Not so Fast: Have we Entered a Bear Market?

Not so Fast: Have we Entered a Bear Market? Header Image

A lot of talk around the market today is the enviable recession, or the bear market is just around the corner.  Yet a few years ago I found a chart that ties in some fundamental analysis to technical analysis that stands as a counter to these claims.  When analyzed the results are surprising, and also outlines a potentially viable trend following trading strategy that can predict broad market cycle moves.

$SPX and its EPS

We are looking at the GAAP SPX earnings (S&P 500 earnings per share) compared to the price chart of the SPX (S&P price chart, or simply known as the ‘market’ to most financial people).  By looking that these charts in comparison, I can take a devil’s advocate view, and suggest that the bear market hasn’t quite started yet.

BASIC CHARTS

These chart comparisons will give us insight to a potential cycle strategy that spans over the past 2 decades (1998-01-01 to today, 2019-01-16) that could show us major, multi-year directional moves, indicative of trend following strategies in the market, from bear to bull, or vice versa.  Using this, we can develop a buy or sell indicators which helps us refine a potential TREND FOLLOWING strategy.

GAAP is derived from generally accepted accounting standards (overseas it is called IFRS, similar in most ways to GAAP).  GAAP is the generally accepted accounting principles and is how financial statements are made from accountants auditing the companies.  We look at the strongest companies, typically determined by market cap, and what many consider to be the “market” which is the $SPX or S&P 500.

GAAP earnings is a number that tells us how much a company has earned on a per share basis, or typically what shareholders earn.  It is a defined number used to determine whether a company is even profitable, and how profitable they are on a per share basis.  It can help us determine valuable information like P/E ratios, and if the market or stock is over or undervalued.  But when comparing it to its underlying, in this case the SPX, we can see if there is an overall trend.

Initial Opinion

The results in my opinion are quite surprising, and it appears we can see when a major trend develops, and it is not simply from two moving averages that cross (a pure technical derivate calculation, and I am not saying it can’t be, a future blog post can propose problems with this), it is from the GAAP earnings (a fundamental number, not directly tied to stock price, like a SMA [simple moving average], which is directly a derivative of the price of the stock/index, or in this case the $SPX).

GAAP earnings are released quarterly, so this is a “longer” term strategy that could identify major market trend changes, so minimum trade reaction time is when the quarterly !GAAPSPX EPS is released.  As I talked about in a recent post, trade duration is one factor to fitting a trader’s personality, which is why this proposed strategy is not for everyone, even myself included.

 (Remember we are ignoring other potential indicators, like revenue per share in this study.)

 

Buy and Sell Signals

This is my observation of looking at the !GAAPSPX to $SPX charts:

A buy signal (bull market begins) occurs after !GAAPSPX are already moving in downward stairstep, EPS is lower and lower each quarter, followed typically by even a slight (or any) uptick (minor positive EPS change) marks a major bottom.

A sell signal (bear market begins) occurs after !GAAPSPX makes a MATERIAL (something I can refine and quantify more in future blog posts) down move, typically after QoQ uptrends. Even if earnings relavively are flat (or a slight downtick) on a QoQ basis, this DOES NOT mark a SELL signal.

ALL CHARTS

Here are some buy and sell signals I have derived from the charts:

  • 1998-01-01 BUY
    • Price: 927
    • SPX EPS is flat
  • 2001-05-01 SELL
    • Price: 1283
    • Material downward move in earnings after period of QoQ stairstep
  • 2002-09-01 BUY
    • Price: 900
    • First uptick in EPS after downward stairstep
    • Buy signals are trigger after any increase after downward stairsteps
  • 2003-03-24 SELL
    • Price: 864
    • Material downward move in earnings after period of QoQ stairstep
    • Unrealized drawdown of 10% occurs during this period
    • A potential bear market seems to be emerging during this time. This is normal to get false or even losing signals in a strategy, it is important to look at the overall strategy and what it is trying to accomplish from its indicators.
  • 2003-05-29 BUY
    • Price: 950
    • Buy signals are trigger after any increase after downward stairsteps
  • 2008-01-11 SELL
    • Price: 1400
    • Material downward move in earnings after period of QoQ upward stairstep
  • 2009-10-01 BUY
    • Price: 1000
    • Incredibly small upward move, but still a small move upward in earnings, potential risky trade, but historically ANY positive move in upward earnings means a BOTTOM has formed off a downward stairstep in EPS.
  • 2015-04-07 SELL
    • Price: 2060
    • Material downward move in earnings after period of QoQ upward stairstep
  • 2016-10-15 BUY
    • Price: 2150
    • Similar EPS move to 2009-10-01, any upward tick in earnings after a downward stairstep is a BUY signal.
  • No sell signal since then!

TRADE TABLE

LONG SHORT
Date Price Signal Price Change % Change Price Change % Change
1998-01-01 927 BUY
2001-05-01 1283 SELL 356 38.40%
2002-09-01 900 BUY 383 29.9%
2003-03-24 864 SELL -36 -4.00%
2003-05-29 950 BUY -86 -10.0%
2008-01-11 1400 SELL 450 47.37%
2009-10-01 1000 BUY 400 28.6%
2015-04-07 2060 SELL 1060 106.00%
2016-10-15 2150 BUY -90 -4.4%
Today 2610 460 21.40%
# of Trades 5 4
Winning Trades 4 2
Losing Trades 1 2
Win Rate 80% 50%
Average Gain on Trade 41.83% 11.03%
1998 - 2018 CPI Inflation 54.05%

Initial Analysis of Buy and Sell Signals

From the initial analysis we can see that the strategy works.  From the long side we get a great strategy, 80% win rate with an average gain on trade of 41% occurring 5 times. 

From the short side we get a more mixed result during the dot com crash we get about 29% return, and the 2008 crash we get a 28% return.  We get a minimal drawdown during the 2003 false signal (which also happened in the long position as well). 

We can see in 2003 we get a losing trade from the downturn, however, broadly speaking the market traded sideways from a range of 770 – 930 (still a 20% range).

I will analyze this trading strategy in future blogs post to give additional risk metrics and also give a possible way to practically trade it, even for retail accounts.

 

Final Thoughts

While the price drop in late 2018 – early 2019 in the SPX, and earnings warnings from its releated companies, our trend following strategy using the SPX EPS giving us hard numbers and tells a more optimistic tale.  The latest EPS data point is at an all-time-high, inferring that this bull may still have some more legs, or it is not quite time to sell just yet.

At a glance there seems to be promise for this strategy, even given its low number of occurrences.  However having a fundamental value associated to the stock price appears to give more credence to this trend following strategy, rather than just having a derivative calculation from the SPX price itself.  This strategy will be developed in a future blog post, and maybe placed in the public trading strategies section of this website, as it is forward tested with real money.

 

Sources:

Inflation Calculator

Stock Charts

SPX Earnings – Cross Reference


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