Memo To: Edwin Finn, Jr. [Editor, Barron's]
From: Jude Wanniski
Re: Market forecasting
I know you have to put something on your cover every week, but pumping up Morgan Stanley's Byron Wien this week on the grounds that he has been "Right on the Money" could not have been a decision made soberly. You must know that Byron, for all his charm, is not a serious market forecaster. You can always be right half the time in calling a coin toss. To do better than 50% you have to have an analytical framework. Even your article makes it clear that Byron's forecasts are based on nothing more than the elementary formula that when interest rates go up, the stock market goes down, and vice versa. Like the coin toss, over time the formula is 50% correct.
As you know, for 18 years I have been forecasting without a black box. We interpret the impact that political events will have on the financial markets, using our homegrown supply-side analytical framework. This year, we said the Dow would top 6000 because of Steve Forbes' exposition of a flat tax, and that it would top 8000 if he won. We attributed the market selloff early last month to the "increased risks associated with presidential politics." Yet we were not panicky. On July 11: "It would appear that all three entrants in the presidential sweepstakes will be competing for the honor of representing economic security over economic growth. If that were to hold true, we would see a much more serious sell-off on Wall Street, but there remains ample time for the growth forces to make some moves. Going into the August conventions, it will be roller-coaster time on Wall Street, so strap on your seat belts."
On July 17, our client letter noted the "Wall Street Roller Coaster" that immediately followed. We noted a report in that day's Wall Street Journal that Republicans were so worried about Bob Dole's campaign that they were urging a big tax cut as the antidote. A meeting would take place the following Tuesday organized by Jack Kemp: "Perhaps Dole can get his act together with the help of Steve Forbes, Don Rumsfeld and Jack Kemp. As long as the possibility exists, we can't be jumping to conclusions about the early demise of Bob Dole." On July 25, noting the success of the Kemp economic summit in pulling together the GOP congressional factions, we asked: "What do these developments mean to the roller coaster on Wall Street? It could mean that the darkest days on the NASDAQ may now be behind us." NASDAQ in fact hit bottom on July 24 at 1042 and closed yesterday at 1137.
Ed, I'm not saying our analytical model is flawless, but unlike Byron, whose forecasts are free, we have to be right more often than not or we would have been driven out of business long ago. I'm prompted to write this after getting a memo from my colleague at Polyconomics, who I asked to do some elementary reporting on Byron's forecasts, after seeing all the publicity he has been getting in recent weeks for being a wizard. The memo follows:
MEMORANDUM TO: Jude Wanniski
FROM: David Gitlitz
RE: Byron Wien
The current issue of Barron's gives Morgan Stanley strategist Byron Wien a big wet kiss in its cover story, "Right on the Money," for his supposedly prescient call of a 1,000 point correction on the Dow.
Despite the fact that the Industrials are now back within 100 points of their high, the Barron's valentine thrown Byron's way by Andrew Bary quotes the strategist as sticking to his guns. Last week's rally, Byron said, was not "a mind-changing reversal. The response to the economic data shows the market's yearning for good news. I think stocks are going to run out of upside soon." From what I can gather based on a press search of the past several months, Byron's model holds that as interest rates go up, stocks go down (and vice versa), but with a highly adjustable lag. Byron holds that the economy will grow faster than anyone expects in the last two quarters of this year, bringing higher inflation and sharply rising interest rates.
To be fair, Byron's initial April call saw some further upside potential (to 5800) before the bear market that would hit "in the second half of this year, making his target for a Dow low of 4800 (after which a new bull run would commence). And, in fact, the average did come close to hitting Wien's mark (5778) at its high in late May.
The interesting thing is the way Byron has been spinning himself silly in order to maintain the relevance of his original call since the market started to drop sooner (he thought it would happen in the fall), apparently has bottomed out with less than half as much of a loss as he forecast, and is already within a hundred points of surpassing its previous high. He variously has declared the market overbought, oversold or just about right all at roughly the same time, dispensing with any pretense of consistency. The other interesting thing is the way the press lets such an influential and powerful figure in the markets get away with these feints and dodges without challenging his underlying assumptions and preconceived notions.
For example, following the Dow's 83-point slide to 5520 on July 11, the Journal of July 12 quotes Wien as declaring the market having entered the corrective phase. "The most significant thing is the bond market was up and usually we've seen a close correlation between bond-market and stock-market direction. So that divergence says that perhaps something bigger is happening here." Presumably, then, Wien was expecting the sell-off to continue and, in fact, on the following trading day (Monday, July 15) the Dow took its worst hit of the slide, dropping 161 points to 5349. But over the rest of the week, the market posted some decent gains, closing on Friday, July 19 at 5427.
The following Monday, July 22, Wien tells the Journal: "My feeling is we got pretty deeply oversold and then had a pretty strong snap back last week, but that's all it was." [Emphasis added.] Within the space of a few days, then, Wien went from seeing the market beginning a major correction to snapping back from an "oversold" position. Subsequently, the market touched bottom at 5346 on Tuesday, July 23, and has rallied from there. On Wednesday, July 31, with the market closing the previous day at 5482, the Journal finds Wien agreeing that stock valuations are "fine, at these interest rate levels," but cautioning that he expects rates to rise further, leaving the market looking overvalued again. What's particularly noteworthy is that the 30-year yield that Byron saw as being "fine" for valuations on July 30, at 7.04, was only 2 basis points below the yield that was confirming the onset of a correction on July 11.
As I understand it, with the bond yield at 6.75%, stocks should again be looking pretty attractive in Byron's model. But judging from his comments to Barron's, he seems to be fighting his own methodology in order to sustain his correction call, which is based on a bond yield of 7.5% before year end and 8% early next year. Unfortunately for Byron, this is looking less and less likely all the time.