2019 Stock Prediction

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Happy New Year! Hope 2018 has been a blast, and I wish everyone a fantastic upcoming 2019! It’s been a while, but I’m feeling inspired today to write. I want to revisit my stock market prediction at the beginning of 2018, and provide some updated comments on how I think the market will progress going forward. Typing this post now, I realize there is a lot more information to present then I intend to write (it’ll also become extremely lengthy), so if you have questions or want to to hear more, do feel free to reach out and I can elaborate more.

 
As a quick refresher, on Jan 22, 2018, I concluded my 2018 stock market prediction post with the following summary:

My prediction for the S&P500 index, and the U.S. equity market more generally, is the end of the current bull-market near the beginning of 2019 with a peak price level of ~3360 (with an estimated ‘max melt-up’ to ~3600 and an estimated ‘early stoppage’ at ~2800). An accompanying market crash is likely, with no end in sight yet to this next bear market (currently, at least through to 2027).

It turned out that indeed the market has been through some turbulent times in 2018, especially the latter half, with a peak S&P500 index price of ~2940 in mid-September of 2018, right between my levels for ‘early stoppage’ and ‘peak price’. Granted the range I provided is quite wide, so the actual peak price this year falling in that range isn’t too impressive, but I am quite impressed that the predicted timing of the top of this bull market has been correct (at least so far). Turning toward the second part of the summary, my prediction then and still now, is going forward for the next 10 years, I expect equities to perform very poorly with average annual returns near ~0%. This has yet to be proven true, but I did want to share two key points to show why I feel this will occur.

 

Point 1 – Valuation-Based Measure Predicts Poor Returns

First, below is the key chart that I used previously in the original 2018 post to make my stock prediction for 2018, except I have now extended the chart from 2014 through to 2019 using the updated data we have today.picture2As a refresher, the chart shows on the left y-axis the compound annual growth rate over 10 years (shown by the black line) starting from any chosen year indicated on the x-axis. On the right y-axis is an Allocation Score (shown by the red line), that corresponds to the degree of allocation to equities, which is reported quarterly from the Fed. To interpret the Allocation Score, we can see that a less negative score, which roughly means that current allocation of investments to equities is low, tends to result in high future returns, and vice versa for more negative scores, which translate into high current allocation to equities and poor future returns.

In fact, the correlation between the Allocation Score and Annual Return Rate over 10-years from 1951 to 2009 is 0.903! This can be seen by how close the predicted return rate (in red) tracks the observed return rate (in black). I also made one special addition to this updated plot. Technically, the annual return rates past 2009 have yet to be fully observed, so the observed return rate after the vertical dotted black line at the start of 2009 is imputed by setting the future SPX500 price to be the same as today’s price from 2019 to 2029. This way we can make use of as much data as we have – for example, for 2012, we do already have 6 years of results from 2012-2018, and then the last 4 years of results will be imputed to be 0% – to get a sense of how accurate the predicted annual return rate is likely to be beyond 2019 (the closer to 2019 we go, the less likely the actual observed annual return rate will be accurate, since more of each 10-year period is imputed at a annual rate of 0%). In any case, the key point is that the correlation observed up to 2004 was 0.911 when the relationship was first presented, and has continued to remain high (correlation of 0.974) in the future years from 2004 through to 2009 in this ‘out-of-sample’ period, suggesting the Allocation Score is potentially a reliable indicator of returns going forward. It currently sits at ~0% over the next 10 years.

 

Point 2 – Financial Conditions are Tightening

Second, the Fed and other central banks are raising rates and tightening liquidity via quantitative tightening or diminished easing. This means that the influx of ‘money’ into the system that has been a huge contributor to rising assets prices is drying up and reversing, which means economic growth must be able to supplement for that withdrawal of ‘money’ to keep asset prices at these high prices. Unfortunately, economic growth has been anemic at best in comparison to past boom periods. Another way to think of this is the default risk-free rate that the US government pays increased from 0% -> 3%, and many investors are likely to take money out of recently poor performing equities to obtain a much safer guaranteed return in US government bonds, because now there is actually an option to make risk-free money (remember before at 0%, you’re aren’t earning anything with the risk-free rate so you are forced to go to something riskier to get yield). There’s a lot more details here that I’m brushing over, but the key message is that financial conditions are tightening, which often precedes market crashes and recessions. Ray Dalio has a series of articles that does a great job of explaining this in his debt-cycle framework.

