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Beat the markets with fact-based analysis instead of faith-based “analysis”

Are you sick and tired of financial media, research firms, and economists that have “predicted” 10 out of the past 2 bear markets and recessions?

So am I.

These people have an incentive to scare you because it drives traffic to them. But in reality, following their advice leaves investors and traders worse off than buy and hold! The “crashes” that they successfully predict don’t even make up for the rallies that they miss!

There’s a lot of financial dogma out there. Wall Street and mainstream financial media firmly believes in faith-based “analysis”.

E.g. “a fall below the 200 daily moving average must be bearish for stocks!”

How much of this faith-based analysis is actually true?

Reality: a lot of it is false. Most of what Wall Street and the media promotes as “analysis” is just random guessing (we have the data to prove it). In the words of Warren Buffett, no better than a monkey throwing darts at a chart.

That’s why over the past 10 years, the average professional trader and hedge fund has consistently underperformed buy and hold. Their faith-based “analysis” is no better than a coin toss.

*Trading success has nothing to do with IQ. Hedge funds and Wall Street firms are filled with PhD’s and Ivy League graduates. Meanwhile, most of these professionals are no better than “dumb” buy and hold.

We are different.

We don’t use financial dogma to “guess” where the market will go next. We let data, facts, and trading models tell us where the market will most likely go next (from a probability perspective). 

Moreover, we don’t overcomplicate things for the sake of appearing “sophisticated”. Many professional traders and hedge funds use esoteric indicators/data, and the result is that they can’t even beat buy and hold!

Trading and investing is about probability. Use probability to your advantage. The market usually (but not always) goes according to its most-probable direction. Over the long run:

  1. Those who consistently trade with probability on their side will outperform.
  2. Those who consistently trade against probability will underperform.

My journey

My name is Troy Bombardia, founder and head trader at Fundamental Capital, the investment strategy and research firm behind Bull Markets.

I worked in my family’s hedge fund for almost 10 years (from 2008-2017). We increased our capital by 40x during those 10 years, which is an average annual return of 44%.

We traded gold, silver, and stocks based on traditional technical analysis. But in 2014, I noticed a very interesting pattern:

  1. All of our profits were from trading gold and silver.
  2. We were no better than “dumb” buy and hold when trading U.S. stocks!
  3. When we turned bearish on U.S. stocks, the market often went up another 15% before it “crashed” 10%. But it was still higher than when we first turned bearish! In other words, we underperformed buy and hold!
  4. For every 1 time technical indicator XYZ “worked”, there were 2 other times it didn’t work. No technical indicator on its own gave us a significant edge in the markets.

Meanwhile, the research coming out of Wall Street was no better:

  1. Investment research firms only highlighted their accurate market calls. But when you look at the number of times they were wrong, they’re no better than a 50-50 coin toss!
  2. Wall Street research firms don’t tell you exactly how much money you would make or lose from following their advice. There was no way to gauge exactly how accurate their analysis was.

What were we doing wrong in the U.S. stock market? What were other firms doing wrong? After a year of research, I realised:

  1. Traders and investors who combine fundamental analysis with technical analysis outperform traders who only use technical analysis.
  2. Proper fundamental analysis is not even hard! Most people are just doing it wrong.
  3. Simple, quantitative trading models allow traders to backtest their strategies and know EXACTLY how well a strategy works. No more “guessing”.

With this insight, I developed the Medium-Long Term Model and other trading models, which generate an average of 20-30% a year trading the U.S. stock market.

Here’s why my quantitative trading models are so successful.

Focus on the medium-long term

The stock market’s short term is harder to predict because there is a lot of randomness in the market’s short term movements. The stock market’s medium-long term is much easier to predict because it follows the fundamentals of the stock market (i.e. the economy).

On any random day, the U.S. stock market’s short term outlook is mostly a 50-50 bet. But as time goes on, the stock market has a higher and higher chance of going up.

The U.S. stock market’s medium-long term direction follows the U.S. economy.

The U.S. stock market and the U.S. economy (macro) move in the same direction in the medium-long term. This is inherently logical. The economy drives corporate earnings, which drives stock prices.

This chart demonstrates that the stock market (S&P 500) rarely makes big declines (bear markets, which are 40%+ declines) outside of recessions.

*Recessions are in grey, bear markets are in orange.

Some people say that “the stock market leads the economy”, while others say that “the economy leads the stock market”. Both of these camps are right, but each camp is only telling you half of the story.

The stock market leads the “economy”, as defined by GDP. As you can see in the above picture, the stock market tops (bear markets start) before recessions begin. However, GDP is a lagging economic indicator.

