The Best Stock Market Signal I've Found

I have to thank PIMCO's Bill Gross for helping me find this fantastic stock market signal, which I'm 100% sure nails it every single time. Yes, I said every... single... time.

It was in this month's PIMCO investment outlook that Gross declared the end -- or at least the progressing death -- of the "cult of equity." It wasn't a view that was received favorably and I even took a shot at picking it apart.

But what struck me was that the tone of Gross' view on stocks and the extremely dour prediction perfectly reflected the past 15 years of stock market returns. Over that period, the S&P 500 (INDEX: ^GSPC  ) has returned an average of 2.8% annually, which is pathetic.

So, I got to wondering: Could we use commentator and media views as a consistent predictor of past returns? Let's take a look.

1964-1965
In early 1964, The St. Petersburg Times ran an article titled "Investing -- for the long pull..." Here's how it began:

For many years now we've been trying to get more and more people to invest in good common stocks. ... [W]e've always felt that the odds on making money were all in favor of anyone who invested in the stocks of leading American companies. Now we feel more convinced than ever -- thanks to the recent report issued by the Center for Research in Security Prices at the University of Chicago.

Even a monthly decline was cause for bullishness, as covered in The Robesonian in mid-1965: "The tumble of stock market averages from their May 14 peak has brought many issues to a level that makes their yields much more attractive to long-term investors."

In late 1964, Kiplinger's wrote: "The stocks that should be invested in, of course, are stocks that can be expected to participate in the long-term rise that seems to lie ahead -- stocks that not only will keep up with the Dow-Jones Industrial Average but that will outpace it."

That excerpt was followed by a chart showing what would happen if gross national product, Dow Jones (INDEX: ^DJI  ) company earnings, and stock prices all continued to rise at the current rates for the next five years.

Optimism could be seen in book titles as well, as that year saw the publishing of Growth Opportunities in Common Stocks, Common Stocks as Long-Term Investments in the Nineteen-Sixties, and Techniques for Maximum Market Profits: A Guide to Pre-Selecting Growth Stocks.

Now, the big question: Did all that optimism accurately predict a bull market over the previous 15 years? You bet! As of mid-January 1965, the S&P had averaged 11.5% annual gains over the previous 15-year period.

Perhaps this was just a fluke. Let's look at another.

1974
The tone got notably more dour this year, and it was tougher to find the media talking about stock investing for the long term. Let's head back to the St. Petersburg Times, to a May 1974 article titled "Interest Rates Makes Buying Bonds Attractive." "At these rates," the author noted, "high-grade bonds are rivaling the long-term growth record for common stocks."

Coverage from the Ellensburg Daily Record, also from May of '74, takes an even harsher tone:

"There is a danger of a near term violation of the 790 to 800 by the Dow Jones Industrial which could well lead to an acceleration of the decline building up to a final climax," says Merkin & Co. Inc. ... "many erstwhile attractive stocks disintegrate in the atomic shock waves of inflation and towering interest rates," says Paine Webber Jackson & Curtis Inc. Some stocks have taken such a beating that they will not recover fully even if the market has a peaceful summer, it continues.

I ran across a New York Magazine article castigating Bear Stearns over "special offerings" and Kiplinger's ran a column titled "Stocks: There's a Time to Sell, Too." It appeared that there were far fewer books on investing in stocks published this year, though Speculation in Gold and Silver Mining Stocks managed to make it into print.

And how did all of this pessimism translate into backward-looking, 15-year returns? Happily for my system, quite well! By midway through 1974, the 15-year trailing returns for the S&P 500 had been just 48%, or a measly 2.7% per year.

Score another point for my indicator!

1982 and 2000
I continued testing with 1982, another year that had a paucity of new books on stock investing, but saw another gold-focused book -- Gold Versus Stocks, Bonds and Money Markets in Six Countries -- published. Kiplinger's recommended utility stocks because the "economic slowdown" made "basic services" a good choice for investors. New York Magazine quoted E.F. Hutton chief economist Edward Yardeni saying:

This is not a normal cyclical recession. If it were, the market would be bounding up at this point. The fundamentals are missing that would convince you that the worst is over. I think there is a lot of wishful thinking that the economy will soon improve and that we'll see compromise in Washington on the budget.

Once again, that pessimism was reflected in the preceding market returns. For the 15 years ending in mid-1982, the S&P returned an average of 1.3% per year.

And we all know about 2000. Among the books published in that run-up (1997 to 2000) were: All About Stocks: The Easy Way to Get Started, The Neatest Little Guide to Stock Market Investing, Stock Investing for Everyone: Tools for Investing Like the Pros, 10 Minute Guide to The Stock Market, The 100 Best Stocks to Own for Under $20, The Beardstown Ladies' Pocketbook Guide to Picking Stocks, and The Bluffer's Guide to Stocks & Shares.

If you weren't investing in stocks in 2000, people thought you were some sort of alien. Or just dumb. And, of course, that optimism once again reflected past returns -- as of the end of 1999, the S&P 500 had returned a massive 15.2% per year over the previous 15 years.

The burning question
Now that I've proved without a shadow of a doubt that the present-day media commentary on stocks perfectly reflects the returns over the previous decade and a half, some of you may be thinking to yourselves, "That's almost completely useless to me, does this tell us anything about the future?" Alas, it doesn't.

You see, while pundits and market "experts" have been great about reflecting past returns in their commentary, their views haven't been as on point for future returns. Take a look at the time periods we examined.

