Stock market behavior has always been a source of surpizes for researchers, traders, and investors. The long term aggregate price trends have been explained as related to fundamental factors. Here we present a model, which makes the difference. Only one factor drive the long-term trends. Hence, the market volatility will be suppressed when everybody understands the market driving force, which is well predictable at a several year time horizon.
It is worth noting here that share prices of some companies in the S&P list can be also predicted at a five- to ten-year horizon. See our previous post:
We have been carefully tracking the evolution of S&P 500 since 2007, when predicted a sudden fall in 2008 . The 2008 crisis revealed one major mistake in our prediction for 2008 and 2009 – we were afraid to recognize the possibility a dramatic drop in the S&P 500 returns, when the relationship describing the years between 1985 and 2003 was applied. The right relationship is:
Rp(t) = 165dln[N3(t+6)] - 0.17 (1),
In (1), Rp is the 12-month cumulative return;N3 is the number of three-year-olds; N9 is the number of 9-year-olds; t+6 – time shifted six years ahead to extrapolated the number of 3-year-olds in the number of 9-year-olds. Correct coefficient is 5.5 times larger than that used in the paper for the prediction after 2007.
Originally, the link between real GDP growth rate and the change rate of the number of 9-year-olds was found by Kitov . Corresponding relationship should work in both directions, i.e. one can estimate the growth rate of real GDP from population measurements, and the number of 9-year-olds from real GDP measurements.
So, in relationship (1), one can replace N9(t) with GDPpc(t), taking into account that second term in the relationship between real GDP per capita and population is constant. Figure 3 displays the observed SP500 returns and those obtained using real GDP, as presented by the US Bureau of Economic Analysis (www.bea.gov). As before, the observed returns are 12-month cumulative values. The predicted returns are obtained from the relationship
Currently, relationship (2) is in a good shape. The 2008-2009 deep fall is well described. It also predicts that real GDP will start to increase in the nearest future following the observed increase in S&P 500. It would be very strong evidence in favor of (2) is valid. Red circle is the prediction for 2009Q2. The rate of growth should be +5% relative to previous quarter. We also expect a positive revision to real GDP estimates during the last four years. The May 2009 revision actually shifted many readings up, including the last three.
Finally, as predicted S&P 500 rose in May by +47 (not +80) units from 872 to 919, however. In June, we expect another rise by approximately 70 to 90 units. Figure 4 shows the past and future predictions using the number of 3-year-olds. The number of 9-year-olds should be measured precisely in the future to stabilize the stock market.
Figure 1. Evolution of S&P 500. Red line – observations; black line – prediction from the number of 9-year-olds. The prediction is obtained using a transformed form of (1).
Figure 2. Incorrect prediction of S&P 500 return given in . Actual returns fell much below the predicted ones.
Figure 3. The link between S&P 500 and real GDP between 2000 and 2009. Red circle is the prediction for 2009Q2. The rate of growth should be +5% relative to previous quarter.
Figure 4. Observed and predicted S&P 500 returns. The next (June) level of S&P 500 index is around 985, or ~70 from May close level of 914. Last three months we well predicted.
References Kitov, I., Kitov, O., (2007). Exact prediction of S&P 500 returns, MPRA Paper 6056, University Library of Munich, Germany, http://ideas.repec.org/p/pra/mprapa/6056.html http://mpra.ub.uni-muenchen.de/6056/01/MPRA_paper_6056.pdf
 Kitov, I., (2006). GDP growth rate and population, Working Papers 42, ECINEQ, Society for the Study of Economic Inequality, http://ideas.repec.org/p/inq/inqwps/ecineq2006-42.html, www.ecineq.org/milano/WP/ECINEQ2006-42.pdf
 Kitov, I., Kitov, O., Dolinskaya, S., (2009). Modelling real GDP per capita in the USA: cointegration tests, Journal of Applied Economic Sciences, Spiru Haret University,Faculty of Financial Management and Accounting Craiova, vol. 4(1(7)_ Spr), pp. 80-96.