Good Things Happen After 50

In life, as we enter our golden age, we are usually rewarded with a trove of memories from our past, and may maintain an expectation of creating more positive experiences in the future. Technical analysis is no different—good things also tend to happen after 50. Historical data suggests that following a sell-off in the S&P 500 Index, when the index price is sustained back above its 50-day moving average and its Relative Strength Index (RSI-14) is above 50, stocks tend to move higher. Today we analyze the efficacy of using these two common technical indicators in conjunction to evaluate potential tactical opportunities to reengage equities following a pullback, should one occur.

What to Watch

The 50-day moving average is a security’s—or in this case—the index’s average daily closing price over the last 50-trading days. If the price is above this moving average, most times the short-term trend can be interpreted as bullish. For this study, confirmation comes when the price is sustained above its 50-day moving average for three trading days, in order to prevent potential whipsaws or false signals in the price movement.

The RSI-14 is an internal indicator which denotes the velocity of the index’s price movement over the previous 14 trading periods. The value is calculated based on the closing prices of the index and is normalized between 0–100. Through our experience at LPL Research, we have determined that an RSI-14 value above 50 increases the likelihood for bullish price momentum (Figure 1).

Dating back to 1972, historical data on the S&P 500 shows that following a sell-off event, when the closing price moves back above its 50-day moving average for three consecutive trading days and the RSI-14 is above 50, subsequent price returns on the index tend to be positive (Figure 2). Since that time out of 146 instances, when the two indicators triggered a bullish signal at the same time, the S&P 500 was higher 6-, 9-, and 12-months later with positive returns found in more than 71% of the instances, on average. Over the longer-term time horizon, 12-month returns were higher 73% of the time with an average return of 9.4%*, which is modestly higher than the average annual return for the index during this timeframe at 8.5% in which the same number of years generated positive returns (73%).

Once the S&P 500 begins to lose strength and move lower, many investors want to know when to reengage and potentially buy into any weakness. We at LPL Research recommend a dollar cost averaging strategy[1] for most investors. In the upcoming days and weeks, we will continue to monitor the technical indicators in order to assess the equity markets’ momentum and determine whether potential tactical opportunities exist. Stay tuned for future updates.

*Please note: the returns in Figure 2 do not include reinvested dividends. It is assumed the total return data for this study which includes dividend will be approximately 2–3% higher based on historical data.

[1] Dollar cost averaging is a strategy in which an investor places a fixed dollar amount into a particular investment on a routine basis.  The investment generally takes place each and every month regardless of what is happening in the financial markets.

 

IMPORTANT DISCLOSURES

The economic forecasts set forth in the presentation may not develop as predicted.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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