July 29th, 2010

"Black Cross" and MTI: A Divergence

Remember the controversy back at the beginning of July when the S&P Index posted a “Black Cross” (the 50-dma crossing under the 200-dma). A Brandeis University professor had his five minutes of fame when he published a study concluding that the black cross was an unreliable indicator. The study was picked up by Mark Hulbert in the NYTimes and other media. Just the other day, Mebane Faber of the World Beta blog, renewed the debate by writing:

“the conclusions the professor has made are somewhat curious. It looks like timing improves every metric from CAGR to vol and maximum drawdown reduction. It also looks like the timing model did an impressive job of sidestepping two devastating bear markets and the psychological damage that causes”

He also included the following chart which I believe categorically proves the soundness of the “Black Cross” as a market timing tool (courtesy of World Beta; click on image to enlarge):

But the message of the “Black Cross” is now diverging from that of my Market Timing Indicator (a back-test of relative positions of 4 moving averages plus the Index itself). These conflicting signals underscores the mixed signals resulting from the market’s recent action.

The last time I discussed the “Black Cross” was on July 7 in New Bull Run or Sellers Remorse in which I wrote:

“Even if the Index closes back above the 300-dma tomorrow, the Black Cross hasn’t been reversed and the all-cash signal remains in place. It would take a move above the descending 50-dma at around 1080-1100 for the red light to turn yellow.”

Well, that’s exactly what has happened and the light, for me, has definitely turned yellow from red. While the Black Cross is still warning of continued declines, the MTI has fluctuated back and forth and is now indicating that it’s o.k. to be all-in (click here if you want to see the two indicators since May 3 along with daily moving averages).

The Black Cross occurred on July 2 when the 50-dma crossed under the 200-dma for the first time since June 19, 2009 and has yet to reverse itself. The MTI, because it takes into consideration the relative positions of four moving averages and the index itself flashed an all clear on July 22 when the Index itself crossed back above the 50-dma.

If the Index continues to remain above that moving average, it will pull the average up. Furthermore, if the Index is able to move back and stay above the 200-dma (which it did intra-day last week), then there’s a chance to Black Cross will expire. Some of the credence given to the “Black Cross” as an indicator will have been compromised.

For right now, I’m tying to split the difference between the two by leaving about 50% invested long with the rest of the portfolio in cash. Although some stocks have pretty compelling charts, until this divergence is resolved, I can’t put more of my money at risk.

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  • Bala

    short SnP with target of 950, stop loss = recent high of 1121
    conclusive break above 1131 = bull mkt