Friday, February 3, 2023
The sharp rally in U.S. equity markets has created many skeptics, given the size and scope of the advance. As of February 2, the S&P 500 is up 8.9% year to date, marking its best start to a year since 1987. The big question now is if ‘this time is different’—meaning is this another head fake, or have stocks actually reversed course from a dismal 2022. Fortunately, technical analysis can help investors answer this very important question.
As shown below, the S&P 500 developed a downtrend starting in January 2022. The connecting series of lower highs acted as a dynamic resistance area throughout last year. After several failed breakouts and a bear market drawdown, the S&P 500 finally broke above its downtrend in January. Furthermore, the index also cleared the December highs at 4,100 this week, suggesting a new uptrend is now underway.
While trendlines can vary and sometimes be subjective, especially when utilized across different timeframes, moving averages provide an objective perspective on trend direction. As a backdrop, a simple moving average is calculated by taking the arithmetic mean of a security’s price over a specific number of lookback days. For equity markets, the most common moving averages used are the 50-day moving average (dma) and 200-dma. When price is above a long-term moving average, such as the 200-dma, the security is generally considered in an uptrend, and vice versa if price is below the long-term moving average.
Moving averages can also provide an additional layer of trend confirmation. For example, when a shorter-term moving average, such as the 50-dma, crosses above a longer-term moving average, such as the 200-dma, a bullish ‘golden cross’ signal is generated. Conversely, a bearish ‘death cross’ signal is generated when a shorter-term moving average crosses below a longer-term moving average.
As we highlighted on the S&P 500 chart, a bullish golden cross signal was generated on Thursday, February 1, marking the first golden cross signal in over two years. To gauge what this signal means for future returns, we backtested golden crosses going back to 1950. We also broke each signal down by whether the 200-dma was rising or falling at the time of the crossover. The table below highlights the results of this study.
The table shows that the S&P 500 has historically tended to generate positive returns over the next 12 months following each golden cross. Of the previous 36 signals, the index produced forward average 12-month returns of 10.5% with 77.8% of occurrences yielding positive returns. For reference, the average S&P 500 annual price return since 1950 is 9.1% with 72.6% of years generating positive returns.
What we found even more interesting was the performance variance after filtering for golden crosses above a rising or falling 200-dma. When a golden cross occurs whenever the 200-dma is declining, such as the most recent occurrence, the average 12-month return for the S&P 500 jumps to 16.8% with 93.3% of occurrences producing positive returns.
In summary, the recent golden cross adds to the growing technical evidence of a trend change for the S&P 500 and further raises the probabilities of the bear market low being set in October. While the current pace of the rally is unstainable, the change in direction from last year’s downtrend appears durable.
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