Regression to Trend: New S&P 500 Update (dshort.com)

Tuesday, April 28th, 2009

Doug Short (dshort.com) provides useful analysis to make the point statistics however reliable or unreliable can cause us to change or modify our perspective. For example, Has the US Government been reporting reliable inflation data since the elimination of the Gold Standard in 1971? Or are the inflation stats according to economist John Williams of shadowstats.com more in keeping with reality.

After all, we’re aware that our cost of living has risen faster than our incomes, right? So what happens when we apply this standard of thought to the long term trend regression in the market? This is what Doug Short has done here. Take a look, you might be surprised:

About the only certainty in the stock market is that, over the long haul, overperformance turns into underperformance and vice versa. Is there a pattern to this movement? Let’s apply some simple regression analysis to the question.

Bearish View

Here’s a chart of the S&P Composite stretching back to 1871. The chart shows real (inflation-adjusted) monthly averages of daily closes. We’re using a semi-log scale to equalize vertical distances for the same percentage change regardless of the index price range. The regression trendline drawn through the data clarifies the secular pattern of variance from the trend — those multi-year periods when the market trades above and below trend.

The Bearish View
The peak in 2000 marked an unprecedented 154% overshooting of the trend – double the overshoot in 1929. The index had been above trend for 17 years, but it has now fallen 9% below trend. The major troughs brought declines in excess of 50% below the trend. If the S&P 500 were sitting squarely on the regression, it would be hovering around 830. If the index should decline over the next year or two to a level comparable to previous major bottoms, it would fall to the vicinity of 425-450.

The Bullish Alternative
A critical factor for the reliability of a regression analysis of stock prices over many decades is the accuracy of the inflation adjustment. The Bureau of Labor Statistics (BLS) has been actively tracking inflation since 1919 and has estimated inflation rates back to 1913 using data on food prices. In 1982, however, the BLS began incorporating changes to the Consumer Price Index (CPI), which is used to calculate inflation. These changes have resulted in much lower “official” inflation rates than would have been the case if the method of calculation had remained consistent.

At his www.shadowstats.com website, Economist John Williams publishes an “Alternate CPI” employing the earlier BLS method. Here is a chart that illustrates the significant difference between these two calculation methods.

Bullish View

Statistics and handicapping are funny that way. They can warp our perceptions in immeasurable ways. Which one do you agree with? Are you bullish or bearish?

We side with Doug Short, that the answer is somewhere in between.

Tags: 17 Years, According To John, Bls, Bottoms, Bureau Of Labor, Bureau Of Labor Statistics, Consumer Price Index, Critical Factor, Deca, Declines, Economist John, Food prices, Gold Standard, Incomes, Index Cpi, Index Price, Inflation Adjustment, Inflation Data, Inflation Rates, John Williams, Long Haul, Overshoot, Percentage Change, Regression Analysis, Simple Regression, Stock Market, Stock Prices, Term Trend, Troughs, Variance, Vertical Distances
Posted in Gold, Markets | 2 Comments »

NFP = 18,000

Friday, January 4th, 2008

Barry Ritholtz’s blog The Big Picture featured this story today, Non-Farm Payroll (jobs) grew by a stunningly disappointing 18,000, which further reinforces the likelyhood the Fed will cut, probably by at least 50bps at the next FOMC meeting, on the back of this recessionary news.  
 
Mr. Ritholtz’s highly acclaimed blog is by far one of the best on the web.

Wow, that’s a pretty ugly chart above.

Here are the details, via BLS:

“The unemployment rate rose to 5.0 percent in December, while nonfarm payroll employment was essentially unchanged (+18,000), the Bureau of Labor Statistics of the U.S. Department of Labor reported today.

Job growth in several service-providing industries, including professional and technical services, health care, and food services, was largely offset by job losses in construction and manufacturing. Average hourly earnings rose by 7 cents, or 0.4 percent.”

So, December NF Payrolls rose much less than expected, up a marginal 18,000 — or as BLS described it, largely unchanged – versus a consensus of 70,000. This was the lowest reading since August 2003. Construction job losses are now finding their way into the data, regardless of the aforementioned Birth Death adjustment.

Unemployment rate rose to 5.0%, the highest in 26 months. As we have noted repeatedly in past months, to keep up with population growth requires ~150k new jobs to be created each month. Given the number of months we have seen below that level, an uptick in unemployment was inevitable.

The spin coming from the usual sources will be that this poor showing was the result of the August credit crunch, and is therefore likely to be a temporary phenomena.

I disagree. 

These same folks will point to the increasing odds of a 50 bps cut at the January meeting. Those futures have risen to 44% from 36% yesterday. Unfortunately, the Fed finds itself somewhat hamstrung by elevated inflation, $100 Oil and $850 Gold as signs proof of inflation.

~~~

Coming on top of the slowing Housing market, weak income levels, ISM manufacturing index, and auto sales, this is further evidence to the building thesis that a recession is increasingly likely.Sources:Employment Situation Summary   
BLS, DECEMBER 2007
http://www.bls.gov/news.release/empsit.nr0.htm 

   BLS, DECEMBER 2007http://www.bls.gov/news.release/empsit.nr0.htm    BLS, DECEMBER 2007http://www.bls.gov/news.release/empsit.nr0.htm  

Fed’s Inflation Fears Might Trump
Calls for Another Big Rate Cut Monetary-Policy Makers
Appear to Have Less Room To Maneuver Than in Past
GREG IP
WSJ, January 4, 2008; Page A3
http://online.wsj.com/article/SB119940394997266181.html

Tags: Average Hourly Earnings, Barry Ritholtz, Birth Death, Blog, Bureau Of Labor, Bureau Of Labor Statistics, Chart, Construction Job, Credit, Credit Crunch, Credit Market, Desc, Earnings, Economy, Fed, Food Services, Gold, Housin, Housing Market, inflation, Likelyhood, New Jobs, Next Fomc Meeting, Nfp 18, oil, Payroll Employment, Population Growth, Recession, REW, risk, Services Health, The Big Picture, Thesis, U S Department, U S Department Of Labor, Unemployment Rate, Uptick
Posted in Credit Markets, Gold, Markets, Oil and Gas | No Comments »