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

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

So am I. Just because something sounds “smart”, doesn’t mean that it’s the right thing to do.

Following their advice and conventional strategies leaves investors and traders worse off than “dumb” buy and hold in the long run! The market crashes that they successfully predict and avoid don’t even make up for the market rallies that they miss!

Here’s the S&P 500 Total Return Index vs. the HFRI Fund Weighted Composite Index, an index that tracks the performance of 1400 hedge funds net of all fees. As you can see, almost all the outperformance came in the 2000-2002 and 2007-2009 bear markets. From 2009 – present, hedge funds have lagged the S&P badly. So much for being “smart money”.

Click here to download the HFRI hedge fund data in Excel.

Conventional investment and trading strategies rely on too much dogma and faith-based “analysis”, such as “a breakdown below the 200 daily moving average must be bearish for stocks!”

How much of this dogma is actually true?

Reality: a lot of it is false, and we can prove this with data.

Most of what Wall Street and the media promotes as “analysis” is not much better random guessing. In the words of Warren Buffett, no better than a monkey throwing darts at a chart in the long run.

That’s why over the past 10-20 years, most professional traders and hedge funds have consistently underperformed buy and hold. Their faith-based “analysis” is no better than a coin toss. They believe in conventional investment strategies and conventional “wisdom” just because everyone else believes in it. Monkey see, monkey do.

It’s not that coin-toss analysis “never works”. It works 50% of the time. Which is no better than a monkey throwing darts at a chart.

We think differently

We don’t use financial dogma to “guess” where the market will go next.
We don’t trade the news.

We let data, facts, and quantitative models tell us where the market will most likely go next (from a probability perspective).

Investing and trading 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:

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

Hence, the optimal investment strategy is to:

Consistently bet on the side that probability favors. We use models to determine whether the market will most likely go up or down.
Incorporate quantitative risk management rules in case a low probability event occurs.

My journey

I’m Troy Bombardia, founder of 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%.

By 2014, I noticed a very interesting pattern in the U.S. stock market:

The average professional trader and hedge fund underperformed buy and hold for 10 years in a row. The random probability of someone underperforming 10 years in a row is 0.09% (0.5^10 = 0.0009). In other words, there is no way this should be happening if conventional investment and trading strategies actually worked, as the experts and gurus claim!
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!
Most research consisted of charts. Meanwhile, no one bothered to backtest exactly how useful those charts were for predicting tops and bottoms! (There are plenty of psychological studies explaining why staring at charts is useless – the human eye tends to see what it wants to see, which is confirmation bias).
Investment and trading professionals are great at producing complicated, smart-sounding research. But when they apply their “award winning proprietary research”, their results are worse than buy and hold.

What were they doing wrong in the U.S. stock market? After a lot of research, I realised:

Traders and investors who combine fundamental analysis with technical analysis outperform traders who only use technical analysis.
Proper fundamental analysis is not hard! Most people are just doing it the wrong way. The financial industry’s conventional belief about “what is fundamental analysis” is wrong.
Simple, quantitative models allow investors and traders to backtest their strategies and know EXACTLY how well a strategy works. No more “guessing” and hoping that strategies preached by “gurus” actually work.

With this insight, I developed multiple investment and trading models, some of which generate 20%+ a year in the U.S. stock market.

Here’s why my investment and trading models are so successful.

Key insight #1: 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 short term movements. The short term is heavily impacted by random events and factors that one cannot consistently and accurately predict without 20/20 hindsight. 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.

Key insight #2: the U.S. stock market’s medium-long term direction follows the U.S. economy.

Everyone knows that corporate earnings and the stock market move in the same direction in the long run.

As corporate earnings increase, the stock market goes up in the long run (it’s a bull market).
As corporate earnings decrease, the stock market goes down in the long run (it’s a bear market).

But the key insight is that the U.S. economy drives corporate earnings in the long run.

As the U.S. economy improves, corporate earnings increase.
As the U.S. economy deteriorates, corporate earnings decrease.

This is why we focus on the U.S. economy to predict the U.S. stock market’s medium-long term direction. The economy drives corporate earnings, which drives the stock market.

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. This is a log scale chart.

Recessions + above-average valuations = bear markets (40%+ declines)
Recessions + below-average valuations = “big corrections” (15-30% declines)

Everyone knows if the stock market is “overvalued” or “undervalued” right now. The most basic of valuations indicators will tell you that (e.g. Tobin’s Q)

But it’s the predicting economic deterioration part that is difficult, which is what our models do.

Take this statistic into consideration. The S&P 500 and real GDP have a 0.92 correlation from 1947-2018

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.

Certain LEADING economic indicators (e.g. Initial Claims, Housing Starts, Heavy Truck Sales) lead both the stock market and the economy.
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.

