The valuation model is used in conjunction with the technical model for the purpose of bolstering the technical view and greatly reducing the subjectivity that often plagues virtually all technical analyses. Both models are also used in conjunction with a third model, namely, the buy/sell model, to identify high-probability trade opportunities on both the long and short sides. The three models are the pillars of the TriModel Framework. While the technical model uses best-of-breed technical analysis tools and disciplines, the valuation model tracks the trailing earnings and the forward estimates of the S&P 500 index, which is considered to be the best-known proxy for the U.S. stock market since it captures roughly 80% of
the total market capitalization. According to Investopedia, "the S&P 500 represents a happy medium of sorts; It's comprehensive enough to
indicate the relative strength or weakness of the larger economy, but not so exhaustive as to include too much noise in the signal. On balance, the
S&P 500 is the index of indices. It's the bellwether adopted by analysts, policy makers, and ordinary market participants alike."
The valuation chart below illustrates the various stages of the 2009-2020 bull market from a valuation perspective, which are also correlated with the technical model's own interpretation of those same stages. On the heels of the summer 2011 swoon, the S&P 500 was undervalued by as much as 38%, reflecting the unanimous disbelief in the rally that emanated from the wreckage of the financial crisis (1st waves are always disbelieved). By 2018, the S&P 500 was trading at lofty valuations that eventually precipitated two notable corrections that same year. By the time the second one ended in late-December 2018, the S&P 500 was deemed undervalued by almost 12%, setting the stage for a V-shaped recovery. The same lofty valuations were subsequently revisited in late 2019 and early 2020 simultaneously with the technical model signaling the end of the bull market and the buy/sell model triggering a SELL signal on February 21.
The next valuation chart tracks the price movement of the S&P 500 (daily highs and lows) relative to a wide range of P/E multiples, the trailing earnings, and the forward earnings estimates. Earnings estimates are always a moving target, hence it's essential for the valuation model data to be kept up to date. There's no telling which 'multiple' will mark the end of a bull or bear market, or even a reactionary bear-market rally or a profit-taking bull-market sell-off. That's where the technical model comes in; The two models work hand in hand to come to a consensus. and with the buy/sell model to produce actionable triggers.