What are your odds of being mauled by the bear?

by | Jun 7, 2016 | All Articles, Technical Analysis, Education

Last week, we delved into a longer-term moving average crossover signal on the S&P 500 that was brought to my attention. Here’s that ominous looking chart again below. At first glance it says, ”I smell a Bear!” — and no one wants to get mauled like the last two bear markets.

Review

We saw that historically, and maybe surprisingly, when the 50-week moving average crosses below the 100-week moving average, the S&P 500 was higher 65% of the time 1-year and 2-years later. However, like in the chart before, this signal was present in front of some significant bear markets. It would be nice to know if this time is different.

Before we can do that, let’s see if there’s something special about the S&P 500. What more can we discover if we apply the same signal to other indexes? After all, this only happened 21 times with the S&P 500 from 1930–today. Ideally we’d like to see more results than that.

More Results = Bigger Picture

Our next two candidates offer a good amount of history to review, which is what we need. The Dow Jones Index (DJI) goes back to 1900 and the Dow Jones Transportation Index (TRAN) back to 1930.

Below are their weekly charts. The 50-week moving average is green and the 100-week moving average is blue. When the 50-week crosses below the 100-week, I’ve set Optuma to show a red vertical line, making it easy to visualize and test the signals.

These charts look similar to the S&P 500, so let’s look at the crossover signal results for comparison with the S&P 500. The crossover signal occurred 24 times for TRAN, and 19 times for DJI. The average results of the signals for the two indexes behave remarkably similar to the chart of S&P 500 results in last week’s blog.

To summarize, average returns for all three indexes were in decline for roughly one year before the crossover signal happened (shown with the red downward arching arrows). Afterwards, average returns on all three indexes rallied to gains both 1 and 2 years later. Let’s look at those stats at 1 and 2 years in more detail.

(Above: TRAN 50 Week Stats)

Up first and above, the 50-week stats for the TRAN show returns being up 65% of the time one year later and with above average returns.

(Above: TRAN 100 Week Stats)

Above, the 100-week stats show TRAN returns up an astounding 78% of the time, again with impressive average returns. TRAN confirms the S&P 500 stats from last week. How about the DJI, more of the same?

(Above: DJI 50 Week Stats)

(Above: DJI 100 Week Stats)

Above are the 50-week and 100-week stats for the DJI.

Both had positive positive returns a close percentage of the time as the S&P 500 and TRAN. Though the returns for DJI at one year were nothing to write home about.

So, the DJI stats also confirm what we found in the S&P 500 and the TRAN.

Putting together what we know from the S&P 500 and the new information from the DJI and TRAN, we now have a good picture of the odds and how this signal behaves. Is this the end of the road? Could we dig deeper? You know we can.

Could This Time Be Different?

We could ask, “What’s different about today than during scary 2001 and 2008?” One basic difference I notice is that price is currently above both moving averages during the most recent crossover. This happened 4 times before in the S&P 500 since 1930. If I filter out my tests to only include those instances, here’s what the average return looks like:

Notice something? Leading into the signal at 0, price was consolidating before resuming an uptrend. Weigh this against just the basic crossover. Also worth noting, 75% of the time, price was higher 1 and 2 years out, up an impressive 15 and 34% respectively. The one time it was negative was -20%. And, in case you’re wondering, the DJI and TRAN results were similar; both combined for 11 signals, up 80% of the time, with the 2 losses at -7% and -13% at two years.

These stats paint a completely different picture than the initial chart just showing the most recent bear markets. And, the weight of the evidence is pointing to the importance of considering what the market was doing before the signal. If the market is consolidating, like it is now, the odds are even better.

Does that first chart still “smell” like a bear? I’m certainly looking at it differently! Examining the numbers often leads to surprises — potentially learning some pretty 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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