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Markets S&P 500

Is It Time To Dip Your Toe Into Troubled Waters? Here’s What The ‘Perfect’ Indicator Says

Thiiiiis close to a "buy" signal.

If you think “way” back to January, when equities were riding the tax cut euphoria on the way to blowing through nearly half of Wall Street’s year-end targets for the S&P, you might remember that on January 26, BofAML’s Michael Hartnett made what, in retrospect, was a remarkably prescient call.

Specifically, he warned that the bank’s “Bull & Bear Indicator” was sitting at 7.6 or, just shy of flashing a “Sell” sign. In that note, he reminded everyone that to the extent you’re inclined to put a lot of faith in backtesting, that indicator is infallible – literally. From the January note:

BofAML Bull & Bear indicator has given 11 sell signals since 2002; hit ratio = 11/11; average equity peak-to-trough drop following 3 months = 12%; note the last Bull & Bear indicator flashed was a buy signal of 0 on Feb 11th 2016.

This is what “11/11” means:

BullBear

Earlier that month, Hartnett’s Global Fund Manager Survey flagged “short vol.” as the most crowded trade on the planet.

Well by God, he was right on both accounts – and spectacularly so.

The very next week (so, the week of January 29) ended up being one of the worst 5-day stretches for risk parity and balanced portfolios on record as the Treasury selloff finally flipped the stock-bond return correlation positive (i.e., diversification desperation). That Friday (February 2), the above-consensus AHE print that accompanied the January jobs report tipped more dominos and the whole thing came to a head the following Monday, culminating in the largest VIX spike in history, an event that triggered termination events in some of the short VIX ETPs. Equities plunged into correction territory and the systematic crowd de-risked to the tune of some $200-250 billion.

So yeah, Michael Hartnett was right and that damn “infallible” indicator apparently notched it’s 12th hit out of 12 signals.

Given all of that, you might be wondering where that “perfect” indicator is sitting now that the entire world is laser-focused on the prospect of a devastating trade war. To be clear, U.S. equities have obviously held up reasonably well, but EM sure hasn’t (Q2 was the worst quarter since 2015 for stocks and FX). Zooming in on China (which is obviously a big driver of EM sentiment), the SHCOMP is sitting in a bear market (“Do you ever have déjà vu, Mrs Lancaster?“) and in Europe, the automakers and the banks are similarly downtrodden.

Well, here’s where Hartnett’s indicator is now (and this graphic is super-fun because it shows you where things stood the week after that 7.6 reading in January versus where things stand currently):

Buy

There you go – “very close to a buy signal.” Here’s the historical context:

HistoryBBI

For his part, Hartnett thinks you should maybe wait for the S&P to fall below 2,670 before you go diving in.

You do have earnings going for you (Q2 season should paint a pretty upbeat picture), but given the geopolitical backdrop, one can’t help but wonder if maybe the old Bull & Bear Indicator is about to send a false positive.

Because in the event it hits “Buy” territory without a concurrent improvement in the trade tensions, I’d be a little gun shy.

 

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5 comments on “Is It Time To Dip Your Toe Into Troubled Waters? Here’s What The ‘Perfect’ Indicator Says

  1. seems like markets are moving up on the trade war realization. they must have read this article.

  2. I can’t predict what I’ll eat for Breakfast, how the hell can BofAml have a 12 for 12 indicator that no one has every heard of until today? I like my Cash, I’m keeping it!

  3. Anonymous

    It can sub as a pump-and-dump indicator in a pinch. Ingenious!

  4. Benjamin Hertzberg

    The sell-signal indicator works very nicely, but what do the upside results on the buy-signal look like? The behavior of an indicator isn’t necessarily symmetric. Based on the historical chart, this indicator gave buy-signals (dropping below 2.0) in early and mid 2008, before the crash, as well as in mid-2011 and mid-2015, when the stock market pretty much went sideways for a whole year. If anything, oscillation from “extreme bull” to “extreme bear” is a sell-side indicator.

    • Anonymous

      Exactly. It seems this is more of sell indicator tool, and less beneficial for knowing when to buy. BTFD at your own risk…

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