Trader’s Narrative

Here is an interesting idea from Worden Bros (see video below). By accident, they stumbled on an indicator which seems to find the major market trend.

The idea is simple. Look at the earnings for the “Dogs of the S&P 500″ - that is, those in the lowest 10th percentile of earnings in the index. When the earnings fall below an average (in this case a 50 week average), the market goes into a protracted decline.

It seems interesting but there are a few caveats. For one, the video only covers a short period of time: from 1999 to 2007 (present). That’s because as you’ll notice in the video (before he zooms it in) the chart for the years prior to 1999 don’t seem to offer any sort of significant data.

In fact, if you pause the video at the 1:46 area, you can notice that the earnings in 1998 declined at the same time as the market was bottoming. And the earnings only recovered their 50 moving average line in mid 1999 when the S&P 500 had already recovered well above its 1998 highs.

The other caution about this indicator is that we are comparing a dollar (or billions) of earnings to previous ones in time. Unless you do so within a short period of time, this can be misleading. Inflation skews the value of a dollar when we look at anything approaching 10 years or more. So we would need to look at inflation adjusted data for long term charts.

As most savy investors and traders will tell you, looking at earnings as a tell is a lot like driving by looking in the rear view mirror.

To watch video, click the image below: