By Mark Hulbert
A year from today, the Russell 2000 Index may be only 0.1% higher.
That’s the prediction of a valuation model based on a single number published each week in the Value Line Investment Survey . That number represents the median of the projections made by Value Line’s analysts of where the 1,700 widely followed stocks they closely monitor will be trading in three to five years’ time.
That indicator is the focus of this month’s review of valuation indicators. A month ago , you might recall, I focused on eight long-term valuation indicators with good track records predicting the stock market’s subsequent 10-year return. A number of you asked that I also focus on other indicators whose forecasts apply to the shorter term. I’m happy to oblige.
(I am not giving up on those eight longer-term indicators, I hasten to add. Their current status appears in the table at the end of this column. A full description of each indicator is available in my column a month ago .)
Market timers refer to this month’s shorter-term indicator based as VLMAP, which stands for Value Line’s Median Appreciation Potential. The timers translate the number into a return forecast by searching for the formula that, when applied to the VLMAP, best fits the historical data. One who has done the necessary econometric modeling is Daniel Seiver, a member of the economics faculty at California Polytechnic State University and editor of an investment advisory service named The PAD System Report . (Disclosure: Seiver’s newsletter is not one of those that uses my firm to audit its returns.)
In a study that appeared in the Journal of Wealth Management in 2013 , Seiver reported that the VLMAP has a statistically significant ability to forecast the market’s returns over periods as short as one year. While that’s not short enough to indicate where the market will be in a couple of weeks or months, this prediction horizon is still a lot shorter than 10 years.
I replicated Seiver’s analysis by focusing on the Russell 2000, which reflects the small-cap and mid-cap universe that perhaps is a better representation of the median stock in the Value Line universe. Since 1978, when this benchmark was created, the VLMAP has been able to explain or predict 22% of the variation in subsequent 12-month returns. While this is a lot lower than 100%, note carefully that no indicator is able to predict the stock market with 100% accuracy; in fact, most of the indicators that capture Wall Street’s attention have no statistically significant explanatory ability whatsoever.
In reaction to the bearish message of the eight longer-term indicators I focused on one month ago, many of you complained that their bearish posture won’t change much from month to month. One of the virtues of the VLMAP is that its forecast changes much more often. In April, for example, in the wake of the stock market’s waterfall decline in February and March, Seiver flashed a buy signal based on the VLMAP .
In the following table, the three right-most columns are the percentile that the last value represents — 0% means it is the most bullish it has ever been, while 100% means it is the most bearish it has ever been. (Scroll the table to see all the data.)
Unfortunately, the VLMAP since then has retreated significantly from its bullish posture then — as evidenced by its forecast that the Russell 2000 will rise by just 0.1% over the next 12 months.
As I invited you to do a month ago, please continue to send me (at the email below) your suggestions of valuation indicators that you would like to see added to this monthly review. If they have a statistically significant historical ability to forecast the stock market, I will add them.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com