I’ll be honest… I didn’t even turn on the State of the Union Address. I had a couple friends text me about it as it was going on, and I let them know I was instead watching The Punisher series and Impractical Jokers with Donna. I think my choice of viewing pleasure that evening was much kinder on my soul, but to each his own. Watching the State of the Union probably causes most more stress than it does them any good. Similarly speaking, watching the market closely throughout the year doesn’t do the average investor much good, either. Rather, let’s step back from the noise – and allow me to provide some historic perspective regarding where we’ve been, where we are today, and what could play out over the course of the next several weeks and months.
I’m going to take you back through history, but I promise to make it full of pictures and best of all, brief and to-the-point.
First, however, we have to start with three, quick definition so that I can keep it concise!
Definitions / Explanations:
Moving Average (MA): The average price movement of an investment or index over a stated period of time. MA’s are used to reduce day-to-day noise and more easily determine the prevailing trend. Today, we’ll be focusing on the 200-day moving average (DMA), which means we’re paying attention to the average movement, or trend of the market (S&P500) in this case, over the last 200 trading days. Oh, and I made the 200DMA a red, shaded area on the chart to keep things as easy on the eyes as possible.
Relative Strength Index (RSI): RSI is a measurement of momentum that simply observes the difference between how good the up-moves are vs. how bad the down-moves are over a given period of time.
Overbought vs. Oversold (OBOS): Traditionally speaking, when RSI rises above 70, it’s considered a positive. On the other hand, when RSI falls below 30, it’s considered negative. When RSI falls below 30 and/or cannot seem to cross above 70, this is considered unhealthy, bearish (bad). Conversely, when the market crosses above 70 and/or cannot seem to get below 30, this is considered healthy / bullish (good).
Now that you’re educated on these three main definitions, let’s briefly take a trip through time and observe some of the biggest market crashes since the late-60’s…
The chart below shows us the market crash between 1969-70:
- Notice now the market (black line) crosses below the 200DMA (red line/shaded area), tries to come back, touches it from below (red circle), but continues lower.
- Also, in the lower-pane, you see RSI (momentum), which had been exhibiting lower-highs, all while crossing below 30, indicating an unhealthy market landscape.
- Finally, after several crosses below 30, RSI manages to head northward, crossing above 70 (healthy) just as the market manages to reverse upward into a long-term uptrend.
The next chart below is the market crash from 1973-74:
- Similar story here. Notice how the market crosses below the 200DMA, peaks its head above it in the 4th quarter of 1973 (first red circle), but fails and heads slower.
- It tries to reach out and touch the 200DMA again in the 1st quarter of 1974 (2nd circle), but fails even faster this time around.
- In the lower pane, we see momentum trending downward (lower highs) with several drops below 30.
- These crosses below 30 in momentum continue until late-1974 when RSI holds above 30 and then crosses above 70 into the new year.
Our next chart is the market between 1981-82:
- Again, the market crosses below the 200DMA, peaks its head above it in July/August of 1981 but fails and falls below it again.
- It tries to head back above the 200DMA twice (late-1981 and again in mid-1982) but can’t manage to muster up any strength to head higher.
- Speaking of strength, notice how momentum never crossed above 70 throughout all of 1981!
- Instead, we see a lot of unhealthy drops below 30 in the lower pane, until late-summer of 1982, when RSI turns bullish (above 70) and the market heads higher.
Our next picture is a chart representing the Dot-Com Bubble:
- This one is a little messier, but I didn’t want to take off all the up and down % moves. I think it’s important for everyone to see how many times the market swings up and down (and how BIG the swings are) throughout the crash.
- But again, notice how the market crosses below the 200DMA, tries several times to cross back above it, but just can’t manage to gain any traction as the long-term trend remains decisively downward.
- There are several, short-term drops and bounces along the way, but notice how momentum never got above 70 throughout the tail end of 2000, all of 2001, and all of 2002 as well!
- In late-2002, we see momentum heading higher with a low above 30, but it wasn’t until later (in 2003) that we finally saw an upward reversal in the long-term trend… not until after investors lost 47% in the S&P500, that is.
Our next picture is a chart of the market in 2007-08:
- You all getting the hang of this yet? See anything familiar?!
- Again, the market falls below the 200DMA (rebounding a few times in late-2007), but by late-2007/early-2008, the market follows momentum into unhealthy territory and trends downward.
- In mid-2008, the market fakes out investors, making them think that the end is near, literally touching the 200DMA, only to fail again, falling further into negative territory.
- Notice (in the lower-pane) how momentum never once got above 70 throughout this entire time period, but did cross below 30 a couple times. That’s neutral-to-negative at best, definitely NOT an uptrend, and with the market below the 200DMA, why would anyone take the risk in buying stocks?
…and here’s the rest of the story for 2007-09 (continued from above):
- I had to use two charts here because the -58% crash was so deep, it makes the earlier pain more difficult to see.
- The main point of scanning out and looking at the entire crash period is to again notice how momentum never got above 70 throughout this entire timeframe.
- There were many crosses below 30 in RSI, but it wasn’t until early 2009 when we started to see momentum pick up, the market followed, as we saw RSI head above 70, the market reversed into a positive trend.
Now… let’s look at the market today. You should all be pros at this point! Can you spot the main issues on the chart below? Let’s go through them together:
- In the 4th quarter of 2018, the market crossed below the 200DMA four times, bouncing back above it three of those times, but for very short periods of time.
- Notice how momentum trends downward throughout 2018, then crossing below 30 in October/November and again in December.
- Then, the market pulled off an impressive bounce, causing financial news to talk all about the “historic January,” causing investors to get a serious case of FOMO (Fear of Missing Out).
- But what happens then? However impressive this rally has been, the market was not able to cross above the 200DMA this week. Instead, so far it’s a failed test of the moving average.
- Then, if you look at momentum in the lower-pane again, even with the huge bounce off the bottom, RSI was not able to cross above 70. Sound familiar?
Mark Twain is rumored to have said, “History doesn’t repeat itself, but it rhymes.”
Will the market do today exactly what it has in the past? Probably not. It’s always a little different each time.
Also, I’m not predicting the market here, and I’m not predicting a crash – that’s not what I do. All our clients know that we’re not “trend predictors.” We’re trend followers. No one can predict what the market is going to do tomorrow, next week or next month.
While there are several more fancy, complicated, and more difficult-to-understand market indicators than the moving average and RSI, by looking back through history with me today, observing the market vs. the 200DMA, and paying attention to momentum ranges, what does the market’s long-term trend look like to you? For me, I say the current trend is definitely not up.
Could the trend change soon? Of course it could! When? I have no idea, and neither does anyone else! …but it could also continue, so what kind of person are you?
- A gambling day-trader trying to scalp every short-term low and high?
- A long-term investor who wants to get as much of the upside in the market as possible, but more importantly, doesn’t want to participate in market crashes?
So whether the trend could change soon or not, I’m not a gambler, which means I do not try to anticipate what the market is going to do. Nope… what I do is analyze a bunch of indicators so that I can allocate our clients’ portfolios today, according the amount of risk there appears to be in the market.
I am not interested in being heavily invested in stocks when the amount of reward that appears in the market is small, relative to the amount of risk at hand. Until that changes, a defensive stance is one that I’ll continue to implement.
Till next time…