At the end of June, an event known as the Death Cross occurred in major stock indexes. The Death Cross is a term used to describe the 50-day moving average crossing below the 200 day moving average for the Dow Jones Industrial Average or the S&P 500 Index. The 50-day moving average is used as an intermediate indicator and the 200 day moving average is a long-term indicator of the market’s direction. Here’s a chart showing the S&P 500 Index along with its 50 and 200 day moving averages. Note the 50 day crossing below the 200 day at the end of June.
Market technicians like to point out that when the 50 day average crosses below the 200 day average, the markets immediate future is bleak and declining prices are likely. Mr. Mark Hulbert, of the "Hulbert Financial Digest," recently crunched the facts on this using his extensive database and found that in the last 114 years there have been 85 Death Cross events, or about one every 16 months. And, in fact the average returns over the subsequent 6 and 12 months following one of these crosses were below normal, but were, in fact, positive on average.
Of course, average returns are made up of a lot of positive and negative events and the Death Cross has correctly predicted some very bad periods when it would have been good to avoid the stock market. The most recent of these was in December 2007, when moving out of equities would have been a great idea to avoid the carnage of the 50 percent decline in stock prices from late 2007 to early 2009.
Of course, the indicator has its failings and would have moved an investor out of the stock market in late 2005, causing him/her to miss some reasonable profits as the market did well from 2005 into 2007. The lesson here is that no one indicator will work perfectly each time, so investors should have a plan to use multiple decision tools and have a diversified approach to investing to help avoid the inevitable mistakes from using any one tool.
Mr. Hulbert also points out some research, which shows the effectiveness of the Death Cross, has declined markedly in the last 20 years. There is a theory that with the explosion of personal computing in the last two decades, it is now easy for any individual to have access to moving average calculations on any financial Web site and that with more investors now using these tools, they have lost some of their value.
Not that a month determines the success or failure of an investment decision, but since the Death Cross occurred for the Dow Jones Industrial Average and the S&P 500 Index in late June (supposedly predicting further declines) those two stock market indices are up about 8 percent as of the end of July. Not so deadly so far!
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.