Jan 11, 2016 | Post by: Roman Chuyan, CFA Comments Off on Simplistic Trend-Following Will Push US Stocks Lower

Simplistic Trend-Following Will Push US Stocks Lower

Trend-following is one of most-favored methods used to time the market – after all, “a trend is your friend.” Investors who use trend-following watch for indicators such as the popular 50-day moving average crossing above (a bullish signal) or below (bearish) the 200-day MA.

This indicator seems to have worked in the past: the bearish crossover (known as the “death cross”) occurred in the S&P 500 in January 2008, and a bullish crossover in June 2009 – a nearly-perfect way to time the 2008-09 bear market and protect portfolios! However, it didn’t work since then, for example, it was perfectly out of sync in the 2011 correction, directing its followers to sell near bottom, and to buy after the market rebounded.

It appears that the signal is about to whip-saw investors again. The 50-day MA of the S&P 500 index moved above the 200-day MA on Dec 21, 2015 – some took it as a bullish sign, which supported the market in late December (see chart). Of course, being a lagging arithmetic based on past 2.5 months (50 trading days) of index prices, the 50-day MA simply reflected the late-October rally.

With higher late-October S&P prices rolling out of the 50-day window, the 50-day MA retreated last week (the blue line on the chart), accelerated by the sharp 6% selloff in the S&P 500 during the first week of January. The indicator will give a “death cross” signal at market close today, January 11th, likely directing more selling by trend-followers this week – hardly a transaction that improves performance, after a 6% drop in the S&P last week (a 9% retreat from recent peak on Nov 3rd).

Academic research says that the market is at least somewhat efficient (the weak form of market efficiency). And practical evidence confirms that simplistic lagging indicators, used without further analysis and as primary basis for making active investment decisions, can hardly work.

Model Capital Management LLC is a tactical investment manager. For more information on Model Capital’s fundamental, forward-looking approach to tactical investment management, please review the following pages, see the list of our tactical management strategies here. Please contact us for information on how we work with advisors.

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