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| Timing Outlook FAQ |
NOTE:
The Timing Outlook described in SENSIBLE STOCK INVESTING has been changed,
because some of the component indicators used in the original are no longer
available. They have been replaced by similar indicators.
This page has been added to the Web site both to introduce newcomers to the
Timing Outlook and also to explain the changes to readers of the book.
Q: What is the Timing Outlook?
A: The Timing Outlook is a short-term indicator of the likely direction of the stock market. In
this context, "short-term" means over the next several weeks.
Q: Where did the Timing Outlook originate?
A: I created the Timing Outlook in my book, SENSIBLE STOCK INVESTING. It was a natural
outcome of my research and analysis in the book about factors that affect stock prices.
Q: Does the Timing Outlook work?
A: It is certainly not infallible. No timing system is right 100% of the time. In SENSIBLE STOCK
INVESTING, it is presented as just one of several tools to help the investor make better buy,
hold, and sell decisions.
Many stock authorities eschew "market timing," stating that it is impossible, and that it more
often than not leads investors to make flawed decisions.
In my opinion, market timing can be useful, especially in helping avoid catastrophic losses. In
2008, for example, my Timing Outlook has influenced me to keep most of the money in my
Capital Gains Portfolio in cash rather than in the market. That has been a hugely successful
decision.
If as an investor you believe that market timing is impossible or stupid, simply ignore it. The
other sound principles of being a Sensible Stock Investor still apply.
Q: What are the elements of the Timing Outlook?
A: The Timing Outlook is relatively simple. It utilizes several factors that are readily available
for free to the average individual investor. These are the factors:
- Economic forecast. Over time, stock prices follow corporate earnings. Corporate
earnings, in turn, often depend on how the overall economy is doing. I use the widely
reported Conference Board Index of Leading Economic Indicators for this purpose. - Interest rate.. Generally, falling interest rates are good for the stock market and rising
interests rates are not. I use a simple indicator based on the Federal Reserve's widely
publicized Fed Funds Rate. - Market valuation. "Low" market valuations usually portend market rises, while "high"
valuations suggest the opposite. I use two valuation indicators: (1) The P/E ratio of the
S&P 500 compared to its own historical average. (2) Morningstar's free Market
Valuation Graph. - Market trends. Many investors believe that once a clear market trend has been
established, it tends to continue until something causes it to change. Using the most
basic of technical analysis techniques, I monitor six market trends, two each for the
Dow Jones Industrial Average, the S&P 500, and the NASDAQ.
Details about the specific factors used in the Timing Outlook, and how they are used to
calculate the Timing Outlook, are explained in the last two questions of this FAQ.
Q: How often do you recalculate the Timing Outlook?
A: Generally every two weeks, although I might do it more often if the markets are changing
significantly. The Timing Outlook is not meant for extremely rapid trading decisions--day
trading and the like. Rather, it is meant to improve the buy, hold, and sell decisions of
investors who have a longer-term outlook. In particular, it is meant to help investors get their
new purchases off to good starts, and to help them avoid losses that might result from
purchasing, selling, or failing to sell at the wrong times.
Q: Is the Timing Outlook available precalculated, so I don't have to do it myself?
A: Yes. I include an updated Timing Outlook, with appropriate commentary, in my free
Newsletter. Use the button to the right to sign up for the Newsletter. You will find the latest
Timing Outlook if you go directly to the Newsletter.
Q: How is the Timing Outlook calculated?
A: The Timing Outlook is calculated from ten component indicators. Each component can
suggest a negative future direction of the market (worth 0 points), a neutral view (5 points),
and a positive view (10 points). After all ten components have been evaluated, the total
points are added and divided by 10. The result is a single number, between 0 and 10, which
is interpreted as follows:
- 0 to 4.9: Negative outlook. The stock market is unlikely to rise over the short term.
5 to 10: Positive outlook. The stock market is likely to rise in the short term.
Q: What are the specific components of the Timing Outlook, and how is each of
them evaluated?
A: As indicated above, there are ten individual components. Here is a brief description of
each and how it is evaluated:
- 1. Economic indicator: Conference Board Index of Leading Economic
Indicators. The evaluation here is not so much concerned with the Leading Index's
value as with its direction. The Leading Index is calculated once per month, and it is
widely reported in the media and on the Conference Board's Web site. Interpretation:
- Rises for three straight months: Positive. + 10 points.
