July 22nd, 2008

Another Bear Market Signal

I’ve received several inquiries about my Market Timing Indicator and today seems appropriate for some more information because without much fanfare, the MTI clicked to a new reading. The MTI is a momentum indicator. Other momentum indicators have been constructed using RSI’s (relative strength indicators), MACD’s (moving average convergence/divergence), stochastics (too tough to describe in so short a space) or one of many other possible technical indicator tools.

My MTI blends the ranking alignment of four moving averages (MAs) — the 60-, 90-, 180- and 300-day — and the position of the Index itself relative to the four. As of yesterday’s close, the MTI just barely went into perfect bear market alignment. This happened because the 60-day MA crossed under the 90-day MA for the first time since last April 15. Here’s the chart for a quick visual:

This perfect bearish arrangement has occurred 53 times since June, 1964, has lasted an average of 18 days (the longest being 84 days beginning June 14, 1974) with an average loss of 2.23% (the largest loss 22.96% in that same run in 1974). When the Index and MA’s have been in this arrangement, 41 times, or 77% of the time, have resulted in a loss. With less than a 25% probability, or 12 times, did the run end with the Index moving up.

Granted, some of the runs (trading days before the alignment of MA’s and Index change) were relatively short. Just over a 25% of the runs last for only 3 trading days or less or a sum total of 28 days before the alignment changed. During each of those runs, however, the Index declined an average of 1.42%.

In only one instance, near the bottom of March, 2003, did the MTI switch from the current alignment into an absolute bullish, “all-in”, signal. Each of the remaining 51 occurrences ended with the MTI moving into another, albeit slight less bearish though still “all-cash” alignment.

It’s impossible to predict how or when this run will end. The MTI is only a barometer, it’s not a forecaster. It only indicates probabilities based on what the alignment of MA’s and Index resulted in over a 45-year history.

Some say this exercise results in a model that is built on historical statistics and can only be accurate 0r reliable when those same past conditions repeat in the future. I content, however, that the MTI reflects market momentum and the relative strength and direction of that momentum. Market participants react and behave in similar ways to unspecified conditions that may be very different and produce similar end results (as reflected in the changes in a broad market index like the S&P 500 Index).

The MTI has signaled an all-cash reading since December 27, 2007 when the Index was 1476.27; that was 14.6% higher. I’ve second guessed the MTI on occasion when I was blinded by the siren song of “market bottom”, “capitulation” or “no more bad news” talk and paid the price. It’s frustrating and difficult to sit on the sidelines and do nothing. But, sometimes, that’s just the only safe place to be.

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