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Finding the right time to jump back in the market is a conundrum for virtually all investors.

  • Some skirt the issue by purchasing regularly in all markets
  • Others who buy only when sentiment is decidedly bullish often find themselves accumulating right before a correction
  • Valuation techniques are valuable tools that reveal current market sentiment, but a drop in aggregate fundamentals can also create equilibrium without rising share prices

When is a good time to buy back into the market? What timely trigger can we use?

One technique I employ involves the looking at the trends of analyst earnings forecasts. Historically, this technique has kept investors sidelined during every bear market of the past 10 years. How does it work and what is it telling us right now?

Market Timing and Analyst Estimates

Analyst earnings estimates are frequently inaccurate, which makes forward-looking valuation difficult. In addition to an unpredictable future earnings or revenue figure, you have the challenging task of estimating a price ratio based on this fundamental number. Arriving at a 12 month price target is an educated guess at best.

Analyst estimates can be used for far more than price targets or even earnings growth estimates – you can chart broad trends as well. How will this help us with market timing? By using estimated earnings for a broad market index, such as the S&P 500 (NYSEARCA:SPY), you can look for earnings momentum and a change in sentiment.

First there is momentum. If earnings estimates for the year are expected to grow at an anemic pace, this is apparent on the forecast earnings chart. Also, analyst estimates are a mix of sentiment and realized earnings so when fear and panic permeate the market this should also be reflected in the forecast. If year over year growth is low, our market timing rules should keep us out of the equity markets and in more favorable products. If the economy undergoes a radical change during the year, it will generate a market timing signal.

The broad market timing signal I use for the total earnings forecast on the S&P 500 is a crossover of the 3 and 15 week moving average - provided the short-term moving average of the current year’s earnings forecast can stay above the longer average we stay invested. How well has this worked over the past 10 years?

Click to enlarge charts

Ranking our data on weekends only, we would have sold on Monday July 25th, 2011. Monday, November 7th is our first day back in. Since March 31st, 2011, this simple system would have resulted in 233% profits by investing equally in the 500 stocks (equal weighting) in the S&P 500 index as opposed 8% total gain in the market-cap weighted index.

*You can find this data at Stockscreen123 or Portfolio123 which are sister sites that I have no affiliation with

Confirming the Signal

One problem you can encounter when trading with one signal only is whip-saw or multiple buy and sell signals in quick succession. Therefore, we need to add a confirmation signal. It is a 100 day moving average on the S&P 500 price chart. Thus, even if our earnings estimates get locked in a tight zone, we will not be buying and dumping our shares with every little move.

The S&P 500 is above our confirmation signal of 1228.84 thus giving us a confirmed market timing buy signal. If the 3 week earnings estimates fell below the 15 week and the S&P 500 fell below this 100 day moving average, we would need to once again liquidate our holdings.

Beyond Market Timing

As an Aggressive Dividends investor this is only the first, although most important, trading rule to follow. From here we need to come up with a stock selection strategy that has potential to beat the market. Some simply use market timing to jump aboard or sell hot stocks such as Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), or Inhibitex (NASDAQ:INHX). While you can do so, there are many back-tested strategies that attempt to squeeze excess gain from the market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.