Economic expansions and equity bull markets DO NOT die of old age. As you can see from the following chart, the U.S.’ economic expansions over the past 150+ years have lasted longer and longer. There is no such thing as “an economic expansion MUST end after X number of years”.

Temporary deviations between the stock market and economy are technical in nature. Our models and indices can predict some of these deviations.

But 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.

Our models for trading and investing in the stock market

We developed quantitative models for trading and investing in the U.S. stock market.

The Medium-Long Term Model is our most complicated model. It generates an average of:

14.7% a year when traded with SPY (for investors)
30% a year when traded with SSO (for traders)

*SSO = S&P 500’s 2x leveraged ETF

We have other investment and trading models that yield an average of 15%-25% a year when traded with $SSO. These models outperform the S&P 500 in the long run, which generates an average of 7-8% per year.

Armed with our models, an investor or trader can significantly outperform in the long run with smaller drawdowns than buy and hold.

Why trade with models?

We use models for a few reasons. We don’t use non-quantitative “analysis” for investing and trading. Non-quantitative analysis = non-existent analysis. Non-quantitative analysis is just random guessing based on whatever makes sense to your own version of “logic”.

If you are serious about trading/investing, you must treat it like a business. Successful businesses run on clearly defined processes and decision making rules. Successful businesses do not make random, off-the-cuff decisions. Successful businesses don’t use analysis based on “feelings” or “it looks like” or “random guessing”. The best businesses use cold, hard data to help them make decisions.

Fact-driven analysis > faith-driven “analysis”

If someone doesn’t even know how well their strategy performs under various market environments (e.g. 1987 crash, 1995 rally, 2013 rally, 2008 crash), then you need to be wary of using such a strategy. And generally speaking, discretionary traders don’t know how well their strategy performs under various market environments because they can’t even backtest their strategy.

With discretionary trading strategies, you have no idea how well it works. Moreover, you don’t know if a discretionary trading strategy is working right now because of dumb luck, or because the strategy actually works in all market environments. All you can do is hope and pray that it does work.

With quantitative trading strategies, you know exactly how well it works under different market environments. You are no longer guessing and hoping that it works.

Morever, there will always be bullish and bearish factors are any given point in time. Never will you have a case in which 100% of the factors are bullish or 100% of the factors are bearish. By using a quantitative model for trading, you are clearly expressing which factors are more important and which factors are less important. In other words, models help you separate the signal from the noise.

Why multiple models?

We provide multiple models in the Bull Markets Membership Program.

So why produce multiple investment and trading models? Why not just recommend 1 model to members?

Because there is no such thing as a Holy Grail in the financial markets. Every model has its advantages and disadvantages.

Some models have higher returns. These models also have higher drawdowns.
Some models have lower returns. These models also have lower drawdowns.
Some models perform better in trending markets.
Some models perform better in choppy markets.

There is no “best” model. The model that is most suited to each person depends on their own personal preferance, risk tolerance, etc.

We explain each model’s advantages and disadvantages. By laying it all out, our members can pick the model that best suits them.

Our attitude in the markets: we are cautious optimists

This website is called Bull Markets because the big money is made from investing in bull markets and sidestepping bear markets. It isn’t made from blowing every single risk or “worry” out of proportion.

Pessimists always sound “smart” because humans respond stronger to loss than to gain (Daniel Kahneman won the Nobel Prize for proving this). Why is pessimism so popular?

Optimists tell you that the world’s major problems will eventually get solved. While this seems stupid (especially if you’re reading this in the depths of a recession), it is the reality. On a multi-decade basis, the world continues to get better and asset prices continue to climb.
Misery loves company.
Pessimism grabs your attention. Optimism requires slow growth. Pessimism requires CRASH AND BURN. So while good things take more time (not as sexy or headline-grabbing), bad things happen more quickly.
Pessimism sounds like someone is trying to save you. This isn’t true. The only way permabears make money is from selling their message to other gullible pessimists. If permabears actually traded on their own advice, they would lose 90% of their capital within a decade.

While pessimism sounds “smart”, optimists generally outperform in all aspects of life.

Just look at the Forbes 500 list.

How many permabears are there?
How many doom-and-gloom billionaires are there?

Matt Ridley wrote in his book The Rational Optimist:

If you say the world has been getting better you may get away with being called naïve and insensitive. If you say the world is going to go on getting better, you are considered embarrassingly mad. If, on the other hand, you say catastrophe is imminent, you may expect a McArthur genius award or even the Nobel Peace Prize.

The same applies to the stock market.

If you say that “stocks will go up 20% next year”, you will be called reckless, ignorant of risk, blind, etc.
If you say that “stocks ‘could’ go down -30% year next year”, everyone will reach out to you and congradulate you for being so savy and aware of risk. (Never mind the fact that anything ‘could’ happen. Probability is more important than possibility.)

If you know nothing about the stock market, just know this. The stock market goes up more often than it goes down. Be a cautious optimist and ignore the permabears.