It certainly seems as though the political gamesmanship that rules Washington, D.C., also rules the markets. But this isn't really the case.
In fact, there's one single "magic" number that far outweighs everything else when it comes to long-term influence.
This number's predictive power has saved me from some of the steepest market drops of the century, and it's given me everything I need to position myself for maximum gains in bull markets.
And the best part is, it's widely available – access to it costs nothing.
It's how you use this simple number that counts…
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Earnings season is the key to it all. That's when over half of all public companies report the revenue and earnings results for the previous three-month period.
Here's where the number comes in. You can track these earnings with a metric called the trailing 12-month earnings per share (EPS).
You can always find it right here, over at Barron's.
At a single glance, it tells you whether earnings are trending higher or lower. Staying ahead of that trend is the key to beating the markets.
The number, the current aggregate EPS of the S&P 500, is $90.95.
This metric is incredibly accurate, and historically speaking, when earnings increase in the aggregate, stocks tend to go up in the aggregate. Of course, you might see an individual stock sell off after it reports rising earnings, and conversely, you might see an individual stock rise on downbeat earnings. Yet, by and large, when corporate earnings are rising, stock values also rise. The reverse is also true: When earnings are in decline, stock prices also decline.
But when you have the aggregate EPS in hand, you can prepare for these declines.
Get Ahead of Bear Markets
This happens rarely, but when the aggregate measure of earnings on the S&P 500 declines for two consecutive quarters, the market is telling us to sell. This has only happened twice this century – so far – once in January 2001 and again in October 2007.
In 2007, earnings began to decline in the second quarter, as many companies – primarily financial – began booking losses due to the subprime loan crisis. By the end of October 2007, S&P 500 earnings had once again declined sharply because of the huge third-quarter losses booked by many of those same financial firms.
Given that the S&P 500 was trading near its all-time highs midway through 2007, it was easy to see that earnings were not keeping up with stock prices and that this situation was about to right itself via a sharp market correction. As we all know, that's precisely what happened in the fall of that year, after earnings showed they had declined for the second consecutive quarter.
Like an "all-clear" siren, the aggregate EPS will also tell you when the worst is over… and when it's time to go pick up shares.
When to Go Shopping
This "two consecutive quarters" of directional earnings signal also works as a buy signal, particularly after a big downturn.
For example, two consecutive quarters of positive earnings on the S&P 500 in 2009 served as the green light I had been waiting for to get back into stocks after the 2007 meltdown. And that is precisely what happened in July 2009, after I saw that the S&P 500 had logged its second consecutive quarter of earnings growth.
I know this may seem relatively simple, but if you would have followed this "two consecutive quarters" metric, you would have been on the right side of the market during two of the largest market declines in this century.
This indicator got me out of U.S. stocks in October 2007, and I stayed that way until July 2009.
It saved me from the near-40% plunge in the U.S. stock market during the crisis years. The same indicator also kept me out of stocks between January of 2001 and July of 2002, avoiding the worst declines of the tech stock bust.
So, it really is as easy as this: When earnings decline for two quarters, that's your signal to exit stocks. And when earnings rebound for two quarters, it's time to get back in.