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BofA’s “Perfect” Indicator Close to Another Powerful Sell Signal

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On January 26, 2017, with the S&P at an all-time-high, Bank of America made an unsettling announcement: a powerful sell signal, based on its quant-developed Bull Bear Indicator, was triggered.

What makes this indicator particularly interesting is that it supposedly has a perfect or near-perfect track record for predicting the size and relative timing (within three months) of a market turn.

As it turned out, the Bull Bear Indicator predicted the 12% drop that subsequently took place in early February.

Was that an accurate prediction, or pure coincidence?

Let’s back up a bit and take a look at how the indicator works: it has a set of 19 criteria which are analyzed to measure the potential for a bullish or bearish market turn. When these conditions accumulate, they trigger a warning signal that a market turn is imminent.

In January, 11 of those 19 conditions were occurring, prompting BofA to announce its conclusion that “a tactical S&P 500 pullback to 2686 in Feb/Mar now very likely.”

Source: BofAML Global Investment Strategy

Today, the indicator is once again sensing an accumulation: 13 of the 19 conditions have been triggered.

Here’s the full list:

Source: BofAML US Equity and Quant Strategy via Zerohedge

A breakdown of what had already been triggered:

  1. Bear markets have always been preceded by the Fed hiking rates by at least 75bp from the cycle trough.
  2. Minimum returns in the last 12m of a bull market have been 11%.
  3. Minimum returns in the last 24m of a bull market have been 30%.
  4. 9m price return (top decile) vs. S&P 500 equal weight index.
  5. Consensus projected long-term growth (top decile) vs. S&P 500 equal weight index.
  6. We have yet to see a bear market when the 100 level had not been breached in the prior 24m.
  7. Similarly, we have yet to see a bear market when the 20 level had not been breached in the prior 6m.
  8. Companies beating on both EPS & Sales outperformed the S&P 500 by less than 1ppt within the last three quarters.
  9. While not always a major change, aggregate growth expectations tend to rise within the last 18m of bull markets.
  10. Trailing PE + CPI y/y% >20 in the prior 12m.
  11. Based on 1- and 3-month estimate revision trends; see footnote for more detail.
  12. Trailing PE + CPI (y/y%) >20 within the last 12m.
  13. In the preceding 12m of all but one (1961) bull market peak, the market has pulled back by 5%+ at least once.

And here are the remaining six to watch out for:

  1. Each of the last three bear markets has started when a net positive % of banks were tightening C&I lending standards.
  1. Companies with S&P Quality ratings of B or lower outperform stocks rated B+ or higher.
  2. Forward 12m earnings yield (top decile) vs. S&P 500 equal weight index.
  3. A contrarian measure of sell side equity optimism; sell signal triggered in the prior 6m.
  4. A contrarian measure of buy side optimism.
  5. Does not always lead or catch every peak and all but one inversion (1970) has coincided with a bear market within 24m.

In light of this data, the main question investors are asking is “what should we do about it.”

Here’s what Bank of America has to say:

“Our US Regime Model, a quantitative framework for stock-picking, suggests we are in the mid to late stages of the market cycle and in this stage, momentum is the best way to invest. As contrarian value investors, this is not an easy call to make. But if this bull market is closer to over, our analysis of factor returns indicates that late-stage bull markets have been dominated by stocks with strong price momentum and growth, while value, analyst neglect, and dividend yield have been the worst-performing factors.”

In other words, it’s all about “momentum” as fundamental factors no longer mean much at this point.

But trading momentum is a dangerous game, as there are no rational–i.e. fundamental–factors to accurately analyze turns in sentiment.

As a prudent investor, this leaves you with two choices: begin hedging now by accumulating gold and silver positions, or if you are feeling lucky, ride out the bull and exit the markets before everyone else does.

Of course, if you’ve got a lot of money at stake (especially if you are retired), I’m not sure that betting on luck is a good strategy.