The ETFOptimize Blog

Actionable, ETF-based Quantitative Investment Research and Education

The Coming Earnings Slowdown
(that's nowhere to be found)


• The financial media has been painting a very negative picture as the market slumped throughout October-November.

• Despite the negative speculation, the U.S. economy remains sound, with robust trailing and near-term growth statistics.
• The S&P 500 has only experienced a decline of -10.23%, and there are no indications that a bear market is imminent.


Long-Term Bull Market Overwhelmed by Short-Term, Bearish Noise

For investors who regularly consume the financial media, market activity since early October has been extremely unnerving. The vast majority of "nattering nabobs of negativism," to coin the old Spiro Agnew characterization of the media (in this case, guests on CNBC, Fox Business, or bloggers across the internet), is overwhelmingly packed with bearish interpretations of conditions, despite the fact that stocks have only suffered a relatively minor, superficial wound and the economy remains sound at this point in time.

On a monthly basis, October was down -6.91%, November was up by 1.85%, and so far, December is down -4.38%. However, put together, the downturn since the October 3 high (at 291.72) on the S&P 500 ETF (SPY) until last Friday's close at 263.57 is only -9.65%.

Accordingly, what we see right now is nothing more than a garden-variety correction. On a long-term chart of the S&P 500 since 1925, the current market turbulence barely registers as a little noise. However, if we didn't have a chart to refer to and put things in perspective, one might believe - based on the abundant, bearish noise in the media - we are in the grips of a devastating bear market.

Chart 1 below shows the S&P 500 with weekly prices since 1925. We can clearly see how prices follow along with an upward-sloping trendline, which represents a monetization of the steady growth of a well-diversified economy. Stock prices regularly elevate significantly above this trendline during constructive economic conditions, often for years at a time, but always return to the touchstone of the trendline, usually in an abrupt fashion that is characterized as a bear market.

Extension above Long-Term Trend Support, 1925-2018
Chart 1: Since 1925, the S&P 500 has followed a steady, upward-sloping trendline, with regular, years-long overextensions.


Prices reached 140% above the long-term trendline before the current turbulence began, which certainly qualifies as an overextension. You can see from the chart that during the 50s and 70s, bear markets ensued after prices reach 131% above the trend line. The last bear market, in 2008, began after a 159% overextension above the long-term trendline.

Technical analysis of stock prices is consistently same-similar across all time-frames, from annual to monthly, monthly to weekly, weekly to daily, daily to hourly, and even down to five-minute charts. The primary requirement for accurate chart analysis is sufficient volume to represent US-based corporations and the economy accurately. Low-volume indices can easily be whipsawed by the kind of over-amplified news (noise) we have seen lately in the financial media. However, the S&P 500 provides the amplest, broad-based volume of any market index, representing a wide diversity of corporations, which is why we use it to analyze market conditions.

Chart 2 below provides a closer look (from 2000 to 2018) at the long-term trendline (green line), along with an intermediate-term trendline (purple line) that spans from 2009 to 2018. This chart puts the extent of the recent downturn in perspective when compared with truly significant selloffs experienced over the past two decades, such as occurred in 2000-2003 and 2007-2009.

Long-term and Intekrmediate-Term Trendlines
Chart 2: The S&P 500 has dropped to its intermediate-term trend line and is at a critical point.

We can see - highlighted with yellow on the right side of Chart 2 - that the S&P 500 has dropped to its purple intermediate-term trend line,  which is a decline of almost exactly -10% – the lower threshold to qualify as a market correction

Corrections are defined as downturns from a recent high of -10 to -20%, while bear markets are defined as downturns totaling more than -20%. The stocks that comprise the S&P 500 would have to collectively plunge another -10%, or effectively doubling the lengthy downturn they've already experienced, in order to qualify as the bear market that so many seem to be so worried about at this time.

Chart 3 below shows how the S&P 500 droppped below its trend channel this year in October and has consolidated sideways for weeks since. Prices will go one way or the other from here, either bouncing upward off the trendline to resume the bull market or dropping below the trendline and heading further downward.


October-November 2018 Consolidation
Chart 3:
Stock prices dropped below their 3-year trend line in October and have been consolidating sideways for weeks since.

Based upon the current chart patterns, there's a good chance that prices may go down a bit more, but we DON'T believe it's possible the S&P 500 will drop all the way to its Long-Term trendline (green), which would be an additional -50% loss for the S&P 500. If anything, prices might go down another 2-5% further, but that will be the extent of it. FYI: the average decline for the S&P 500 during a correction is -18%.  Based on economic data, we don't think this correction is anywhere near to becoming even an average correction (downturn of -18%).

No Imminent Bear Market

Many professional analysts and armchair pundants are calling for an imminent Bear Market - defined as a market decline of more than -20% - and while that scenario will most assuredly occur at some point in the future, it's highly unlikely it will happen in the near-term, i.e., in the next six to nine months. How can we be so sure? Because economic measures continue to be robust and growth is positive. S&P 500 corporate earnings are on track to increase 23% year-over-year and gross domestic product grew at an annual rate of 3.5% from July through September.

The ETFOptimize strategies closely monitor as many as 38 key microeconomic and market fundamental measures to gain an accurate insight into the depth, breadth, and strength of the economy.

In modern market history, there has only been one bear market in the US without a correlated recession. It occurred in 1987 and was an incredible buying opportunity as the market snapped right back and then continued higher. Bear markets and recessions go hand-in-hand, and with economic conditions still climbing higher and corporate earnings accompanying economic conditions higher, it is likely that stock prices are very near their ultimate low for this cycle.

We are not seeing any of the telltale signs of an imminent recession, such as rising unemployment or an inverted yield curve. While these measures are obviously getting closer to those thresholds with every passing day, there certainly not a threat at this time. Based on proven quantitative analysis systems, we think an economic contraction will probably begin in the 2nd to 4th quarters of next year – and certainly not in what remains of this year. If you are on the sidelines or holding defensive positions in preparation for a bear market, you should get accustomed to holding that position for a looooong time.

Our advice is to carefully follow the guidance of the quantitative ETFOptimize strategies and don't diverge for a second! A track record of 66 out of 66 winning (money-making) years should provide you with a measure of confidence that the strategies will do the right thing at the right time.

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