S&P 500 Vol & Valuation
Bear Market Warning Performance
Did the strategy signal SELL one month before each major market peak?
| Bear Market | Peak Date | Decline | Valuation (1mo before) | Fear (1mo before) | Warning? |
|---|---|---|---|---|---|
| Dot-com Bust | Mar 2000 | −36.8% | 94.1 | 64.5 | ✓ YES |
| Dot-com 2nd Leg | Jan 2002 | −32.0% | 87.2 | 68.9 | ✓ YES |
| Financial Crisis | Oct 2007 | −51.9% | 42.1 | 67.8 | ✗ NO |
| GFC 2nd Leg | Jan 2009 | −27.6% | 18.8 | 94.5 | ✓ YES |
| COVID Crash | Feb 2020 | −33.9% | 82.7 | 41.2 | ✓ YES |
| 2022 Rate Hikes | Jan 2022 | −25.4% | 89.9 | 34.2 | ✓ YES |
Compared to individual indicators: P/E 50%, CAPE 33%, VIX 17%, Yield Curve 33%, HY Spread 33%
Position Sizing Results
At optimal thresholds (Val > 85, Fear > 90), quarterly rebalancing — how much to trade each signal?
| Trade Size | Final Value | CAGR | vs Buy & Hold | Trades |
|---|---|---|---|---|
| 2.5% | $232,726 | 9.35% | +7.8% | 29 |
| 5.0% | $247,863 | 9.54% | +14.8% | 27 |
| 7.5% | $261,191 | 9.71% | +20.9% | 26 |
| 10.0% | $270,442 | 9.82% | +25.2% | 24 |
| 12.5% ★ | $276,318 | 9.88% | +27.9% | 24 |
| 15.0% | $275,958 | 9.88% | +27.8% | 23 |
| 17.5% | $275,071 | 9.87% | +27.4% | 22 |
| 20.0% | $272,916 | 9.84% | +26.4% | 21 |
| 25.0% | $263,158 | 9.73% | +21.8% | 20 |
Buy & Hold baseline: $215,986. All variants beat buy & hold at optimal thresholds. 12.5% is the sweet spot — gains plateau above this while risk increases.
Threshold Explorer
Each cell shows how much the strategy beats (green) or trails (red) buy & hold at that threshold pair. Use the sliders to inspect any combination.
SELL signal: Valuation > threshold OR Fear > threshold
BUY signal: Both below threshold
Methodology & Analysis
The Problem With Single Indicators
Traditional market timing fails because different bear markets have different causes. Dot-com (2000) was a valuation bubble — P/E hit 94th percentile but fear was only middling. The 2009 GFC second leg was pure panic — valuation was low (19th percentile) but fear exploded to 95th percentile. Using only P/E or only VIX as a signal caught just 50% and 17% of bears respectively.
Five Indicators, Two Composite Scores
We combine five established market indicators into two composite scores using historical percentile ranking:
- Valuation Score = average of (P/E percentile, Shiller CAPE percentile) — how expensive is the market historically?
- Fear Score = average of (VIX percentile, inverted Yield Curve percentile, HY Credit Spread percentile) — how stressed are markets?
Percentile ranking is adaptive: a P/E of 25 might be extreme in the 1990s but normal today. By ranking against the full historical distribution, the scores automatically adjust for changing market regimes.
OR Logic: The Key Insight
The critical design choice is using OR logic: sell when Valuation is extreme or Fear is extreme — not both. AND logic (requiring both) caught 0% of bears in backtesting. OR logic catches different bear market types: bubble bursts (high valuation, calm fear) and panic crashes (moderate valuation, extreme fear).
Strategy Rules
- Starting capital: $10,000 fully invested in S&P 500 (Nov 1990)
- Rebalance quarterly (first trading day of each quarter)
- SELL signal: reduce equity by 12.5% of holdings
- BUY signal: redeploy 12.5% of total portfolio from cash back into equities
- No transaction costs or taxes in backtest
Why Thresholds Matter (The Heatmap)
Setting thresholds too low (50–70th percentile) means selling constantly — the strategy is out of the market most of the time and misses the bulk of long-run gains, underperforming by 50–77%. Thresholds in the 85–90th percentile sweet spot mean only selling at true historical extremes: 24 total trades over 35 years (roughly one trade every 18 months). This selectivity is what drives outperformance.
Current Market (Feb 2026)
The Valuation Score sits at 90 (P/E ~29.2, Shiller CAPE ~40.0 — near all-time highs in percentile terms). The Fear Score is only 41 — VIX calm, yield curve normal, credit spreads tight. This "expensive but calm" combination has historically preceded major corrections: Dot-com 2000, 2022 rate hikes. The strategy signals SELL, though the absence of fear means a catalyst could still be months or years away.
Limitations
- Backtesting covers 1990–2026; future market regimes may differ
- No transaction costs, taxes, or slippage modelled
- Credit spread data begins only in 1996 (early period uses 4 indicators)
- P/E and CAPE are monthly — slight lag vs daily signal indicators
- This is not investment advice