Is There Another Golden Opportunity?

With traders focused on the double dose of big-time macro events lately (the election and the FOMC meeting), the market has ended up doing a lot of nothing over the past eight days. And with just one more session to muddle through before we get some results, we find ourselves with a little time on our hands. As such we thought we’d do a little research on something that up until QE II took over, used to garner a lot attention amongst the talking heads and the popular market press: The Golden Cross.

In case you’re not familiar with this indicator, a “Golden Cross” occurs when the 50-day moving average of the index or security in question crosses above a 200-day ma of the same index or security. The idea here is that when this type of a technical pattern occurs, the trend is considered to be strongly up and likely stay up for a while. The reason we bring this up now (besides having little else to do until Wednesday) is that such an illustrious buy signal was given again on October 22nd.

Frankly, we’re not exactly sure why the media loves these long-term indicators. Any technician worth their keyboard will tell you that there are any number of more useful indicators that can help investors stay on the right side of a trend. For example, while we do plot a 50-day moving average on many of our screens, we don’t pay much attention to the crossings. Why not? In short, our experience has been that taking action on a crossing of the 50-day would cause one to miss an awful lot of a move – in both directions. In other words, the signal tends to be consistently late.

If we were stranded on a desert island with our laptops, an internet connection, and only one trend-following indicator, we’d probably go with something either MUCH longer-term or MUCH shorter-term. For example, if our goal was to stay in tune with the longer-term trend of the stock market, instead of a 50-day moving average, we’d be more likely to cast our lot with a 15-month weighted moving average. And then just for grins (and to enhance performance), we’d shift the MA forward by two months.

The results of this type of trend-following indicator aren’t half bad. While there aren’t a lot of signals (just 11 since 1994 to be exact) had an investor gone long the S&P 500 on positive crossings of the MA and gone short on negative crossings, an investment on 12/31/1994 would have grown by +1,238.8% through the end of October. And had one simply put the same amount of money in the S&P 500, they’d have +151.5%, which by my calculations is a bit less.

And if we were forced to pick a shorter-term trend-following indicator, we’d likely wind up with an 18-day weighted moving average, also moved forward two periods. Why do we favor such an odd sounding MA? Well, if you plot it on the security of your choice we think you’ll see the answer in relatively short order.

But I digress. The point of this little missive was to talk about the magical “Golden Cross.” Looking at history, while the results aren’t bad, they aren’t as strong as many other indicators of the same ilk. And when one really digs into the data, it becomes clear that the Golden Cross is actually not a very good indicator to follow when the market in not in a secular bull market.

We have to give Ned Davis Research the credit for this concept as the firm found that during secular bull periods, a Golden Cross produced an average gain of +25.0% before a “Death Cross” (the opposite of a Golden Cross) occurred. And since 1941, 16 of the 21 Golden signals have profitable. Not bad.

However, the problem is we aren’t in a secular bull market at the present time. No, we believe that we are in the midst of just the opposite: a Secular Bear market. We bring this up not to depress you, but rather to point out that the Golden Cross isn’t nearly as effective during a secular bear market.

Again according to the computers at NDR, the average gain generated by a Golden Cross during a secular bear market is a far cry from the +25% gain seen during a secular bull. We’re sorry to say that the gains in a secular bear average only +2.9% and only 15 of the 26 such signals since 1930 have been profitable.

However to be fair, we should point out that the last six signals given during secular bears were indeed profitable. Going back to 1979, the Golden Cross’s produced gains of 2.2%, 10.9%, 16.6%, 8.0%, 13.1%, and 14.2% respectively. But then again, all six of these returns are well below the average gains derived from a Golden Cross during secular bull markets.

So, the next time you hear some talking head yammering on about the Golden Cross, ask yourself a question: Are we in a secular bull or secular bear? The answer just might make or save you some money.

 

  S&P 500 Last 5 Years

 

Remember, you are in control your email alerts! You can receive alerts for up to 25 free research report alerts including:

• FLASH Headline Alerts: Get an executive summary of the really important market-moving headlines
  
• Quick Hit Commentaries: Short and to the point, we break in during the day with key insights to the action
  
• The “10.0” Report: These are the REAL Best of Breed companies
  
• The Insiders Report: Want to know which stocks Corporate Insiders are buying heavily?
  
• ETF Leaders Report: Don’t Miss TSP’s Weekly ETF Leaders Report
  
• TSP’s Daily TopStock Focus List: It’s Your Own Private Research Department
  
• The Daily Stock Pick: Our daily stock pick highlights one of our favorite TopStocks that also presents a good entry point at the present time.

To Add or Remove email alerts, simply Login to Your Portfolio and click on Email Alerts