Stock market predictions – like when a market might pull back or if it's a good time to buy stocks – sound like a great idea. Who doesn't want to know what's in store for their money or if there will be a stock market crash in 2021? But these forecasts, even from experts, can vary widely. How are both short- and long-term stock market forecasts made, where does the information come from, and what information should investors look at?

Leading Economic Indicators

Leading economic indicators can tell you where an economy is headed and provide information so that investors can make stock predictions. A leading indicator shows economic improvement or decline before the economy shows it.

These indicators include:
• Stock prices
• Average Earnings
• Consumer Spending
• Unemployment Claims
• Building Permits
• Product Inventory

Leading economic indicators tell investors whether an economy is expanding or contracting. For example, if unemployment claims are down and earnings are up, then it’s likely the economy is expanding.

Leading economic indicators also influence the actions of central banks. These banks may implement easing or lower interest rates if an economy is lagging. Interest rates, as they effect the cost of borrowing money, effect the economy.

These statistics and the policies which impact them tend to change before the economy changes. Experts can use these statistics to make stock market predictions.

Market Indexes

Just as leading economic indicators predict and reflect economic conditions, market indexes also predict and reflect economic conditions. Understanding the trends of these indexes can help experts forecast the stock market and estimate the future price of shares.

Looking at market indexes both in the short- and long-term can provide investors with information about momentum and mean reversion.

Momentum is the assumption that the market—or a particular share—will continue in the same direction that it’s going.

Mean reversion is the idea that the market will even out over time. Mean reversion may happen over many years or decades, and can be hard to observe at a given moment.

Over the short term, or 3–12 months, momentum provides some information for investors: stocks that are going up are likely to continue to go up. However, over the long term, or 3–5 years, stocks that have gone up are likely to underperform, or revert to the mean.

Martingales are another way to approach how market indexes might help predict future stock prices.

Martingales refer to the idea that past pricing trends have no effect on future prices, and that the best predictor of tomorrow’s market price is the current price plus a small amount. The inputs for martingales are stock-specific, and include the current price and the estimated volatility.

Martingales are about tomorrow’s price, momentum is about short-term trends, and mean reversion is about long-term trends. By following stock market indexes and by using one—or all three—of these methods, an expert can make a more accurate stock market prediction.

Value

Value investors don’t believe that share prices reflect all information available or that shares necessarily trade at their fair value. These investors forecast the stock market by including information outside of the market itself.

Value investors look for stocks priced less than their book value. Value investors believe that the market reacts to good and bad news, and that stock market prices might not reflect the intrinsic value, or valuation, of a stock. These investors look to purchase undervalued stock to buy at a discount, hold long-term, and sell later at a profit.

Examining a company’s financial performance, including their revenue, earnings, cash flow, and profit as well as their business model and market can all help an investor determine the valuation of a stock. Looking at a company’s earnings reports over time can also help investors analyze a firm’s financial health.

With this information, an investor can calculate the price-to-book ratio (P/B). This ratio compares the stock price with the value of the company’s assets.

Value investors look for stocks with a below average P/B ratio. Investors purchase these stocks when they can predict that the share price will rise to a more average position.

Predicting the Stock Market

To predict the stock market, understanding the health of the economy, as well as the policies surrounding that economy, are key. Examining your goals as an investor—such as knowing your time-frame and risk tolerance—will help you choose the right information to look at.

Additionally, unusual economic circumstances can make variations in stock profitability wider and much more obvious, and these variations can help investors observe trends and make long-term stock market forecasts.

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