FYI | Aug 09 2010
By Mike O'Rourke, market strategist BTIG
Last Monday marked the one month anniversary of the Death Cross for the S&P 500. On July 2nd, the S&P 500's 50 day moving average crossed below its 200 day moving average triggering the ominously named sell signal. As market participants are well aware, the May-June equity market correction was as short and sharp a variety as one gets in this business. This created the notable irony that this technical sell signal was triggered on the actual day of the correction low.
The abrupt nature of the correction created an interesting dynamic. Tracking the S&P 500 back to 1928, we have counted 44 death cross sell signals (there was a 45th that occurred two days following another one in 1941, therefore, we only used the original cross). In examining the characteristics of the forward returns of the crosses, an interesting pattern emerged. In half of the scenarios, the S&P 500 was higher on the one month anniversary date, and in half of the scenarios, it was lower on the anniversary date. The interesting aspect is that this initial performance in the first month following the signal appears to have had a notable influence on the forward returns in the one year following the cross.
For all 44 death cross signals, the average performance in the 12 months following the cross was an 0.18% loss. The median performance was an 0.63% gain (Table 1). The average and median performances following the cross for the 22 instances where the S&P 500 sold off further that first month were -5.25% and -4.86%, respectively. For the 22 instances where the S&P 500 rallied in the first month, the one year forward average and median gains were 4.89% and 3.39%, respectively. Just to keep the situation in proper context, the S&P 500 was already up 10.2% in that first month.
The data indicates two important probabilities if the market continues to follow this historic trend. The first is that this sell signal was very likely a false positive. The other is that it further solidifies the July low as an important lower bound and level of support for the market over the next 6-12 months. In the previous top 8 first month performances, there was only one instance where the S&P 500 was below the cross date level for any reading 2, 3, 6, 12, 18 or 24 months forward (see table 2). In other words, a single 6 month forward reading was below the actual cross date level of the S&P 500. In the current scenario, the cross level is 1010. Although a correction back to that level would certainly be painful, it is good to know that if it does occur, that level should hold.
The initial first month rally following this death cross has already achieved levels in the proximity of both the average and median 12 month gain for the first month positive performances. Some might take that to indicate the market has already garnered the majority of the gains it is due to receive, but there is a relationship between the strength of the first month and the forward returns over the next year, i.e. the stronger the first month, the stronger the future forward gains tend to be. This is the second best first month performance on record. In the end, every situation plays out differently so in an effort to be conservative, we would not necessarily interpret the data to be an all out positive for the market, although some could. We do think this indicates it is highly unlikely that this death cross is a negative for the market.
The views expressed are O'Rourke's, not FNArena's (see our disclaimer).
Disclaimer: https://btig.com/disclaimer.php
FNArena subscribers can also read FNArena editor Rudi Filapek-Vandyck's analysis on this matter, originally published on 5th July 2010. See "Black Cross", Weekly Insights.