 

Summary

  • Due to this backdrop, I feel that now is NOT the time to be invested in equities, as the expected return rate of ~0% is too low to justify the risk. Chances are a market crash is forthcoming as the central banks around the world continue to tighten financial conditions.
  • To confirm this prediction, I would like to see economic indicators, like the ISM to continue lower (e.g., below 50% and into recession territory) and the US unemployment rate begin to increase. I would also like to see price confirm this prediction with lower highs and lower lows in a sustained high volatility environment.
  • I would be worried my prediction is incorrect if economic indicators continue to be strong, and the US reaches new highs on the back of a reversal from tightening to easing by the Fed (and followed by other central banks).
  • In the short term, it is very possible for the market to bounce as technical conditions are oversold, but I would sell the rally and not expect upside to be sustained in 2019. Ultimately, I expect the 2019 year-end stock price to be, at best, at its current level of ~2500 and more likely to be much lower.

Financial Independence 101

tl;dr To achieve financial independence, you need to focus on generating enough passive income to cover your expenses. Three strategies to generate passive income are: (1) be a lessor, (2) create re-usable content, and (3) hire other people to work for you.

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Financial independence is worth achieving because you will gain freedom and security.

I don’t know about you, but I really dislike worrying about money. Not having enough money makes me feel restricted and insecure. It can hinder my ability to provide for that ones I care about, prevent me from doing the things that I’m most passionate about, and control my life with incessant worry and stress. Too often we find ourselves grinding our lives away, just to earn enough to be able to wake up and do it again. And I want out, and so should you.

Picture this. Imagine you wake up the next day and you have all the money you need to satisfy your basic needs – money to buy a nice house, eat good food, pay your bills, etc. What would you do with your time? How would you feel? That’s the financial independence dream. You’ll be free to do whatever you like and you’ll feel secure because all of your basic needs will be provided for. It doesn’t necessarily mean you’re going to be happy, but it sure as heck will make it easier.

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To achieve financial independence, you need to increase your revenue above your expenses without using up all of your time.

A simple definition of financial independence (FI) is the money you earn – your revenue – needs to be greater than the money you spend – your expenses – AND the way you earn that money is passive, i.e. does not eat up all of your time. The most common example of being able to cover your expenses, but still be financially dependent, is the typical 8+ hour-a-day job. You earn enough each year (hopefully) to cover your expenses, but it takes up roughly 70% of your time to do it (based on working 5 days a week). In order to maintain your financial security, you have to actively work, and the moment you stop working, then the revenue stops coming in. To achieve FI, you’ll have to find a way to earn revenue without actively working to earn that revenue.

To make this clear, let’s first start with the two ways to get your revenue to be greater than your expenses: (1) decrease your expenses and (2) increase your revenue.

Decreasing your expenses will definitely help toward FI – theoretically if you had no expenses, then you’d achieve FI – but in reality, there is a limit to how low your expenses can be. Attempting to live the rest of your life being extremely frugal to maintain minimal expenses is not the life most people want to live. Balancing expenses by setting priorities and budgeting to find your personal spending sweet spot would be a topic for another day, but the point is decreasing your expenses will only take you so far. To achieve FI, you’ll have to figure out how to increase your revenue.

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The standard approach to increase your revenue is by increasing your revenue rate, $ / Time.

The standard approach to increase your revenue can be illustrated by this equation:

Revenue = $ / Time * Time

Where $ / Time could be your hourly rate, Time could be the number of hours you worked, and Revenue would be the amount of money you made in total.

One way to increase your revenue would be to increase $ / Time. This could be accomplished by going to school and getting an advanced degree. Then when you search for a job, companies will pay you a higher salary because of the unique value you are able to bring with your advanced skills. And as you gain more experience and seniority, your salary will increase even more and so will your revenue.

