I put together this model by looking at conditions of inflation, interest rates, Fed moves, breadth, dividends, earnings, etc. over the last 45 years.  Those were the things that typically led the stock market in a general way.  The model was obviously out of synch between 2000and 2003, particularly with the NASDAQ/high-tech sector. This disconnect implies, to me at least, that things were different during that period from most of the past 40 years. Seeing the stock market continue to fall while interest rates are also continuing to fall was not at all typical of the past four decades. One of the big differences was a collapse of earnings, unequaled in the previous 40 years. Interest rates and inflation have clearly dominated the stock market in the past 40 years, while earnings have had less of an intermediate-term effect. Consequently, my model reacts more to interest rates than to earnings. One other strong influence on the market is the change in the inflation rate. Accelerating inflation has nearly always been a negative for the stock market and the next change in the indicator may well be the addition of some sort of inflation measurement.

A long series of studies has shown me that the business cycle with its associated fluctuations of inflation and interest rates seems to be the primary controlling factor for the stock market. Developing the composite indicator of stock market conditions involved more than five years of work in analyzing 50 years of weekly historical data. The long period of data has been used in order to include a wide variety of economic and market conditions. The indicator is based on 13 separate components that tend to lead the stock market or to reflect in some way on its strength or weakness. The 13 components that make up the indicator use data on short and long interest rates, several commodity price indexes, bond prices, earnings and dividends. I also include components based on market breadth and new highs vs. new lows. I am experimenting with monthly economic data, although my experience with that data so far is that it comes out late and is subject to even later revision. The indicator is in a continuing process of evolution and, hopefully, improvement. The last revision prior to 2008 was made in 2001.

I take a different point of view of the stock market from most people. Most private and professional investors seem to view the market as a horse race and try to pick the fastest runners. I view it instead as a big bunch of horses that moves as a herd. As I see it, the forces that most actively move the herd are inflation, interest rates, valuations, dividends, earnings and emotion. I have created my composite indicator of stock market conditions in an attempt to quantify some of these forces and thus to anticipate broad moves in the market. I hasten to acknowledge that no indicator can ever include all of the complex forces that move the stock market up and down, so I do not expect to pick every market top and bottom. However, I believe that this indicator will forecast most of the big moves in the market and thus outperform the average horse in the herd over a long period of time.

Please understand that my comments here about my own particular approach are not meant to discredit those investors, private and professional, who have used other techniques to outperform the market as a whole. Nor is this the primary method used by Martin Capital.  There are many ways to excel in the financial markets and I see this particular method of market timing as just one of them. Warren Buffett has made more money in the market than I ever hope to make by using his own completely different methods. Graham and Dodd wrote down ideas on value investing decades ago that have helped many to excel in picking stocks. In contrast, my ideas are new and relatively untested.

The overall performance of the indicator, as far as being in line with major market trends since 1961, is excellent. Besides 2000 to 2002, two specific periods bother me, however: the market declines of 1962 and 1977. The indicator recommended staying in the market during these substantial declines. These instances inspire caution, as this type of experience could be repeated in the future. I will continue to work on improvements and not expect to be right every time.

I must give credit and thanks to those whose ideas have been the most valuable in the development of the composite indicator and the evolution of my newsletters. Martin Pring on the subject of the business cycle, John Murphy on intermarket technical analysis and Norm Freeburg's newsletter, Formula Research, have all been major contributors. If you as a reader get anything useful out of reading this material, you owe thanks to all of them just as I do.
 

Martin Capital Advisors, LLP is not responsible for the accuracy of the data contained in any of these charts or indicators.  This information is provided for informational purposes only.