Bear On Vacation? – Update

by | Dec 15, 2016 | All Articles, Technical Analysis

Throw-Back Friday

This week we wanted to re-post one of our most liked articles from 2016. It may be hard to remember right now, but earlier this year the bears were having a party over the death-cross. It is great to see that Carson’s quantitative approach was able to examine this set up and show that it does not always have the negative outcome that so many were calling for.

Here is an update image as of right now.


Following Up

By mid-May, a death cross signal and its bearish implications made its way into the financial news limelight. Being both curious and sceptical—and a bit of a mythbuster at heart—I felt compelled to dig in. I blogged about my findings here and here. Since it’s been two and a half months, I’m following up with some bonus material.

Where Are We Now?

The death cross here is when the 50-week moving average crosses below the 100-week moving average. If you haven’t guessed from the name, it’s assumed to signal a negative outlook for the markets.

A chart of the S&P 500 Index (Fig. 1) shows the most recent death cross signaled with a purple arrow. After some near-term volatility, an advance of nearly 6.5% followed. Perhaps the bear didn’t like his odds, or maybe he’s just on vacation.

(Figure 1 – S&P 500 Index & Death Cross – Click to enlarge)

The Backstory

First, let’s review the environment. Just how negative was the sentiment at the time?

For starters, the S&P 500 had been experiencing high volatility for over a year. In fact, the S&P 500 Index had not been able to get back above a high set one year ago (May 2015). This can be seen in Figure 1.

Next, a chart similar to Figure 2 was making its rounds in the news and social media. Figure 2 displays the previous two death crosses with red vertical lines. If the only information you have to go on is this chart, then the message isn’t a subtle one:

red line = market goes boom!

(Figure 2 – S&P 500 Index & Death Cross – Click to enlarge)

An apprehensive marketplace: check.

A chart reaffirming our greatest fears: check.

Cue the news cycle.

The Usual Suspects – Bad News

Pew Research Center did some interesting research into American news preference across decades. Figure 3 summarizes the results. Care to guess where Money ranks among the usual suspects?

cd_01_09_2016_img4

Money, which includes news from Wall Street, ranks number 2 among the “super categories”. In fact, it was the only category where the following grew each decade.

It’s easy to get caught up in the bad news. The fact that financial news is so tantalizing doesn’t make it any easier. Combine the two and you get headlines like the following:

h

This S&P 500 Death Cross Could Be The Real Deal

Bloomberg (May 18, 2016)

h

The Dreaded Death Cross Formation Just Hit Stocks

Zero Hedge (May 19, 2016)

This Time Is Different

Findings from previous blogs suggest the weekly death cross isn’t as bearish as the two recent events suggest. The majority of the time (65%) the S&P 500 is higher both one and two years later. Averaging the returns of every death cross yields Figure 4. The results are similar for the Dow Jones Industrial Average (DJI) and the Dow Jones Transport Average (TRAN).

(Figure 4 – Average Death Cross Returns S&P 500 1930 – 2016 – Click to enlarge)

On average, this signal occurs after the S&P 500 has already been trending down for a year. Sounds familiar. Just like May 2016, right? This signal also tends to occur near the bottom. Did you expect that?

Now, to be clear, a death cross did occur before some bear markets, including the two recent scary ones in 2001 and 2008. So was there a difference between those large bear markets and now? Yes, prices were Above both averages when the death cross occurred this year and Below in the previous two instances. Why is this important? In a word: Psychology.

Optimism’s Effect

A moving average of price is the average price over a rolling window of time. This average price can be used as a proxy for consensus. It follows that when price is above the average (above consensus), optimism is prevailing. This is bullish. This is what was different this time.

Figure 5 shows the average returns—for the five death crosses—for our special case of prevailing optimism. When comparing Figure 5 to Figure 4, at least one difference stands out. In Figure 5, leading into the signal at 0, price was consolidating before resuming an uptrend.

(Figure 5 – Average Bullish Consensus Death Cross Returns S&P 500 1930 – 2016 – Click to enlarge)

75% of the time, price was higher one and two years out. The average was up an impressive 15% and 34% respectively. The one time it was negative was -20%. DJI and TRAN results were similar. Both combined for 11 signals—up 80% of the time—with the two losses at -7% and -13% at two years.

Moral of the Lesson

These studies paint a completely different picture than the prevailing sentiment at the time. The weight of evidence suggests when a market is consolidating—like it was recently—the odds are better. This highlights the importance of considering context.

Doing some fact-checking of your own can be a great way to step back and get perspective. Examining the numbers often leads to surprises. Potentially learning some interesting, perhaps counterintuitive, but hopefully useful lessons along the way.

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Carson Dahlberg, CMT

Carson Dahlberg, CMT

Author & Co-founder of Northington Dahlberg Research

Carson comes to Optuma bringing nearly 20 years of experience in the financial markets involved in technical and quantitative trading, research and education. Carson has worked for several notable firms: Morgan Stanley, Wachovia Securities, Wells Fargo, and Schaeffer’s Investment Research. In addition, he is the co-founder of Northington Dahlberg Research, a quantitative driven, volatility-based research firm, and was the Director of the CMTinstitute (an online program to assist financial professionals in the passing of the CMT examination process).

Carson is presently a Director at Large on the Board of the Market Technicians Association and serves the Market Technicians Association (MTA) in various capacities. He was the founder and first Chapter Chair of the Charlotte Chapter for the MTA. His involvement with being the Committee Chair for the Ethics Committee has led to an updated and globally relevant ethics offering for the designation. In the past, he has served on the Admissions Committee, was the Board Liaison for the Journal of Technical Analysis Committee, and was the Director of the CMTinstitute.

Carson received a degree in Chemistry from the University of Cincinnati and was awarded the Chartered Market Technician designation in January of 2008.

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