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.
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