 then the US stock market should recover over the month of August. Therefore, we may see some more downside but limited downside. If the similarity continues the US market will then fall in September and October and increase in November and December. In order to ensure this similarity holds we have taken a look at our rankings as well. In Figure 2 we show the ranking of the US relative to other markets we evaluate. The higher the ranking the worse off the US is relative to other markets. The lower the better off.

Figure 2: BFIA Long Ranking: 2004 versus 2011

Again we find a similarity between the 2004 and 2011 ranking. The US ranking improves dramatically at the beginning of the year but worsens recently. The similarity diverges in June but converges again in July.

Figure 3 displays the BFIA short-term indicator for 2004 and 2011. It has the same interpretation as the long-run indicator, however, it forecasts a shorter investment horizon. Results indicate again the indicators are similar except for June. The 2004 indicator decreases significantly in August suggesting the US stock market will recover some what in August.

Figure 3: BFIA Short Indicator: 2004 versus 2011

Lastly, Figure 4 is the comparison of the short-term ranking for the US relative to other markets for 2004 and 2011. Again we find similarities.
Figure 4: BFIA Short Ranking: 2004 versus 2011

Our analysis suggest that if 2011 is a repeat of 2004 then August should be a month of recovery. There may be more downside to come but the downside is limited. Even so, September and October do not look great for the US stock market.

What should investor do? We recommend to close any shorts for the time being. Potentially add some long positions such as the S&P Index ETF SPY, the Russell 3000 Value Index IWW, and the Russell 3000 Index IWV. If the US stock market recovers during August, sell off some of your shares as September and October look to be down months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.