One Of Bank of America's "Guaranteed Bear Market" Indicators Was Just Triggered

It is undisputed that the last 2 quarters have demonstrated an impressive jump in corporate earnings growth, if mostly due to a beneficial base effect from plunging 2016 earnings which pushed them below levels reached in 2014. And naturally, this rebound has been more than priced into a market which has seen substantial multiple expansion since the Trump election to boot. But what is much more important for the market is what corporate earnings look like in the future, and it is here that Bank of America has just raised a very troubling red flag.

According to BofA's Savita Subramanian, in November the S&P 500's three-month earnings estimate revision ratio (ERR) fell for the fourth consecutive month to 0.99 (from 1.03), indicating that for the first time in seven months, there were more negative than positive earnings revisions, needless to say a major negative inflection point in the recent surge in profits. The bank's more volatile one-month ERR also weakened to 0.94 (from 1.16).

A breakdown of EER by sector showed a sudden and broad-based deterioration, as the three-month ERR weakened across eight of the 11 sectors, with Materials, Health Care, and Financials seeing the biggest declines while, not surprisingly, Tech and Energy have the highest three-month ERRs, with Energy's ERR expanding the most on the back of rallying oil prices. Meanwhile, Telecom, Real Estate, and Discretionary have the weakest ratios, and November saw a drop in the Health Care and Industrials' EER ratio below 1.0 (meaning more cuts than raises to earnings forecasts) for the first time since March. Furthermore, while two sectors have been "improving" in recent months: namely Energy and Tech whose ERRs have been rising; all other sectors have seen their ERRs roll over.

Why is this significant?

As BofA explains, the three-month S&P 500 ERR is used by the bank as one of its 19 key "bear market signposts", and with the one-month ERR falling below 1.0 for the second time in six months, this marks the trigger for the 11th bear market signpost. BofA's ERR rule is triggered when, over a six-month window, all of the following criteria are met: 1) the one-month ERR falls from above 1.0 to below 1.0; 2) the one-month ERR is below 1.0 for two or more months; and 3) the three-month ERR falls below 1.1 for at least one month.

Incidentaqlly, the hit rate of the "ERR" bear market indicator, meaning its historical accuracy in predicting a bear market is 100%, the only question is how long it takes. The last time this trigger was set was mid-2003, and here is the punchline from Bank of America:

Since 1986, a bear market has followed each time that the ERR rule has been triggered. While individual signposts may not be useful for market timing (this one was triggered several years too early in the last two cycles), prior bear markets were preceded by a broader array of signals having been triggered.

This is shown in the chart below:

Ok so one indicator out of 19 now is flashing "bear market" dead ahead. That's hardly bad if the rest are all green, right? Well, they aren't.

As discussed two weeks ago, Bank of America recently compiled a list of bear market signposts that have always occurred ahead of bear markets. No single indicator is perfect, and as Subramanian wrote, "in this cycle, several will undoubtedly lag or not occur at all." And while single indicators may not be useful for market timing, they can be viewed as conservative preconditions for a bear market. In this context, the suddenly "triggered" ERR indicator is one of the bank's 19 bear market signposts.

Here a caveat is warranted: in the last two cycles, the ERR rule was triggered several years too early (Chart 3 above), although a bear market followed each time that the ERR rule has been triggered. As for timing, the more signposts triggered, the greater the risk of an imminent bear market, in BofA's view. And in November, the one-month ERR falling below 1.0 for the second time in six month marked the 11th trigger (out of 19). This is shown in the table below.

It also means that nearly two-thirds of Bank of America's bear market indicators have now been triggered. As Subramanian concludes "every cycle is different, but we expect to see more signposts triggered before the eventual market peak."

Then again, this remains a "market" where even if 12 out of the 11 indicators are triggered, it may just send the S&P limit up as there is no point in selling if all that does is guarantee another central bank bailout.


spastic_colon Joe Davola Thu, 12/07/2017 - 11:50 Permalink

this is why tax reform is soooooooooo important; they must give corps another reason to game earnings and thus registering this indicator useless......but they better hurry only a couple weeks left until next earnings season.i'm not much of a technical person but look at the daily pattern on the dow from dec 2016 to april 2017; see anything familiar forming?? down not allowed...........

In reply to by Joe Davola

MK13 BurningFuld Thu, 12/07/2017 - 12:15 Permalink

You are using cognitive dissonance why this time it's different - it's always different - but it's always the same. Sooner or later debt, leverage, demographics do matter.

