Market Timing: 3 Indicators That Work

Jan. 20, 2014 11:29 AM ETDIA, DOG, IWM, PSQ, QQQ, RWM, SH16 Comments

After my series on portfolio protection by sectors (click here for the conclusion), a reader asked if there was a clue that my timing indicator was a good one. This article compares three market-timing indicators: a technical one ("Golden Cross"), a fundamental one ("EPS Estimate"), and a macro-economic one ("Unemployment").

Here are the definitions of the signals:

  • "Golden Cross" is bullish when the 50-day simple moving average of SPY is above, or equal to, its 200-day simple moving average. Else, it is bearish.
  • "EPS Estimate" is bullish when the S&P 500 current year EPS estimate is above, or equal to, its value three months ago. Else, it is bearish.
  • "Unemployment" is bullish when the U.S. unemployment rate is below, or equal to, its value three months ago. Else, it is bearish.

The first table shows the results of a long position in SPY when, and only when, the indicators are bullish last 15 years (1/2/1999 - 1/17/2014):

Timing Indicator

Tot.Return

Ann.Ret.

Drawdown

Volatility

Buy and Hold

95.46%

4.6%

-55.4%

23.8%

Golden Cross

223.5%

8.1%

-17.0%

14.1%

Unemployment

257.5%

8.84%

-27.2%

15.2%

EPS Estimate

273.2%

9.2%

-20.2%

14.6%

The second table shows the results of holding the short S&P500 ETF SH when, and only when, the indicators are bearish. It is more relevant when using the indicators to hedge instead of going out of the market.

Timing Indicator

Tot.Return

Ann.Ret.

Drawdown

Volatility

Death Cross

19.6%

1.2%

-47.0%

32.7%

Unemployment

60.8%

3.2%

-45.5%

29.3%

EPS Estimate

32.9%

1.9%

-41.4%

32.3%

Similar results can be obtained with other pairs of ETFs for major stock indexes: DIA/DOG for the Dow Jones, IWM/RWM for the Russell 2000, QQQ/PSQ for the Nasdaq 100.

Conclusion:

The main advantage of market-timing is not improving the return, but cutting drawdowns and volatility. The fundamental indicator was the best over the last 15 years for simple market-timing, whereas the macro-economic one was better for timed-hedging. However, it is a relatively short period of time, and results are close: I won't conclude that one indicator is definitively better that others. Compared with "buy-and-hold", any of these indicators has done a good job in reducing risks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article was written by

Fred Piard profile picture
14.34K Followers
Data-driven model portfolios and market risk indicators.
Author of Quantitative Risk & Value and three books, I have been investing in systematic strategies since 2010. I have a PhD in computer science, an MSc in software engineering, an MSc in civil engineering and 30 years of professional experience in various sectors. My aim is making simple and efficient quantitative investing techniques available to my followers. Quantitative models can make investment decisions faster, reproducible and emotionless by focusing on relevant information in the middle of market noise. Moreover, models can be refined to meet specific risk tolerance and objectives. 

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I am an individual investor and an IT professional, not a finance professional. My writings are data analysis and opinions, not investment advice. They may contain inaccurate information, despite all the effort I put in them. Readers are responsible for all consequences of using information included in my work, and are encouraged to do their own research from various sources.

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