(Bloomberg) — Bank of America Corp.’s quant analysts say a US stock market indicator with a perfect track record has bad news for bulls: Equity prices haven’t bottomed out yet.
The measure looks at the S&P 500 Index’s trailing price-to-earnings ratio in combination with US consumer inflation. Every market trough since the 1950s saw the gauge fall below 20. But during the waves of selling that battered markets this year, it only got as low as 27.
“One signpost with a perfect track record is the Rule of 20,” Bank of America’s equity and quant strategists led by Savita Subramanian wrote in a note. They add that unless inflation goes to zero or the S&P 500 falls to 2500 points, an earnings surprise of 50% would be required to push the gauge low enough to signal a market bottom — something they said seems “unachievable.”
The indicator flies in the face of the recent rally that has driven the S&P 500 up more than 17% since its mid-June low, and its track record would be a clear sign to sell if it weren’t at odds with other bullish technical signs. The S&P 500, for example, has already recovered 50% of the drop from its peak, a movement that history suggets means the market won’t test another low, according to research firm CFRA.
But for the Bank of America analysts, rule of 20 isn’t the only signal at odds with the recent stock run-up. So far, the market has crossed only about 30% of the signposts they say indicate that the market has bottomed, compared with more than 80% after previous downturns. That, they wrote, is “suggesting that another pullback is likely.”
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