The other component in this equation, Time, can also be increased to increase revenue, but it has a hard limit. Similar to trying to decrease expenses, the amount of time spent working is limited both theoretically by the number of hours in a day, and emotionally and physically, by the amount of work a person can reasonably sustain. More importantly, FI is about trying to free up your time and spending more time actively working would be doing the exact opposite.

The problem with the standard approach is, regardless of how high you can reasonably increase your revenue rate, $ / Time, it will always require you to actively spend time working to generate revenue. The day when you become too old to work, or suffer a serious health calamity preventing you from working, then instantly your revenue drops to zero, and you’re once again financially dependent. Most of us are well aware of this issue and try to prepare for it by saving some money, while we’re still working, so when the day comes for us to retire and our revenue stops coming in, we will still have our savings to carry us through retirement. Unfortunately, many of us fail to save much money at all (65% of Americans have little or nothing). It’s hard enough just trying to support our expenses now to worry about our money problems in the future.

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Instead of focusing on $/Time to maximize revenue, remove Time from the equation.

The solution is to stop following the standard approach and remove Time from the equation by replacing it with a completely different variable. For example, if you are a software engineer, instead of working for a company to complete their projects, where you are paid based on the hours you work, try to find a way to work for yourself and complete your own project, where you can be paid based on the number of times your software is used. This could be an app, like Flappy Bird, that you could sell and market through Apple’s App Store (Flappy Bird earned $50,000 dollars per day in advertising income!). The key change is you now would be paid by $ / Download or $ / App Purchase instead of $ / Time. The revenue you earn is no longer limited by the amount of time you can spend working, but is instead limited by the number of users you can get.

Another example of a feasible approach to FI is to combine the standard increase  $ / Time approach with passive investing. If your active earnings well surpasses your expenses, then you’ll have money left over to build up a giant savings nest egg over time. By investing it in equities and bonds, you can create a growing source of passive revenue that one day replaces your active income. The reason this works is because you’ve gradually replace the revenue you used to earn based on $ / Time into revenue that is based on $ / Size of Nest Egg. 

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The key is the method you use to generate and increase your revenue must be scalable.

The underlying reason why the two examples are more effective than the standard approach of trying to increase your salary is that they are both scalable. This means that you aren’t restricted in repeating or expanding your method of generating revenue. In the standard approach, regardless of how high you increase your revenue, you are restricted by the amount of time you have available to work. There is no way (at least yet) to clone yourself to allow you to work more hours. In the other two cases, you don’t have that restriction since you’ve removed time from the equation; you can always make more popular apps or re-invest any savings you’ve accumulated. This doesn’t mean that’s it going to be easy to do, but it does mean once you have setup a revenue stream, you still be able to find a new revenue stream (or expand on the existing one) because you don’t have to actively spend all of your time to maintain the original one.

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This scalability condition can be satisfied by searching for methods that can take in nearly unlimited resources, requires limited time to service, and generates a consistent return on investment.

When looking for potential methods to generate scalable revenue, important criteria to check for is: if it can take in nearly unlimited resources, requires limited time to service, and generates a consistent return on investment. For example, when creating a software app, this require you investing some initial resources – your time and money – for a limited period of time, which then generates a certain amount of revenue for an extended period of time. After app development and launch is over, you now have your time back with extra revenue that you can use to create another revenue-generating app. This process and be repeated over and over again, as long as there are users to buy your apps. Since it’s unlikely for you to run out of new users (and your user base refreshes every app), you can always re-invest more income and time into creating more revenue-generating apps.

An example of an approach that would not be scalable is a part-time gig as an Uber or Lyft driver. After you have made extra revenue as a driver, there’s no way for you to re-invest that income easily back into your driving to generate more income (maybe having a better phone or car could help a bit, but then what else could you do?). Also, driving for money is an active method to generate revenue, so it’s essentially amount to increase Time in the standard approach, except now you’re working two jobs instead of one.

