You heard about the infamous “Death Cross” that the Dow Jones Industrial Average had back on August 11 and the possible implications (here and here), but now the S&P 500 has fallen prey to the same ominous sign of doom (or is it?) at Friday’s close, with the 50 daily moving average crossing below the 200 daily moving average. Having nothing better to do, I decided to do a quick backtest to see just how ominous this so-called “Death Cross” has been for the S&P 500. I decided to run the backtest using data going back to 1950, which I realize could have resulted in some skewed numbers compared to data starting from 1980, 2000, or later. Note, I believe all numbers to be correct, but I cannot guarantee I have not made any mistakes in my calculations; if you believe I’ve made an error and would like to see the raw data and the excel file I used, please let me know.
As you can see from the table below, since 1950 the average performance in the S&P 500 following a “Death Cross” underperforms across the board (you can see that the median performance following a “Death Cross” slightly outperforms on a weekly and yearly basis). You can also see the percentage of time the market is higher also underperforms across the board as well. While it may be difficult to draw anything further from this, one thing I noticed was that it appears the underperformance (in terms of average/median performance as well as percent positive) is more pronounced in the intermediate term, specifically in the 1-3 month time frame.
So what does this mean for the S&P going forward? I can’t give you a definitive answer on that. All I can say is that based on this one singular backtest and the corresponding assumptions (the assumptions being that I did not make any errors and this 65 year period best encapsulates the current and future trading environment), there seems to be a historical tendency for underperformance, especially in the intermediate term (i.e., 1-3 months). Given the accelerated drop in the market that occurred late last week and the flash crash we saw in many ETFs on the open on Monday, along with the historic spike in the $VIX that we saw, I’m in the camp that we chop around and base here for a bit. There was a lot of technical damage done in the broader market, which will take time to repair. This belief seems to be backed up by the results above. This doesn’t mean the market can’t pull out the good ol’ V-rally card and shoot back to new highs (I think this would be the most surprising scenario honestly). Nor does this mean we can’t retest or even take out last week’s panic lows. As @awealthofcs has said, “Average is a rarity in the markets at any given time.” History can help serve as a guide for your expectations but you shouldn’t follow historical tendencies so rigidly that you don’t allow yourself to consider the unexpected.
So what would I recommend? That primarily depends on your time frame. If you’re a longer term investor actively allocating funds to your retirement accounts, I don’t think you should be worried (the chances that the actual economy falls back in to a recession are pretty remote in my opinion). For a longer term investor’s time frame, this is merely just some turbulence in the grand scheme of things. If you’re more of an intermediate term swing trader, I think it is probably most prudent to reduce your trading size and the amount of risk you allot to individual trades given the increased market volatility. Sitting the market out and staying in cash is also not a bad idea here, depending on your overall trading strategy of course. I would also recommend keeping a list of stocks that haven’t pulled in much from their highs during this market selloff, that is, stocks that have shown relative strength to the market. If you’re a shorter term (intraday) trader, then this past week’s action is what you live for (read volatility). Be quick and nimble.
So to summarize my thoughts, I continue to think we see relatively high levels of volatility compared to the volatility that we saw – or didn’t see – during the past couple of years (although I highly doubt we see the level of volatility seen during Monday’s open). I think from a technical basis, we chop around, perhaps overshooting to both the upside and downside but ultimately building a larger base. Finally, looking past the intermediate term (1-3 months), I think we’re more likely to see a market towards highs than towards lows. This time is always different, so while you can hope for the best, always be prepared for the worst just in case.
Thank you for reading. Hopefully you found this post helpful. As always, please let me know if you have any questions or comments.