Deterministic prediction of share prices has been long considered as an impossible task in the current market paradigm. Stochastic approach to market prices has really won the hearts of market participants. This conclusion has been made in rash, however. Logically, no finite number of failures to describe and predict a measurable process is enough to prove that it has deterministic nature. People do fail to describe processes and events in scientific way, but this is the characteristic of people not processes. On the contrary, one (or several) example is enough to demonstrate that the link between share prices and CPIs is deterministic in principle, and thus, to demonstrate that the stochastic approach is not fully correct.
The model for CVS Caremark Corporation has been very stable over the past two years and helps to prove the deterministic character of share price setting. A very exciting feature of the CVS price model we developed two years ago is the possibility of prediction at a 4 months horizon. As with Avery Dennison Corporation we have been following the CVS share of since 2009, i.e. since we started to develop our concept of share pricing as related to consumer price indices.
The CVS model has not been changing much and is still defined by the consumer price index of other food at home (OFH) and that transportation services (TS). The former CPI component leads the share price by 4 months and the latter one - by 5 months. Figure 1 depicts the overall evolution of both involved indices. These two defining components provide the best fit model between August 2009 and December 2010. Relevant coefficients are both negative. Therefore the growth in both indices causes the share price to fall with a several month delay. The slope of time trend is positive. The best-fit 2-C model for CVS(t) is as follows:
CVS(t) = -0.51*OFH(t-4) – 1.23*TS(t-5) + 12.15(t-2000) + 195.93
where t is calendar time.
The predicted curve in Figure 2 leads the observed price by 4 months with the residual error of $1.88 for the period between June 2003 and December 2010. The model provides and an excellent and very stable prediction of the share price in the past. Moreover, it foresees a period of no growth in the first quarter of 2011. It is necessary to stress again that the model has been predicting the CVS share price since August 2009 with the same accuracy. The prediction for the first quarter of 2011 is the next step to validate the model.
Figure 1. Evolution of the price of OFH and TS.
Figure 2. Observed and predicted CVS share prices. Black diamonds present the contemporary prediction shifted 4 months ahead to fit actual data.