This is my fifth year forecasting returns for the S&P 500 index. It is time to analyze the accuracy of the forecast. The direction of the stock market’s performance was predicted correctly each year for the last 4 years (see Table 1). Last year, the forecast error was only 23.83 points or 1.2%. In other years, the forecast was less optimistic than the actual stock market performance, but the direction of the forecast remained accurate. When the model predicted the stock market to go higher, the market went up. When the model predicted the stock market to decline, the market went down (see Table 1).
Now, let’s forecast where the S&P 500 Index may close one year from now, on December 29, 2017.
Based on the statistical analysis and the forecast described further in this article, I expect the S&P 500 Index to close between 2,360 and 2,390 at the end of 2017. Based on this range, the midpoint for the S&P 500 Index is forecasted to close at 2,375 on December 29, 2017. That is a potential annual upside of 6.1% from the closing price of 2,238 on December 30, 2016.
This forecast is based on expected Gross Domestic Product (GDP) of the United States in nominal terms, current USD terms. According to the Bureau of Economic Analysis, the current dollar GDP was $18,675.3 billion in the third quarter of 2016 (December 22, 2016).
According to the economic projections of Federal Reserve Bank Board Members and Federal Reserve Bank Presidents made in December 2016, the real GDP is expected to increase between 1.9% and 2.3% for the year 2017. Personal Consumption Expenditure is expected to increase between 1.7% and 2.0% in 2017. As a result, the nominal GDP is expected to increase between 3.6% and 4.3%. Using the expected GDP for the year 2017 of between $19,347 and $19,478 billion, I can forecast where the S&P 500 Index will close at the end of 2017.
I have used an Excel spreadsheet to run a linear regression model where the S&P 500 is a dependent variable, and GDP is the independent variable. Based on the last 10 years of annual data, I forecast the S&P 500 Index to close between 2,360 and 2,390 at the end of 2017 (see Table 2).
Limitations to the forecast:
Based on my prior research, the GDP alone can only explain between 67%-89% of the performance in the S&P 500 Index (see my prior articles on http://www.ecnfin.com). The remaining 11%-33% is not influenced by the GDP growth.
By using a smaller sample of data, I am able to focus on the current economic environment. At the same time, a smaller sample may increase the forecast error. A smaller sample does not incorporate information from historical economic cycles.
This forecast model is very basic. It only uses one independent variable, GDP, to predict the stock market returns. There can be other factors that will influence the stock market performance.
Forecast of the future S&P 500 Index is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor before making an investment decision.
Bureau of Economic Analysis (December 22, 2016). https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
The Federal Reserve Bank (December 14, 2016) https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20161214.pdf
U.S. Department of Commerce. Bureau of Economic Analysis. Gross Domestic Product data was retrieved from http://www.bea.gov
Yahoo! Finance. S&P 500 Price Data was retrieved from http://finance.yahoo.com