We’ve got some interesting things happening with the market technicals with the main concern being the breach of the 200 day simple moving average on the SPY. Similar breaches have occurred on other indices that I find worth monitoring, and so we’ll take a look at what this could mean. I will also link to some good quantitative research that will be applicable to our current environment.
The SPY chart above covers approximately 3 years. I know it is kind of busy, and even though I’m a minimalist when it comes to technical analysis, I included the lines because I think they are important.
First, look at the downtrending channel. I wrote many many months (a year?) ago that the steep drop on September/October 2008 was probably an over-reaction (note how the market breaks well beneath the channel). I have viewed the October 2009 breakout above the channel as a similar over-reaction. So the question is, will the SPY return to trade within this long-term downtrending channel? The answer to that likely depends on many things, but I like the simplicity of thinking this way: Are things really getting better with the economy?
The horizontal line marks support during the bull market period. Note that when this line failed, all hell broke loose in the October Armageddon trade. You may also want to note that the SPY was rejected at its April highs almost to the penny at this line. What does it mean? I’m not sure, but there is a certain symmetry that exists in nature, and in my opinion, this symmetry also exists in the markets.
A Closer Look:
The SPY chart above shows a little more than 1 year’s time. I wanted to include the March 2009 bottom as well as the Golden Cross that occurred in July 2009. I did extensive work testing the Golden Cross, which you may review here.
The most important consideration is the fact that the SPY is trading beneath the 200 day simple moving average, as is VTI and VEU. Basically, most of the world’s stocks are trading in bear market territory, once again. Take a second look at the first chart at what happened when SPY began trading decisively beneath this average. I believe that Friday’s rout was a decisive blow, on volume, and thus a serious rejection of the 200 day average.
So we see all these deteriorating technicals, and we wonder if they can really be used to make wise short and longer-term trading decisions. The answer is absolutely. There is some extremely reliable and valid quantitative research out there that should be used to guide traders and investors looking for help in the challenging environment we currently find ourselves to be in.
Some Quantitative Research Links
Mebane Faber has done some absolutely fantastic research (read it here: A Quantitative Approach to Tactical Asset Allocation) on using long-term moving averages to make investment decisions. His premier research uses the 10 Month Moving Average (which is very close to the 200 day moving average) as a timing signal applied to 5 asset classes: US Stocks, Foreign Stocks, US 10 Year Gov’t Bonds, Real Estate, and Commodities. Basically, when the end-of-the-month price closes beneath the 10 month moving average, you want to liquidate and sit in cash or cash equivalents. You want to be long each of these asset classes as long as their monthly closes are above the 10 month moving average.
Following this model, the only asset classes you would be long right now are Real Estate (and it is very close to triggering a sell) and US 10 Year Gov’t Bonds. Long story short: now is not the time to be long anything except for Gov’t Bonds, especially if you are an investor with a long time horizon.
Here is a link to Faber’s site with the charts of these asset classes and the 10 month moving average timing signal: Faber’s Timing Model.
But what about Mean Reversion? Surely, with SPY and other indices putting in the worst May in many years, we should buy for a bounce? Faber has posted some recent research that shows this may not be the case. The research shows that it may be better to wait a month after the bad month and then buy for a planned hold of ~2 months. Here is a link to this research: Mean Reversion or the Return of the Bear? Or, How About a July and August Rally?
The Good News
There are some indices, particularly the QQQQ and IWM which have managed to stay above the 200 day moving average, but they are very close to breaking beneath it. And that is about all the good news I have.
Summary
The technicals and research regarding application of these technicals to make trading and investment decisions all confirm that this is not a market to be blindly and largely long in. If you are adept at the art of shorting, this is the time to look on the short side. If you are not skilled at the art of short selling, this is a time to be largely in cash. If you want to attempt to get a jump on the longer-term moving averages, rather than waiting for price to re-take them, then I suggest following the breadth reports that are available on my blog as well as on Danny’s blog.
When do we “death cross”?
No guarantee that we will anytime soon, but assuming we keep downtrending or even just range trading, probably a month or better.
Excellent post Wood. Very informative.
Do you think it would be possible for the upper trendline of the down channel to act as support from here?
Kenai, I do. I’ve been considering that as a logical place of support. It is also close to several of the tops from 2008 and early 2009.
Wood,
Thanks for the informative post.
We’ve probably entered into a debt deflation that Bernanke and the CB’s have been worrying about all along, even though they won’t admit it publicly. Remember how the sub-prime crisis was supposedly “contained”? They thought they could contain this thing somewhat through fiscal and monetary policy, but it is growing worse and worse.
Reflation and stimulus is a way to shoot down (or at least maim) deflation, but they are basically running out of bullets. Hopefully this doesn’t go into a death spiral, a la 1930’s-style….nobody wants that, not even the bears (though some may foolishly think they do). It would be a miserable time for everyone.
The final act of this tragedy will end where it started —the U.S.
Alpha, where ya been so long? Good to hear from you!
I agree, no one should really want a true death spiral.
Back on the watch, following what you boys are up to.
Nice work.