Monday, October 6, 2008

S&P Moving Average Behaviour revisited

Back in June I did a study on the relationship between the S&P to its 20-, 50-, and 200-day MAs. The conclusion was not pretty reading:

The take home lesson is for the next month or two further downside is not just likely but probable; only in 2003 did a rally develop soon after the match. For the other five of the six matches the S&P lost between 7% and 30% of its value before it finally turned around.

Well, since then the S&P has trimmed off 14% and even this might yet not be enough. What is the current state of play for the moving average relationships?

As of Friday's close the S&P was 9% off its 20-day MA, 13% from its 50-day MA, and 21% from its 200-day MA. Have there been situations in the past which closely mirrored this - and if so, what happened next?

There were five periods since 1951 which matched this set-up in the S&P

How did markets perform after these periods?

In 1962 the moving average relationship was not an immediate marker for a bottom, but a major bottom did occur 2 weeks later. It was followed by a short term bounce and eventual retest 4 months later. Once the retest completed a new bull market began:

A similar theme played out in 1970. The sharp decline was followed by a relief rally and retest before a substantial bull market followed. As before, the actual bottom occurred 2 weeks later although the retest only required 2 months to complete.

In 1974 there was another match very similar to the previous two except this time the bottom took 2 months instead of two weeks to occur. The retest took another two months before the next bull market kicked off:

The greatest number of matches came in 2001. This time the relationship between the moving averages and the S&P came within a week of the lows, although the attempted retest failed and new lows were posted in 2002. It was in 2002 that another matched relationship was made between the MAs and a positive retest was posted 3 months later. This eventually led to the cyclical bull market completed in 2007:

What do these historical comparisons tell us?

  • We are likely a couple of weeks from a bottom, but it is not impossible for this to take longer
  • During this period the market will see sharp losses, perhaps trimming 10-20% off where the markets lie now (Monday will be the start)
  • The subsequent rally will be short lived and will morph into a retest of the low
  • The retest will be the time to buy heavy
  • A significant bull market has a good chance of emerging from the quagmire - remember markets lead economic news.

    Use Zignals Alerts to notify of your favorite stocks taking 10, 15 or 20% trim from Friday's close, or % move from a moving average as illustrated below:

    Dr. Declan Fallon, Senior Market Technician, the free stock alerts, market alerts, and stock charts website