Time Period

Nature of Commentary

Annualized Returns for Previous 15 Years

Annualized Returns for Subsequent 15 Years

1964-1965

Bullish

11.5%

1.7%

1974

Bearish

2.7%

8.9%

1982

Bearish

1.3%

14.4%

2000

Bullish

15.2%

(4.6%)*

Today

Bearish

2.8%

?

Sources: Yahoo! Finance and author's calculations. *Not a full 15-year period -- spans Dec. 31, 1999 through Aug. 23, 2012.

As you can see, it appears that when it comes to predicting the future, the views from the media and commentators didn't seem to be in line with future returns. In fact, it appears that almost the exact opposite happened.

Could that mean... no... wait... could it mean that commentators are often exactly 180-degrees wrong when it comes to trying to predict future returns?

Yes, I know, that's just plain crazy, right? Yeah, let's banish the thought, there's no way that the "experts" could possibly be that wrong.

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Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 28, 2012, at 8:50 PM, lr280807 wrote:

    Why did you exclude the 1997-2000 period from your chart and analysis? Why are your twisting reality ?

  • Report this Comment On August 28, 2012, at 10:03 PM, DonkeyJunk wrote:

    ^ What?

  • Report this Comment On August 29, 2012, at 11:01 PM, MHedgeFundTrader wrote:

    One of my best calls of the year was to plead with readers to avoid gold like the plague, periodically dipping in on the short side only. The barbarous relic has been in a bear market since it peaked at $1,922 an ounce at the end of August last year. Gold shares have fared much worse, with lead stock Barrack Gold (ABX) dropping 36% since then and the gold miners ETF (GDX) suffering a heart rending 43% haircut.

    However, the recent price action suggests that hard times may be over for this hardest of all assets. Despite repeated attempts, the yellow metal has failed to break down below the $1,500 support level that I have been broadcasting as the line in the sand.

    It has rallied $170 since the last try a few weeks ago. (GDX) has performed even better, popping 20%. For the last month, the entire precious metals space has traded like it was a call option on global quantitative easing (see yesterday’s piece). Dramatically worsening economic data is increasing the likelihood of further monetary easing generating a nice bid for gold.

    Now the calendar is about to ride to the rescue as a close ally. It turns out that in recent years, there has been a major seasonal element to the gold trade, almost as good as the November/May cycle that drives the stock market. Gold typically sees a summer low. Then traders start anticipating the September Indian wedding season when the purchase of gifts and dowries become a big price driver. That explains why India, with a population of 1.2 billion, is the world’s largest gold buyer.

    Next comes the Christmas jewelry buying season in western countries. That is followed by the gift giving and debt repayments during the Chinese Lunar New Year, during which we see multi month peaks in the yellow metal. That is exactly what we saw this year. The only weakness in this argument is that a slowing Chinese economy could generate less demand this time.

    These are heady inflows into such a small space. All of the gold mined in human history, from King Solomon's mines, to the bars still in Swiss bank vaults bearing Nazi eagles (I've seen them) would only fill 2.5 Olympic sized swimming pools. That amounts to 5.3 billion ounces, about $8.6 trillion at today's prices. For you trivia freaks out there, that is a cube with 66 feet on an edge. China is the largest producer (13.1%), followed by Australia (10%) and the US (8.8%).

    Peak gold may well be upon us. Production has been falling for a decade, although it reached 94 million ounces last year worth $153 billion at today’s prices. That would rank gold 5th as a Fortune 500 company, just ahead of General Electric (GE). It is also only .38% of global public debt markets worth $40 trillion.

    That is not much when you have the entire world bidding for it, governments and individuals alike. Talk about getting a camel through the eye of a needle! We may well see the bull market end only when those two asset classes, government bonds and gold, see outstanding values reach parity, implying a major increase in gold prices from here. That is well above my own personal target of the old inflation adjusted high of $2,300. No wonder buying is spilling out into the other precious metals, silver (SLV), platinum (PPLT), and palladium (PALL).

    The thumbnail technical view here is that we have broken the 200 day moving average at $1,649, so we may have a clear shot at a new high. There may be an easy $100 here for the nimble, and more if we break that. The current global mood for more quantitative easing and lower interest rates certainly help. If you had any doubts for the need for such easing, taking a look at the chart below showing global Purchasing Manager Index’s heading in a clear southerly direction.

    Not that it needs it, but gold is about to get some free advertising at this week’s Republican national convention in Tampa, Florida. The right wing of the party has long advocated a return to the gold standard, and a Romney win could take us closer to that goal. I don’t think there is a chance in hell of this every happening, as it would be hugely deflationary. Still a vocal and very public discussion of the topic can’t be bad for gold prices.

    When playing in the gold space, I always prefer to buy the futures or the (GLD), the world’s second largest ETF by market cap, either outright or through a longer dated call spread. The dealing costs are far too high for trading physical bars and coins, and can run as high as 30% for a round trip.

    Having spent 40 years following mining companies, I can tell you that there are just way too many things that can go wrong with them for me to risk capital. They can get nationalized, suffer from incompetent management, hedge out their gold risk, get hit with strikes or floods, or get tarred by poor equity market sentiment. They also must endure the highest inflation rate of any industry, around 15%-20% a year, which hurts the bottom line.

    Better just to stick with the sparkly stuff.

    The Mad Hedge Fund Trader

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