All the negative headlines finally did their job: the S&P 500 is currently down by about 7% from its recent peak of 1460. This drop is fairly small and consistent with typical market volatility. It doesn't even qualify as a correction (which would be 10%). But it can certainly make one nervous, hence we wanted to update our followers on our latest thinking.
While equities sold off, the factors that matter for determining future equity return, according to our PAR Model™, have improved significantly since September:
- Individual investor sentiment, according to AAII, is now at panic level, with the ratio of bearish to bullish investors rising to over 1.5. This is a contrary indicator - high bearishness typically precedes a rising market.
- The drop in oil price to $85 is also very positive for the model's return forecast (the Energy sector notwithstanding).
- Economic and valuation factor data improved as well.
Driven by these improvements in the data, the PAR Model™ gave its highest forecast since August 2010. The actual 6m total return was 27.7% from that point. Forecasts do involve a forecasting error, and one may not expect return as high as that, but the expected, most likely scenario return still looks very attractive.
Don't take us wrong - we consider the deficit and debt to be a real and serious problem. But should we really be more scared than 2,3, 5 years ago, when it was about the same, but NO one even mentioned it? Ironically, because people are now concerned about it, and it's being discussed in top politics and broadly in the media - that's why something will be done about it, and it will improve. Once the solution is found, the markets, in their bipolar way, will view it as positive.
With the latest model result, we are issuing a Significant Overweight equity recommendation, which is our most positive stance. Managers who follow a strategy of adjusting their positions based on the strength of the forecast are advised to increase the overweight. Fortunately, the market seems to present an excellent opportunity to do so after the recent drop.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.