In case of these indicators, if you used negative yield curve, you'd have missed 20% more upside and you'd have been about 12 months off the peak - barely acceptable as investor, killer as trader.

When the next real bear market is a'knocking, this website will be flashing signs like you've never seen before, too early to worry now.

In reply to by BurningFuld

Tolomeo Thu, 12/07/2017 - 11:01 Permalink

This people (ML) are smoking bad weed! If anything, a massive melt up it’s what’s to come!!! CBs pouring in all that’s necessary to keep the markets attractive to keep up with Bitcoin! God forbid an outpouring from their markets to something they can quite put their hands on (yet!)!!! It’s a competition!!!

wmbz Thu, 12/07/2017 - 11:02 Permalink

"every cycle is different"Yea, well this "cycle" is damn sure different!The bankster bastards in control have gone batshit crazy and can not stop, turn back, put the brakes on, whatever you want to say. This cycle will go full blown supernova!

NoDebt Thu, 12/07/2017 - 11:02 Permalink

Throw it on the heap of discredited "guaranteed, works every time" statistics.  We've broken every fucking one of them the last five years.  

buzzsaw99 Thu, 12/07/2017 - 11:06 Permalink

...if we short this market, we're losing all our damn money, and Christmas is around the corner, and I ain't gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain't gonna f... my wife ain't gonna make love to me if I got no money![/billy ray]

LawsofPhysics Thu, 12/07/2017 - 11:06 Permalink

LOL!!  Sure, sure...this time really is different only in so much as the printing effort has been globally coordinated...This time the death of all fiat currency will be something that is felt globally.Get your tribes in order, no man is an island."Full Faith and Credit"

WillyGroper Thu, 12/07/2017 - 11:06 Permalink

FWIW folks...contractor exercises going on in PR setting up command structure for contigious 48.  gov's will relinquish power to DHS.  the proverbial shit is about to hit the fan. recommend YT's Roy Potter & Matt Bracken's latest.

WillyGroper Ron_Mexico Thu, 12/07/2017 - 12:25 Permalink

advised by bud in spek0ps.what troubled me the most is they're mil contractors, so read that mercs...good news is domestic as opposed to foreign.go to Matt Bracken's latest & Roy Potter. add it up:  weensteen/helliary RICO,  then look at the bitcoin madness...this is a proxy for pm's.all the Qanon questions of NK?  see eye yeah spook HQ.remember doug band in the helliary/molesta wikileads?  who's in this pic? 

In reply to by Ron_Mexico

adr Thu, 12/07/2017 - 11:11 Permalink

I think we're getting pretty close to the point where commerce just stops. I don't know how people are buying homes, any new construction costs over $400k anywhere around me. Even an absolute shit 1970s 800sq ft prefab on a slab costs over $200k, there was a near condemned 30 year old trailer park "home" selling for a bargain price of $150k.Going to the doctor for a sore throat costs $250.A Big Mac Meal at McDonald's with tax is now over $9.Dick's Sporting Goods wants more margin or they won't buy, problem is if I give them any more margin I go negative on what I sell. I'm not Amazon so I can't lose money on everything I sell and pay people to work.I laughed when I saw toys at my local Walmart that have actually been on the shelf for more than a year. Last Christmas the store got a pallet of toys in one of the cardboard racetrack displays and after Christmas most of them were still there. One year later the same exact toys are on the shelf. If they didn't sell last year at full price, they aren't going to sell this year either.And to top it all off you have Bitcoin adding $10k in "value" in less than a few weeks after it's last big drop.Insanity doesn't describe our world today.

Dumpster Elite adr Thu, 12/07/2017 - 11:17 Permalink

Not sure where you are, but a Big Mac Meal with a medium drink is almost $14 here. "Fight for 15!!!". It worked here in NY State. As far as homes go, who cares what they cost! We're just buying it so we can turn around and sell it at a 50% profit 3 years from now! We won't even have to unpack, right??

In reply to by adr

Wise Gold Thu, 12/07/2017 - 11:30 Permalink

"Guranteed"  Herd this before.  So far the Shepwave traders have been calling the moves.  We should check this with them.  How many times does Bank of Americal need bailing out.

Snaffew Thu, 12/07/2017 - 11:30 Permalink

simple solution...remove the negative earners from the S&P and load up with the winners.  Hence, the markets will keep the charade alive and well.

KingOfMilwaukee Thu, 12/07/2017 - 11:37 Permalink

I must say, three years ago Martin Armstrong was predicting 30,000 Dow and 800 Gold and another bull in real estate to eclipse 2007. That seemed crazy. But not anymore.