  1. Certain LEADING economic indicators (e.g. Initial Claims, Housing Starts) lead both the stock market and the economy.
  2. The chain of events look like this. Leading economic indicators start to deteriorate. Then the stock market tops. Then GDP turns negative, resulting in a recession.

That’s why we use leading economic indicators to predict the stock market’s medium-long term direction. The leading economic indicators will start to change directions before the stock market makes long term tops and long term bottoms.

I explain this in more detail in my book.

Economic expansions and equity bull markets DO NOT die of old age. How long a bull market and economic expansion lasts depends on the country’s individual circumstances at the time.

As you can see from the following chart, the U.S.’ economic expansions over the past 150+ years have lasted longer and longer.

Short term deviations between the stock market and economy are technical in nature. Some of these deviations can be predicted through technical studies. If the stock market and economy start to move in opposite directions, the stock market will eventually move in the same direction as the economy.

Stop focusing on “it’s a bubble”

Too many traders use “valuations” to to trade. This is silly, to say the least.

  1. Valuations tell you where the market will be in 5 years.
  2. Valuations don’t tell you where the market will be in the interim. I.e. valuations don’t tell you where the stock market will be next week, next month, or even next year.

Here’s the data to prove that valuations don’t matter for short term traders.

These are the S&P 500’s 1 month forward returns vs. its valuation (P/E ratio). Notice how there is almost no correlation between the stock market’s valuation and 1 month forward returns.

R squared = 0.008

These are the S&P 500’s 3 month forward returns vs. its valuation (P/E ratio). Notice how there is almost no correlation between the stock market’s valuation and 3 month forward returns.

R squared = 0.0255

These are the S&P 500’s 6 month forward returns vs. its valuation (P/E ratio). Notice how there is almost no correlation between the stock market’s valuation and 6 month forward returns.

R squared = 0.05

These are the S&P 500’s 1 year forward returns vs. its valuation (P/E ratio). Notice how the correlation between the stock market’s valuation and 1 year forward returns is weak.

R squared = 0.0765

These are the S&P 500’s 2 year forward returns vs. its valuation (P/E ratio). Notice how the correlation between the stock market’s valuation and 2 year forward returns is weak.

R squared = 0.0646

This is from Jeremy Grantham, the hedge fund legend who has predicted every major market collapse:

  1. There’s no difference between selling on the way up (before the bubble’s peak) and selling on the way down (after the bubble’s peak).
  2. When predicting the top of a bubble, you are FAR MORE LIKELY to sell before the peak than after the peak.
  3. So stop calling things a “bubble” and trying to pick the top of a bubble.

Our quantitative models for trading the stock market

I developed quantitative trading models for trading the U.S. stock market. None of these models are very complex. “Simplicity is the ultimate sophistication”.

The Medium-Long Term Model is my most complicated model and generates an average of 43% per year (backtested over the past 50+ years).

I have other shorter term trading models that generate 20%+ per year. These simple models clearly outperform the S&P 500 in the long run, which generates an average of 7-8% per year.

Armed with my models, an investor or trader can easily and significantly outperform in the long run. Because if a trader can’t significantly beat buy and hold, then he isn’t doing is job right.

  1. Click here to access my free trading models that generate an average of 15-20% per year.
  2. Click here to access my premium trading models that generate an average of 20-30%+ per year

Why you should trade index ETFs instead of individual stocks

Trading the index (e.g. S&P 500) via ETFs (e.g. $SPY, $SSO, $UPRO) is much easier than trading individual stocks.

  1. Traders who trade individual stocks have to care about what the broad stock market index is doing. What the index is doing has a massive impact on what an individual stock will do.
  2. Traders who trade the index don’t have to care about what individual stocks do. No single stock is big enough to have a significant impact on the broad index in the medium-long term.

Read more

Why you should trade leveraged ETFs

Leveraged ETFs amplify the underlying market’s returns. For example, a 2x leveraged ETF for the S&P 500 ($SSO) will amplify the S&P 500’s daily returns by 2x.

  1. If the S&P rises +1%, the 2x leveraged ETF will rise +2%
  2. If the S&P falls -1%, the 2x leveraged ETF will fall -2%

In essence, leveraged ETFs amplify your profits when the market goes up and amplify your losses when the market goes down.

My trading models help you sidestep the stock market’s large declines. Trading leveraged ETFs with my models:

  1. Helps you increase your gains when the stock market goes up.
  2. Sidestep periods when the stock market goes down, thereby reducing your drawdowns.

That’s how you easily outperform in the long run.