Unexpectedly Intriguing!
November 26, 2018

"Essentially, all models are wrong, but some are useful."

Those are the immortal words of statistician George E.P. Box, which underlie every bit of serious analysis that seeks to approximate real world processes and outcomes with math. Including our own.

What keeps models useful is to recognize when and how they're wrong. For example, many years ago, we recognized that the projections of our dividend futures-based model of how stock prices work could be skewed off target because it incorporates historic stock prices as the base reference points from which it projects future stock prices. If those historic stock prices were to include a period of abnormally high volatility, the accuracy of the model's projections would be negatively impacted - skewed off by the echo of that past volatility.

With past volatility events proving to be poor predictors of future stock prices, we experimented with different methods to compensate for the echo effect in our model, eventually settling on a very simple method of "connecting the dots" to bridge across periods where we recognized that the accuracy of our model's forecasts would be affected by the echo of past volatility. We show those adjustments as a red-zone on the forecasting charts we produce.

In our latest redzone forecast, which covers the period from 7 November 2018 through 7 December 2018, we assumed that investors would remain focused on the future expectations associated with 2019-Q1. In the Thanksgiving holiday-shortened third full week of November 2018, something changed for the S&P 500 (Index: SPX) to break that assumption, and what had been our stellar track record for previous redzone forecasts....

Alternative Futures - S&P 500 - 2018Q4 - Standard Model with Redzone forecast assuming investors focusing on 2019Q1 from 7 November 2018 through 7 December 2018 - Snapshot on 23 Nov 2018

Instead of falling within our redzone forecast, the trajectory of the S&P 500 has dropped below it, seeming to follow the unadjusted trajectory associated with investors focusing their forward-looking attention on 2019-Q1. That's almost certainly a coincidence, which we'll be able to confirm in the next several weeks.

Instead, we believe that investors have shifted a portion of their forward-looking attention toward a more distant point of time in the future, 2019-Q3, which appears to have been prompted very specifically by a change in the expectations for future revenues at Apple (Nasdaq: AAPL) that occurred on Monday, 19 November 2018, which resulted from the company cutting production orders to suppliers for its newest iPhone models. That news was sufficient to dim the prospects for the company's profits well into the future, and since Apple is still the single largest company within the S&P 500, the news was also sufficient to shift the trajectory of the whole index lower as investors adjusted their focus accordingly.

And that's how we can get useful insights from a model that's wrong! Meanwhile, here are the other headlines that stood out to us from the holiday-shortened week....

Monday, 19 November 2018
Tuesday, 20 November 2018
Wednesday, 21 November 2018
Thursday, 22 November 2018

Elsewhere, Barry Ritholtz listed positives and negatives for Thanksgiving Week of 2018, and also has introduced a catch-all tag for archiving all his weekly succinct summations for the major economy and market-related events he tracks each week.

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