This “single biggest predictor of future stock market returns” has fallen sharply – that’s a bullish sign

Chapel Hill, North Carolina – Much of the bull market’s excess has been addressed, according to the “Single Greatest Predictor of Future Stock Market Returns.” This is good news.

I’m referring to the index, first proposed by the Philosophical Economics blog in 2013, which is based on the average family portfolio allocation to stocks. It’s a contrarian indicator, with higher equity allocations correlated with lower subsequent market returns, and vice versa. According to its econometric tests and other known rating indicators, it actually has one of the best – if not the best – track records predicting the S&P 500’s SPX,
-1.67%
The next real total return for 10 years.

According to the Federal Reserve’s recently released data, over the last calendar quarter this indicator has seen one of its biggest (and therefore bullish) declines since the early 1950s, which is how far the prior data extends. But for the quarter that includes the March 2020 waterfall drop that accompanied the initial shutdown of the COVID-19 pandemic, you have to go back to the last quarter of 1987 — which included the worst crash in stock market history — to find the quarter in which this indicator fell as much as it fell in a quarter June this year.

As of mid-year, that index was 44.8%, down from 51.7% at the end of last year. In the lowest levels of seven bear markets in the last 25 years on the calendar held by Ned Davis Research, the index averaged 37.1%. So from a 14.6 percentage point spread above that average that was there at the end of 2021 value, 6.9 percentage point spread – or nearly half – has now run.

The index is almost certainly lower today than it was in the middle of the year. We don’t know because the data on which the index is based is only updated every three months, and even then with a two-month difference. The latest update, reflecting the end of the second quarter, was released on September 9. The next update, which will reflect the data for the end of September, will not be released until December.

You might object to the positive spin I put on the index decline by saying that the reason for this is nothing more than a decline in the value of household stocks. But this can only be a small part of the explanation, because the bonds have been in a bear market of their own; Year-to-date decline in Long-Term Treasurys TMUBMUSD10Y,
3.710%And the
For example, it is actually bigger than DJIA in the stock market,
-1.32%

COMP,
-1.97%.
Instead, the decline in the index means that the average family has significantly reduced its commitment to stocks.

more: US stocks suffer biggest weekly outflow in 11 weeks

Plus: Investors poured $83.4 billion into these 10 bond funds last year. But here’s what happened

All of this means that the bear market is doing its job. The very primary role that bear markets play in a market cycle is to bring the market back down the farther it gets ahead of itself. And that was certainly the case with this indicator at bull market highs at the end of last year, when it was tied for being the highest ever (linked to the top of the internet bubble, as you can see from the accompanying chart).

To appreciate the work this bear market has already done, consider a simple econometric model that you created that bases its forecast on the historical relationship between an index and the stock market. This model now predicts that the total return of the S&P 500 will closely match inflation over the next decade. This is in contrast to a forecast of minus 4.6% annually at the start of the year and 3.3% annually by the end of the first quarter.

Keeping up with inflation may not excite you, but it’s much better than losing 4.6% annually for 10 years. Keeping up with inflation is probably better than what long-term bonds will do over the next decade.

Valuation indicators do not support the new bull market yet

Separately, the table below shows how my eight rating indicators stack up against their historical range. As you can see from the column comparing current valuations to those prevailing at the end of last year, market valuations today are much more attractive than they were in January.

else

A month ago

the beginning of the year

Percentage since 2000 (declining percentage)

Percentage since 1970 (100th lowest)

Percentage since 1950 (declining percentage)

P/E Ratio

19.68

20.57

24.23

36%

59%

69%

CAPE نسبة ratio

28.35

29.83

38.66

70%

80%

85%

P/E Ratio

1.75%

1.59%

1.30%

70%

80%

86%

Price to sales ratio

2.32

2.45

3.15

89%

89%

89%

P/book ratio

3.74

3.93

4.85

90%

86%

86%

Q . ratio

1.59

1.67

2.10

73%

86%

90%

Buffett’s Ratio (market cap/GDP)

1.54

1.62

2.03

88%

95%

95%

Average family share allocation

44.8%

49.7%

51.7%

85%

88%

91%

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert rating tracks investment newsletters that pay a flat fee to review. He can be reached at mark@hulbertratings.com.

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