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Thursday January 18th 2018

Stock Market Advisory System

Hamburg Railway Station 2010
Photo courtesy Amazing Travel Photos

The Stock Market Advisory System provides a risk assessment for the aggregate U.S. stock market. The risk assessment takes into account three risk factors: volatility, valuation and momentum. These ideas were developed in the article Triple Threat for Stocks?

The volatility measure is the Chicago Board Options Exchange Market Volatility Index, VIX. The valuation measure is Cyclically-Adjusted Price-Earnings Ratio, CAPE or P/E10, which was suggested by Robert J. Shiller based on earlier ideas of Benjamin Graham. The momentum indicator is market trend measured by the 200-day simple moving average. Data is for the S&P 500 Stock Index.

Risk metrics are the current value of the risk factor divided it’s own mean.

Here is the breakdown for the Stock Market Advisory System. For each of the three indicators, the table shows the ranges for each of the five advisory levels. Admittedly, the breakpoints for the various advisory levels are somewhat arbitrary.

Stock Market Advisory System Advisory Levels
Color Coded
Risk Assessment
Volatility
VIX
VIXAVG=19.04
Valuation
CAPE
CAPEAVG=16.42
Momentum
Index/200SMA
SEVERE
Severe Risk of
Stock Market Falling
More than 40 More than 30 Less than .90
HIGH
High Risk of
Stock Market Falling
30 to 40 23 to 30 0.90 to 0.95
ELEVATED
Significant Risk of
Stock Market Falling
25 to 30 18 to 23 0.95 to 1.00
GUARDED
General Risk of
Stock Market Falling
20 to 25 15 to 18 1.00 to 1.10
LOW
Low Risk of
Stock Market Falling
Less than 20 Less than 15 More than 1.10

Current Risk Assessment
The latest risk assessment is shown in the table. Two of the risk indicators are elevated (yellow) and one is high (orange).

Stock Market Risk Assessment
as of Tuesday, 16-Aug-2011
Volatility
VIX/VIXAVG
Valuation
CAPE/CAPEAVG
Momentum
Index/200SMA
ELEVATED 1.74
ELEVATED 1.25
HIGH 0.93

Current Yields and Expected Return
No discussion of risk is complete without expected returns. The latest return expectations for the S&P 500 are shown in the table. The average and median dividend yield of the S&P500 was 4.47% and 4.39%. The average and median cyclically-adjusted earnings yield is 7.12% and 6.34%. Both earnings yield and dividend yield are well below the average and median values.

Stock Market Return Expectations
as of Tuesday, 16-Aug-2011
Cyclically-Adjusted Earnings Yield
E10/P (Mean=7.12%, Median=6.34%)
BELOW AVG 4.86%
Dividend Yield
D/P (Mean=4.47%, Median=4.39%)
BELOW AVG 2.04%

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