March 26th, 2008

Beware Potential Moving Average Crossovers

It was wonderful being able to take my mind off this frustrating market, at least over this past weekend, as my sons, daughter-in-law and granddaughter visited in our temporary winter home in Longboat Key, FL. But, now, it’s time to again get a sense of the market’s momentum to unravel the various crosscurrents for an indication of future direction.

Since in my last post, the S&P 500 Index has edged ever so close to its first hurdle, the 60-day moving average and the question again asked is whether the market has bottomed since it has twice bounced back after touching 1280. All I can say is that my statistical study of the market’s data since 1964 indicates only that we need further confirmation before assuming that risk has approached acceptable levels to begin investing again.

The chart below shows the Index during Tech Bubble Crash of 2001. Note the three periods (circled) when the Index crossed up over the 60-day moving average and after each of those instances turned out to be false bottoms:

We still have nightmares of the market’s freefall through 2002 with the actual bottom of 775.8 in October 2002, or a further 22% drop.

While it may be tempting to start dipping your toe into some beaten down stocks to catch the first big percentage moves off what looks like a bottom, it’s a too risky game. Market psychology and momentum take much longer than just a couple of months to turn around. And before it does, there will be many opportunities to jump in for some spectacular profits.

That’s why we have an “emotion regulator” to avoid acting precipitously, our MMI, Market Momentum Indicator (I learned this weekend that VectorVest already uses something called Market Timing Indicator so we’ll change ours rather than asking them to change the name of theirs).

Based on my data, there have been 51 instances over the past 44 years when the Index itself was below each of the four moving averages (60-, 90-, 180- and 300-day), each of which was inversely ranked with the slowest on top and the shortest on the bottom. That’s been the current alignment since March 10 (the S&P 500 closed on the preceding day at 1293.37), or for 12 trading days.

In 76% of the instances, the alignment remained in force for an average of 21 trading days with the Index dropping an average of 2.57%. That means another 9 days, on average, until a change in the alignment. The discomforting news is that the Index would have to drop to 1260, or 6.1% below today’s close, to replicate the average over the past 44 years.

These numbers aren’t news to anyone who’s been reading these posts. On March 1, in a piece called “1973 and 2001 Market Crashes and Today’s S&P 500 Index“, I wrote:

I boldly predicted [in February 15 post] and reiterated [in February 28 post]that when that crossover occurs, sometime around March 11, the market will resume an even more accelerated decline. The next support areas appear first to be around 1233 (down another 7.3% from here) and ultimately around 1150-1175 (another 11.% from here). That later level would leave the market 25% under the all time high of 1565 set on October 9.

Today’s .88% decline and third unsuccessful attempt to crossover the 60-day moving average further supports a cautionary, bystander’s stance.

Subscribe below or click here to learn more about help for navigating turbulent markets.