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3 strategies to find scalable revenue generating methods are:

  1. Be a lessor
  2. Produce re-usable content
  3. Build a business

Three potential strategies to achieve passive income by changing Time into a different variable are:

  • Be a Lessor – a lessor is a person who owns an asset and rents it out to the borrower for a specified period of time and in return, the borrower pays the lessor a fee. This can be a property owner, who rents out their basement floor of their house, or a money lendor, who lends their money as a loan at a certain interest rate (investing is essentially lending to a business in return for a portion of their returns). The transformation is changing $ / Time into $ / Assets, where the amount of assets you own to lend is what drives the revenue generated.
  • Produce re-usable content – this strategy is to utilize your creativity skills to create interesting content and charge a fee for users when they consume it. This can include blogs, youtube channels, e-books, etc. where people come to visit your site or channel and you make money per view through advertisements, or where people directly consume your content by purchasing your e-book. The advantage of this approach is you are only required to use a limited amount of time to first create the content, but afterwards the revenue you generate is mostly all passive. The transformation is changing $ / Time into $ / Use, where use is the amount of times your content is re-used.
  • Build a business – this is all about paying people to create value for you. Using the standard day-job approach before, if you could out-source your job by finding someone to do the work you do for less pay, then you’ve immediately removed your time out of the equation and replaced it with their Although you’ve likely lowered the rate of pay per hours worked, but now that working hours are all derived from someone else’s time, you are free to find more work and more workers. Another advantage is typically there are powerful synergistic effects when building a larger business by creating value that is only possible from the focused cohesive effect of a large group of people. The transformation is changing $ / Your Time into $ / Other Person’s Time.

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I’ll try to get into more details on tactics for each of these strategies in later blog posts, but I hope this general picture helps guide and encourage you toward achieving your financial freedom!

Paying the Price

When I was in middle school, I first started to learn the violin. I had been previously playing the piano for a few years before and my parents decided I should stop, as I wasn’t putting in enough practice time. So, it was a complete surprise to me when, one day, my dad mentioned that he was taking me to violin lessons in the afternoon. No one had asked me if I wanted to learn.

This began a tiresome journey in which I dutifully drew the violin bow back and forth, with my delicate fingers pressing on and off the tough steel violin strings, each and every day, until the end of highschool. Not everyone would describe their experience of learning to create beautiful vibrant music that can touch the soul as a tiresome duty, but for me that’s how I felt. I had not been given the choice to start, and although I consistently expressed my desire to quit, my parents would not allow me to stop. Their justification was simple: (1) it’d look good on college applications being part of a youth orchestra (which I did later join) and (2) the act of persevering was training my self-discipline.

I can’t say I agree with my parent’s methods, but as I look back today, I feel that they instinctively knew that the latter goal of self-discipline was crucial to be successful in life. They had survived the Cultural Revolution in China, where all young teens were sent to the country-side and forced into back-breaking labor 10-12 hours a day with barely any food to eat, and later when reaching adulthood would simply be callously assigned to a life-long job – possibly physically exhausting and with poor pay – by the government. The only escape was through education by scoring high marks on the college wide entrance exams (when schools were later reinstated), and to achieve that goal, would literally require burning the midnight oil studying after a long day of hard labor. Graduating from college meant easier and better paying white-collar jobs, and for a select few, the remote possibility to even go to America – the land of opportunity – to study. Thus to survive, self-discipline was a requirement.

My youth was not so stark in contrast. I did have my own struggles and challenges, but I never had to worry about not having enough food to eat (I was figuring out how to avoid eating certain vegetables), and I didn’t have to worry about being assigned to be a coal miner for life if I didn’t get good grades in school (at most, I’d be yelled at and grounded). Simply put, I was luckier; my parents had already made that sacrifice for me. I only kept playing violin because my parents instructed me to do so, and not because my life depended on it. And because of that difference, I don’t think I truly understood the why behind self-discipline, let alone what it really meant. For me, it was just about gritting your teeth and doing something you have to do that you don’t like, and in life, unfortunately, every once in a while you have to face one of those situations where only “self-discipline”, or rather coerced-discipline, can push you through. Developing that skill was very useful, but if I had the choice, which I would have more and more as I got older, I could always choose to avoid the difficult task by going on a different path…

