domingo, 20 de septiembre de 2015

Are the American Capital Markets Bullish or Bearish?

Normally using technical analysis some traders try to determine if the market is in a bullish trend (upward trend) or a bearish trend (downward trend). I think technical analysis doesn't tell all the story until it is too late. That is why I decided to create an indicator which is experimental and its goal is to tell the probability of being in a bullish or bearish market. Also, I have an indicator which indicates the probability of being in a recession in the United States. 

Both indicators use information that can be considered fundamental and technical, so I can say that these indicators are hybrid. The only problem is that fundamental information, in this case, economic indicators normally take time to be published. The indicators are generated monthly and today I show them in my blog. 

Graph 1.- Probability of Recession in the United States as of August 2015.

 As we can see in graph 1 the probability of a US recession is very low currently at a level of 0.78% but the probability of being in a bull market in August 2015 was of 45.86%. This means that the capital markets correction can become a bear market even if there is economic growth. Most of the time bear markets occur during recessions but there are also bear markets out of recessions. 
Graph 2.- Probability of being in a bull market as of August 2015

Graph 3.- S&P500 vs probability of being in a bull market.

As a conclusion I can say that the risk of being in a bear market is getting higher than ever since this bullish cycle started. In graph 3 you can see the S&P500. In green color you can see the probability of being in a bull market. When the red color predominates you are in a bear market. The indicator is far from perfect, it is volatile, but it can help to see in which state the market is. Right now the probability of being in a bull market it is at 46%, almost like flipping a coin (50-50 chance). The risk of being long in this market is getting higher. In 2012 the risk of being in a bear market increased significantly mainly due to the European crisis.  An interesting feature of this indicator is that when it reaches a probability of zero it becomes a buy signal for the S&P500. The probability of entering a bear market is high but we need to consider that the US economy is in an expansionary mode which can make the market going side-ways or being in a bull market state. If a recession were predicted and if the probability of being in a bull market starts going down then the probability of entering into a bear market is very high. Only time will tell if these two indicators will become useful for macro trading. I did some backtesting and I obtained the results shown in graph 4, it appears that using this indicator, the ending portfolio value from the strategy was 2 times the S&P500 passive investment strategy.

Graph 4.-  Comparison of strategies: 1) Blue line shows the value of a portfolio using the bull market probability indicator and the red line is a passive investment in the SP500.

Well  only time will tell if this indicator works. Interest rates are key indicator and when they start rising the risk of entering a recession will increase. Any comments are welcome. Thanks for reading.

Humberto Aguilar

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