Market Pulse: False indicators
After the recent stock market sell-off I began to see articles on mechanical timing models that claimed to have predicted a fall.
The headlines generate clicks, but most are untethered from reality. For example:
Investor’s Business Daily ran an article that asked whether the market was at a major top. It offered a system that showed “an easy way to find out.” The model counts distribution days, which are days on which the market falls by at least 0.2% on volume that is greater than the prior day.
A market sell signal occurs when there are seven distribution days within a 25-day period. The author was proud to say that this model called the 2008 bear market.
The article doesn’t say, however, that the model also gave many sell signals during the 11-year bull market. Let’s look at 2009 alone. A distribution day occurred on Sept. 23. For the next 25 days the market went sideways and had nine more distribution days.
Again, starting on Oct. 16 there were seven distribution days. Finally, beginning Nov. 12 there were 10 distribution days in the 25-day period.
In 2009, the first year of the long bull market and when the Dow traded at 10,000 (it’s now 25,000), there were three occasions when this system gave a sell signal. Can you imagine how many more sell signals were given since then? No mention of that in the article.
Another model the financial media talk about is the “Death Cross.” With a name like that it must be bad, right? Not so fast. A Death Cross occurs when the market’s 50-day moving average falls below the 200-day moving average. That’s bad. It switches back to a buy when the 50-day moving average rises above the 200-day moving average. That’s good.
Investors who acted on the last five Death Cross sell signals lost money with each trade and bought back in an average of 9% higher than where they sold. But the sell signal in 2008 worked!
Truth is that any timing model that gave a sell signal in 2008 worked. But just because a model worked in 2008 doesn’t mean that its next set of signals will work.
Instead, I want models that are effective in both bull and bear markets. I’ve written about my favorite two. The Nasdaq’s relative strength versus the S&P 500 is on a May 10 sell while my stocks-only Advance Decline Line did not signal a major market top.
So it’s a more difficult environment, yes, but not a market top.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.