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Recently I’ve been asking myself, “Why is it so difficult to achieve certain goals that I set for myself?” It wasn’t like I haven’t pushed myself before, like during in my violin training, and I was clearly trained to have some self-discipline, as my parents had sought to teach me this important skill when I was younger. Yet, this is probably the 10th New Year’s Resolution of wanting to get back into shape and become more healthy, and by the end of the year I’m always made little to no progress! Sometimes I would be more meticulous and lay out a grand detailed plan after doing quite a bit of research – even with daily food meals or pre-designed sets of exercises – but still, without fail, I failed to reach my health goals. What was I missing?

What I believe I was missing was true self-discipline. True self-discipline, rather than coerced-discipline, can be best explained using an example stemming from this quote: ‘if you want success, figure out the price, then pay it’. Everyone knows what success looks like – whether that means owning a luxurious mansion, having a rock hard toned body, or being a well-renowned CEO of a world-wide influential company – but we don’t look hard enough at the price we need to pay to achieve that success. When I was drawing up my plans to get healthier, my research helped me understand the science behind my plan, and my imagination helped me envision the physical specimen I wanted to be, but I did not intensely focus on the difficult path of day-in and day-out hard work and persistence to achieve my goals. What ultimately ended up happening was I would get stuck at a difficult pain point, where it was too uncomfortable to continue, or other times, my mind would find an excuse to not workout like I was too tired from work; and eventually, I’d stop doing anything at all and then I’d block out that I originally had set a fitness goal in the first place. It was much easier and more comfortable to lay on the couch and watch TV, than it was to put in the hard work to pay that bill. The version of self-discipline that I knew only occurred when someone else forced me to keep paying the price because I had to, but I didn’t have the self-discipline to choose, by myself, to consistently pay the dues required for what I wanted to achieve when it became too difficult.

True self-discipline isn’t magically granted to anyone who wishes, but it takes deliberate practice to improve. Success is not easy, otherwise everyone would have it! I was listening to Joe Rogan’s podcast on YouTube and I stumbled across the amazing story of David Goggins, who exemplified seeking to improve his self-discipline and mental will. This man used to be ~300 pounds and had a dead-beat job as a cockroach pest killer, and today is a Navy SEAL and one of the best ultra-endurance athletes in the world, having run over 200 miles in a 48-hour period nonstop, and having set the world record for pull-ups by completing 4,025 pull-ups in 17 hours. Not only are the physical feats mind-boggling, but there were multiple instances where he describes the agonizing physical pain that he pushed through to complete his goals that was unbelievable and awe-inspiring. His motto is to actively seek to be uncomfortable, because those moments are when we discover ourselves and grow. He believes our potential is limitless, but our mind limits our imagination of what’s possible because we too often languish in the mediocrity that comfort inspires.

To achieve my goals, I am going to have to accept that all success comes with a price, and that price is what I need to seek to pay, and then success will follow. I need to develop the ability to carry through the first tastes of discomfort, when my mind instantly grabs on to any reason why I can’t do it and how much better it would feel to stop, through to the hardest moments of intense pain, when I mentally scream to quit, because only then can I surpass the limits that my mind has habitually set for myself. The constant practice of putting myself in that uncomfortable position and choosing to push forward, like any muscle, will cause my self-discipline to get stronger and stronger. And with each step, my self-discipline will be able to help carry me through more and more difficult obstacles to achieve any success that I dare dream. This deliberate practice of seeking the uncomfortable is the key to growth.

