CHAPEL HILL, N.C. (MarketWatch) — Did a bear-market signal ring on Friday when the S&P 500 Index dipped below its 200-day moving average?
Yes, according to a decades-long tenet of technical analysis.
As for me, I’m not so sure. The 200-day moving average’s historical track record isn’t as good as its devotees claim. In recent decades, its performance has taken a big turn for the worse.
For starters, take a look at the accompanying chart, below, which plots the S&P 500 SPX, +1.39% over the past decade, along with its 200-day moving average. Note that there have been at least a half-dozen times since the bull market began in March 2009 in which the index dropped below the average — without triggering a bear market.
On many of those occasions, in fact, the stock market rebounded almost immediately after the S&P 500 fell to below its moving average. Far from marking the beginning of a bear market, in other words, breaking below the 200-day moving average often signaled a reason to buy, not sell.
Indeed, one wonders whether this is what’s happening this time around too, since the market skyrocketed higher on Monday (Feb. 12), the first trading session following the Friday breach of the moving average.
Still, the 200-day moving average has had some successes. It protected followers in the financial crisis, getting them out in December 2007 and back in June 2009. The market had started rebounding in March. But its missteps during the subsequent bull market frittered away its bear-market gains.
Nor is this recent experience a fluke. Over the past three decades, in fact, according to a Hulbert Financial Digest study, an investor would have lagged a buy-and-hold strategy if he got into stocks whenever the S&P 500 was trading above its 200-day moving average and moved his portfolio to a money market fund whenever the S&P 500 was below its average.
To be sure, the 200-day moving average’s track record was better than this over the six decades through the 1980s. But its track record over those earlier decades comes with a huge footnote: It is calculated assuming no transaction costs. And that’s unrealistic. Prior to the advent of no-load index funds, and particularly exchange traded funds (ETFs), it was quite cumbersome and expensive for an investor to move out of stocks into cash, or vice versa.
It seems ironic that the 200-day moving average stopped working in the early 1990s at the very point when ETFs and discount-brokerage commissions became widely available. But Blake LeBaron, a finance professor at Brandeis University in Waltham, Mass., suspects there is a connection between the two. After all, it’s a hallmark of market efficiency that previously successful strategies stop working when too many investors try to follow them.
In this regard, LeBaron notes that moving-average systems also stopped working in the foreign-currency market around the same time that they did for equities. It increases our confidence that the markets have undergone a fundamental shift that these strategies stopped working more or less simultaneously in two entirely different markets.
Note carefully that I’m not saying that a bear market hasn’t started. It may very well have. But if it has, confirmation will have to come from other indicators besides the 200-day moving average.