This is my eighth annual forecast of the S&P 500 Index return for the year. It is based on the simple linear regression model. The model uses Gross Domestic Product (GDP) as explanatory variable to the performance of the S&P 500 Index. The model predicts the S&P 500 Index to closed between 3,207 and 3,234 at the end of the year 2020. This represents almost flat and slightly negative return between -0.75% and 0.09% for the year 2020. If my forecast is correct, the year 2020 will provide very low return to equity investors. Investors may not be fully compensated for taking the market risk. Unexpected negative news, like geopolitics, may easily cause the stock market to enter a negative territory for the year 2020.
During the last seven years, my forecast model had proven to predict a general direction of the stock market performance. Projections by the model and actual stock market performance track each other (see Chart 1).
(Chart 1. Historical Forecast vs Actual Performance of the S&P 500 Index)
When I compare historical historical forecast with the actual returns of the S&P500 Index, I can see a positive correlation (see Chart 1). The model may provide a general understanding and feel of whether the stock market is overprices or cheap. The model does not guarantee or precisely predicts the outcome. Instead, it has correctly projected up and down markets six out of seven years (see table 1). Despite a possible significant margin of error, the model does give a general feel for the value of the stock market. It does track the performance of the stock market.
Looking back, the model failed to predict the stock market decline of 2018. This miss in prediction can be explained by a volatile and steep sell off at the end of the year 2018. The stock market declined sharply by more than 9% in December 2018 and became oversold. The stock market recovered nicely since then. The S&P500 index increased by 7.8% in January 2019 (Yahoo! Finance).
The forecast model may provide the basis to evaluate the stock market and to determine if it is oversold or underbought. Despite the wide margin of error, investors may use this forecast as the general feel for how expensive or cheap the stock market is.
(Table 1. Historical Accuracy of the Forecast)
Now, let’s forecast where the S&P 500 Index will close one year from now, on December 31, 2020.
Based on the statistical analysis and the process described further in this article, I expect the S&P 500 Index to close between 3,206 and 3,233 at the end of 2020. Based on this range, the midpoint for the S&P 500 Index is predicted to be at 3,219 on December 31, 2020) (see Table 1). This translated into a potential annual decline of -0.4% from the close price of 3,231 on December 13, 2019.
This prognosis is based on expected Gross Domestic Product (GDP) of the United States in nominal terms, current USD terms. First, I will take a look at the most recent GDP number. It will be the base from which I calculate the expected nominal GDP. According to the Bureau of Economic Analysis, the current dollar GDP was $21,542.1 billion for the third quarter of 2019 year (December 10, 2019). I will assume that the GDP will increase by 197 billion during the fourth quarter and be at $21,740 billion for the year 2019 in current US dollars (see Table 2).
According to the economic projections of Federal Reserve Bank Board Members and Federal Reserve Bank Presidents made in September 2019, the real GDP is expected to increase between 1.8% and 2.1%, and Personal Consumption Expenditure – between 1.8% and 2.0% for the year 2020. As a result, the nominal GDP estimated to rise between 3.6% and 4.1% in 2019.
By multiplying the estimated current dollar GDP for 2019 by expected nominal change for the year, I calculate the GDP for the year 2020 to be between $22,522.64 and $22,631.34 billion. Now I can forecast where the S&P 500 Index will close at the end of 2020.
I am using the 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 14 years of annual data, I forecast the S&P 500 Index to close between 3,207 and 3,234 at the end of 2020 (see table 2).
(Table 2. Forecast Results for the S&P500 Index at the end of 2020 year)
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. There might be other factors that are difficult to predict; such as, geopolitical risk, rise in inflation, and black swan events that nobody expects.
By using a smaller sample of data, I am able to focus on the current economic environment. I find it beneficial and more appropriate than using lots of historical data from prior economic cycles. One of the downsides of using smaller sample size of data, the model does not incorporate information from historical economic cycles. I believe the recent economic data is better at describing the health of the stock market.
Disclosures:
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.
ECNFIN.com is not associated with nor does it necessarily represent the opinion or advice of Culver Investment Company LLC. Past performance doesn’t guarantee future results.
References:
The Federal Reserve Bank (September 18, 2019)
https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20190918.pdf
Data:
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
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