And so, I’ve started a simple routine of waking up early in the morning before work, and running 3 miles non-stop, then pushing myself more from there. My primary focus isn’t the mileage or even the improved physical health, but instead is to seek out that point of maximum pain and desire to quit, to marinate in that feeling, and then to move forward and take as many steps as I need to finish those 3 miles without stopping. I do not regularly run and I absolutely detest waking up early, so it has been hard already. I can tell you now, after a few tries, my mind loves to find excuses to quit. My mind will tell me that my shoelaces don’t look tied tightly enough, or my lower back injury from years ago is acting up and I shouldn’t push too hard, or that I should stop at the end of mile 2 and walk a bit because my body is too tired in the morning. It’ll jump from a convenient excuse, to a logical compromise, to a tantrum, and back again just to get me to stop. I used to always listen and stop, but now I tell myself that I can’t and I won’t. Each time I say no, I make myself that one little choice better. By consistently seeking out that discomfort and making that choice to persevere every time, I know the improvements in my self-discipline will compound, and I will build the confidence in myself to achieve any goal I set my mind to because I know that I am willing and capable to pay any price that’s needed to achieve success.

2018 – The Last Dance

Introduction

To the readers of this blog, I should perhaps introduce myself before I begin my first post. I am a casual retail investor, who happens to have a background in statistics. My interest in investing started a few years back from a simple question of “how should I invest my earnings?” This was especially pertinent then, because I was finally no longer making meager graduate student pay. Since then I’ve been spending an ample amount of ‘outside-of-work’ time learning about investing basics, and a nagging desire has been gradually building to share some of my educational adventures. The hope would be to provide a useful tidbit of information to the readers, and if not, then at least bring some clarity to my own thoughts through the writing process. This blog may later expand to include other topics, not directly investing related, as I happen to stumble upon something that I find impactful or interesting. Lastly, for those who have been patiently waiting for me to take this initial plunge into writing (or for those whose ears hurt from hearing me talk about this desire, but not act), now I can finally say, “I’ve begun!”

2018 Market Prediction

I felt a great first topic would be to share my prediction of how the investing world will turn out in 2018. To be specific, my primary focus will be on the outlook for equity markets and in particular, the S&P500 index (an index tracking the ‘top’ 500 large- and mid-cap U.S. stocks), as this index is most relevant to casual U.S. retail investors like myself. As a forewarning, none of the discussion below should be construed as investing advice; to be realistic, out of all the predictions from great investors and analysts out there, my prediction – one from a self-proclaimed newbie – is more like a decaying straw of hay in a large haystack (rather than the prophetic needle we all would like to find).

There are multiple ways to approach the markets, and I find for myself that a quantitative approach often appeals most to my senses; numbers often feel more concrete for me as I can play with them to reach a better understanding. I’ll also try to always remember to ask, “why am I wrong?”, because only by searching for what we are missing, can we start to be prepared for when our predictions do miss.

The heart of my prediction stems from a great post in a fantastic blog, titled ‘The Single Greatest Predictor of Future Stock Market Returns‘. In the post, the author describes how to construct a predictor of future 10-year returns of the S&P500 index (SPX), that beats most of the other commonly used measures, and has a outstanding correlation of 0.913! The essence of the predictor is to capture the degree of allocation to equities by investors, where the higher the allocation the lower the future 10-year returns, and the lower the allocation the higher the future 10-year returns (key chart is shown below; x-axis is time in years, left y-axis is average investor equity allocation, and right x-axis is future SPX 10-year total returns annualized).

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The author does a great job breaking down why this predictor makes sense. Intuitively, the idea is if most investors have already piled in to the market, then it would be much harder to find additional investors to keep pushing-up the market. The above chart illustrates that this phenomenon does actually occur. If you follow the red-line, which represents the investor equity allocation, you’ll find that when the red line is low historically, subsequent SPX annualized 10-year total returns, as indicated by the blue line, tend to be elevated. For example, in 1991, investor allocation was ~25%, and the 10-year returns from 1991 onward through to 2001 (which would be found in a chart of the actual SPX prices) increased at an annualized rate of ~17%. In contrast, in 2000, investor allocation was at it’s peak around 52%, and the resulting annualized total return from 2000-2010 was only around -1%. Since the red-line aligns quite closely with the blue-line throughout, this means that investor equity allocation was highly correlated with observed subsequent 10-year SPX total returns (at least since 1952), and may potentially serve as a good predictor of future equity returns.

