Thursday, June 14, 2012

The Ultimate Death Cross

My system moved higher to -775 today. More on the title of this post in a moment but first it looks like the market now has a decent shot of staying above 1266 on any pullback and EUR/USD has a solid bottom. The more I think about the Greek election the more I realize that whatever occurs, it will likely result in more uncertainty rather than any kind of resolution meaning the market will not have an excuse to head to new lows and bears will try to find a place to cover.  If the worst case scenario in the market's mind occurs which is Syriza winning the election, they will unlikely be able to form a coalition government and we will be heading to yet another election. Even if they do form a coalition government, there will be a period of negotiation with the EU that will likely last weeks since the EU likes to have a ton of meetings before deciding anything. The far more important event is the Fed meeting as I believe their comments will weaken the Dollar further and this will allow the EUR/USD rally to continue. The Fed has to be careful not to do too much too close to the election or else they will look like they are helping Obama politically. Since Congress consists of little children, the other side would likely pout and make life hard for the Fed if they chose to step in to help the market which in turn helps Obama's election prospects. With the next Fed meeting in August, they might actually have to do something here as August is pushing it a bit close to the election. You can imagine that if the Fed were to act in August, the market would rally for at least a few months and that would probably be enough to give Obama an easy victory.

Now for the title of this post, there are amusing labels we deal with in the market such as death cross, golden cross, etc. For example, the death cross is when the 50 day SMA moves below the 200 day SMA. It's value is debatable and I don't personally use this as a tool. However, there could be more weight given to a monthly death cross (or golden cross for that matter). The reason why is that 50 months (4 yrs, 2 months) is roughly the length of an election cycle or market cycle. 200 months (16 yrs, 8 months) is roughly the length of a secular cycle. The reason I bring all of this up is that in April 1946, the S&P 500 had a monthly golden cross where the 50 month SMA moved above the 200 month SMA. The 50 month SMA has stayed above the 200 month SMA for 66 years but now we are getting extremely close to the monthly death cross as the 50 month SMA is at 1152 and the 200 month SMA is at 1141. These averages came close to crossing once before in early 1978 and they just barely held but that is when the 50 month SMA turned around and started to move higher and of course the rest is history. This close call came at the beginning of the end of the 1966-1982 secular bear market.

So does this mean anything? Well, we can look at a worst case scenario for equities which is always Japan. The monthly death cross occurred in Japan in 1998 and 14 years later it is still in effect, a scary scenario for equity holders to be sure. But is a death cross always a bad thing? Of course, no. But the death cross needs to be neutralized and in a relatively short amount of time. Let's look at the Dow Industrials. The Great Depression saw a monthly death cross in January 1934 and didn't have a monthly golden cross until February 1946. Another monthly death cross actually occurred in August 1980 in the Dow Industrials but this was quickly neutralized as a monthly golden cross occurred in April 1982. The first monthly death cross in 1934 would have been nice to know as the market and world was tough for several years after that. Even though the nominal low of that secular bear had been hit in 1932, there is no question that 1934 was a lot closer to the beginning of that secular bear market. The monthly death cross in 1980 was without question near the end of that secular bear market. The Japan scenario and the 1934 signal in the Dow make sense as these were deflationary depressions so there was a sharp deflation of prices in the first market cycle of the new secular cycle and the averages eventually catch up with that. Japan is in an unprecedented 22+ years secular bear and the averages crossed 8 years in but this was still early on in their secular cycle. The fact that Japan does not have an election cycle like the U.S. may contribute to some of the difference in time.

So where are we today? As mentioned before, the S&P 500 is very close to undergoing a monthly death cross. The real question is, are we closer to the beginning of this secular bear cycle or closer to the end? If we can answer that, then we can answer whether this monthly death cross will be something to heed. There is a case to be made that the deflation in prices that occurred in 2008-2009 will lead the U.S. into a deflationary depression and the moving averages are now catching up to that fact just like in 1934. In this scenario we wouldn't expect the market to enter another secular bull cycle until 2020-2025. However, a case can also be made that the secular bear cycle actually started in 2000 and with 12 years gone, this would imply that the monthly death cross is actually coming towards the end of the secular cycle which can be seen in the prior secular cycle with both the near cross in 1978 and the Dow cross in 1980 and therefore shouldn't be feared but instead welcomed.

For those who have been trading and investing since before 2000, I think there is a sense that the latter scenario is what we are dealing with. I agree with this as well as it has felt like a secular bear since 2000. Also, 2000 was the inflation-adjusted high of the market.  The fact that the metals began their secular bull cycle at this time adds some credence to this view as the metals entered their secular bear cycle right around the beginning of the equity secular bull cycle in the early 80's so there is a distinct correlation there. Equity and metals secular cycles move opposite to one another. Could the deflationary depression ensue instead which means 2007 was the secular high? Of course, I could be very wrong along with a raft of other market watchers.

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