- Falls for three straight months: Negative: + 0 points.
- Neither of the above: Neutral: +5 points.
- 2. Interest rate indicator: Fed Funds rate. I consider a rate around 4% as "neutral."
If the Fed Funds rate is much lower than that, or if the Fed is actively lowering interest
rates, it is clearly trying to stimulate the economy, which would ordinarily be good for
stocks. If the Fed Funds rate is much higher than that, or if the Fed is actively raising
interest rates, it is trying to slow the economy down to ward off inflation, and that is
usually bad for stocks. Interpretation:
- Current rate is 3.5% or less and the Fed lowers rates: Positive: +10 points.
- Fed lowers rates three times in a row (from any starting point): Positive: +10
points. - Current rate is 4.5% or above and the Fed raises rates: Negative: +0 points.
- Fed raises rates three times in a row (from any starting point): Negative: + 0
points. - Any other condition: Neutral: + 5 points.
- 3 & 4. Market valuation indicators: I use two indicators: the P/E ratio of the S&P 500
compared to its own historical average; and the Morningstar Market Valuation Graph
from their Web site.
- S&P 500 P/E ratio: Standard and Poor's reports that the S&P 500's actual
average P/E, based on operating earnings, has been 19.3 since 1988, when
S&P first began reporting the index's operating earnings data. There have been
wide swings above and below that value. I use 19.3 as the "normal" S&P 500 P/E
benchmark ratio (book readers, note that this is lower than the value of 20 used
in the book), and I have created three "bands" by adding and subtracting 10%
from the long-term average to allow room for normal market volatility and noise.
Interpretation:
- P/E < 17.4: Positive: + 10 points.
- P/E > 21.2: Negative: + 0 points.
- Any other condition: Neutral: +5 points.
- Morningstar Market Valuation Graph: Morningstar creates a ratio that
compares the blended price of the 2000-or-so stocks that they cover to the
combined "fair value" that they calculate for all those stocks. A ratio of 1.0 means
that, on average, Morningstar feels that stocks are fairly valued. Again, I create
bands by allowing a variance of 10% in either direction. Interpretation:
- Ratio < 0.9: Positive: + 10 points.
- Ratio > 1.1: Negative: + 0 points.
- Any other condition: Neutral: + 5 points.
- 5 through 10. Market trend indicators. I use six simple trend-following technical
indicators, two each for the Dow, the NASDAQ, and the S&P 500. The two indicators for
each index are (a) a very-short-term indicator (using the 20-day and 50-day simple
moving averages, or SMAs), and (b) a longer indicator (using the 50-day and 200-day
SMAs).
The calculations for all six are identical and straightforward:
- If the index is above the shorter SMA, which is itself above the longer SMA, that
is considered a confirmed upward trend. Interpretation: Positive: +10 points.
- An example makes this indicator easy to understand. If the actual value of the S&P 500
is above its 50-day SMA, that means the index is leading or pulling the 50-day SMA
upward. And if the 50-day SMA is also higher than the 200-day, that means the index's
value has been generally trending upward for quite a long time (200 trading days is
the equivalent of 40 weeks). A glance at a chart of the index, with the two SMAs
superimposed, would show that at some point, the shorter SMA passed up through
the longer SMA, creating what is known as a "golden cross." So the implication from
that situation (actual > 50-day > 200-day) is that the index is in a long-term uptrend.
- If the situation is exactly reversed, we have a negative situation, where the index
is clearly in a downward trend. This would be the case where the index itself is
below the shorter SMA, which is in turn below the longer SMA. Interpretation:
Negative:+0 points.
- At some recent time, the index will have pulled the shorter SMA down through the
longer SMA (known as a "death cross").
- All other situations--where the index and the two SMAs are not lined up as just
described--is considered ambiguous and neutral. No trend is inferred.
Interpretation: Neutral: + 5 points.
evaluated?
A: The points for the individual components are simply added up and divided by 10. The final
result is a number from 0 to 10. As stated above, that number is interpreted as follows:
- 0 to 4.9: Negative outlook. The stock market is unlikely to rise over the short term.
5 to 10: Positive outlook. The stock market is likely to rise in the short term.
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