I would venture a guess that few investors invest with a 10-year horizon, and even fewer would be able to buy-and-hold SPX through that entire period. Thus, what might be  more helpful is if we were able to transform the above chart into a plot of observed and expected prices of SPX by year; visually this would more appealing as well. To do so, we would simply need to use the predicted total annualized 10-year return to calculate the expected SPX price 10-years in the future, based on the current SPX price for a given year of interest: (current price)*(predicted annualized return^10). And voila! you would get the chart below, where the black-line is the predicted price and the red-price is the observed price (historical data from here).

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We can see that, holistically, the SPX price version (shown here) of the SPX 10-year annualized total return chart (shown previously), does match reasonably well to observed SPX prices. In particular, I highlighted in blue boxes, a few periods where the predicted price did not change: (1) 1971-mid 1977, (2) 1999 – 2009, and (3) mid-2017 to 2024. Looking at the historical price change of SPX during those first two periods, they both contained major market crashes – the bear market of 1973-1974 where the Dow Jones Industrial Average lost over 45% of its value, the popping of the dotcom bubble in 2000-2002, and the most recent financial crisis of 2007-2008 – netting investors possibly huge losses in both periods. Extending this to the third period that has yet to transpire, this plot would seem to suggest that a similarly poor return is forthcoming, with a market crash (or crashes) some time during mid-2017 to 2026.

One important point is that from year-to-year, the observed SPX price may actually deviate quite substantially from the predicted SPX price. To better visualize this, we can plot the %difference over time:

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The mean (median) %difference ends up being close to zero: 1.9% (-0.01%), suggesting the overall prediction on average performs well, but for a given year the prediction could underestimate by as much as ~80% and overestimate by as much as ~-30%. This may seem like a much larger range than expected, but this is largely due to the scale of the original rate prediction compared to this price prediction; differences between the predicted and observed annualized 10-year rates are magnified due to the ^10 scaling to get to a price prediction.

Does this mean our SPX price prediction chart would not be useful? Au contraire! Aside from providing a general sense of when equities will tend to do well vs poorly in the future (ie, predict bull vs bear markets to incorporate into a more general investing framework), we can still use conservative adjustments to mark important price points to watch for. For example, if we take the ‘high’ point price predicted over the start of the third period in 2017-2018, this would correspond to SPX around 2800 at the end of 2018. Then we may want to make a -20% underestimate adjustment (based on the recent % differences suggesting consistent underestimation in recent years) to arrive at a peak price of 3360. An even more conservative (or liberal, depending on your point of view) estimate would be use -30% (largest underestimate historically observed) to arrive at a peak price of 3640.

Lastly, it is always important to ask what assumptions have I made that might cause me to be wrong? The most obvious risk would be that this relationship will no longer be true, i.e. historical predictive value may not translate into future predictive value, for a variety of reasons, like the environment may change in the future (as Irving Fisher had famously proclaimed, “Stock prices have reached what looks like a permanently high plateau” right before the 1929 market crash). Another concern may be whether the predictive relationship found was due to over-fitting to the data (i.e., torturing the data until it tells you what you want to hear). To address that concern, typically one might break the historical data into test and training periods, and/or support any observations with a logical mental model or explanation. Another idea may be to combine this model with other quantitative models for shorter time frames, or assessments of the macro ‘picture’ (won’t discuss here, but o boy! was it elucidating to learn about the killer D’s of debt, deflation, and demographics, excessive volatility selling, never-ending passive ETF inflows, etc.) to develop several supporting lines of evidence. One simple practical plan would be to simply watch for a change in the price trend to confirm any predictions.

Summary 

My prediction for the S&P500 index, and the U.S. equity market more generally, is the end of the current bull-market near the beginning of 2019 with a peak price level of ~3360 (with an estimated ‘max melt-up’ to ~3600 and an estimated ‘early stoppage’ at ~2800). An accompanying market crash is likely, with no end in sight yet to this next bear market (currently, at least through to 2027). This means that you’ll likely still have one last chance to dance your heart out before the party ends, but be careful of staying too long, as you might get stampeded by the crowd when the music stops, the lights turn on, and everyone rushes to go home. And you’ll finally get to clearly see who you’ve been dancing with.