The fun thing about technical analysis is you can take virtually any data and analyze it through its lens. For example we all understand the positive relationship between corporate earnings and stock prices. Higher earnings = higher prices and vice versa. Earnings are a key tool fundamentalists use in their analysis of the markets to look at valuations and other metrics. Now, if I plot reported GAAP earnings on the SP500 companies against the price of the SP500 stock index over the past 20 years it would look something like this …
In the upper pane is GAAP earnings (blue line) and the lower is the SP500 index price. I have added a simple 200 day moving average to earnings (orange line) to smooth out its gyrations and use as a trigger line for a very simple investment system. That system would be to sell stocks when earnings cross below the moving average and buy when they cross above. I have added red vertical lines indicating where those sell signals occurred in the past.
While I have not back-tested this “system”, just using the ol’ eyeball test, it seems to do a pretty good job of avoiding a big chunk of major corrections and keeping you invested while the trend is rising. Like any system using moving averages it is susceptible to false signals/whipsaws like the one that occurred in 1998. Time will only tell if the recent “sell” signal turns out to be a whipsaw or not, either way investors should tread lightly here as the weight of the evidence is flashing warnings signs.