Don't Let Moving Averages Distract You

by: Investment Pancake

Various segments of the domestic equities markets, particularly mid-caps and certain segments like technology, are now past an important inflection point, where short-term trading momentum has overpowered long-term investment momentum, as indicated by the fact that the 50 day exponential moving average has crossed above the 200 day exponential moving average for a number of domestic equities indexes.

Abroad, this technical posture is already old news, and it's more or less universal across major markets (you can take a quick snapshot by following global equities exchange traded funds like GWL).

In a few days, barring a 20% selloff, we'll probably see the same technical posture develop within broader US equities indexes as well. For many traders, that signals an "all clear ahead" long-term bullish trend. It will be widely reported when this happens, and there will be euphoria, conviction and optimism extraordinaire.

It may last a week before the inevitable disappointment comes, or it could be five years. There is absolutely no way to know without taking hallucinogens.

Three points on this.

  1. First, if you wanted to unload some serious equity, and you had sufficient fire power, you might want to nudge markets to a point where traders just blithely go long. I mean, it would be like herding cattle to the slaughter. Mooo mooooo moooooo! Everyone going long without so much as a second thought, ignoring stuff like, oh, I dunno, global recessions, cratering earnings around the Earth, little stuff like that. I'm not one for arguing with the market, and if it is saying bull market, okay. I mean, I guess. I just don't trust it. Too many clanking cow bells and strange looking men with thick rubber gloves and aprons, with metal objects.
  2. Second, one thing some technical trading guys forget is that many times, you see a moving average cross, such as the one unfolding now, and the first thing the markets like to do is to sell off. Test moving averages like the 200 day simple moving average as support. My guess is that ought to happen this time around. But it is only a guess because I have no idea. Anyhow, if it does happen, expect much wailing and gnashing of teeth. Breathless news stories about the new "long term technical uptrend" will go up in smoke, the weak shall be killed and eaten, and once they are, the market can go on about it's business climbing the great wall of worry.
  3. Third, the news about the exponential moving averages obfuscates a more interesting technical development that gets very little attention. I call this "The Big Squeeze". What is The Big Squeeze? The Big Squeeze comes when short sellers take their best shot, and come up... well... short. This can be measured with charts, in fact. What happens is you see a super short-term moving average get close, maybe even skirt along, an intermediate-term moving average. For example, a 30 day simple moving average might come into contact with, or get flirtatiously close to, a 50 day simple moving average. It looks for a while like the two will cross paths and the market will plunge lower as the hyper short-term traders (which the 30 day simple moving average sort of tracks) feast on the nervous, timid sort of want to be long-term investors but we're too scared types of folks (I'm looking at the 50 day simple moving average when I think about these guys). It gets tight, uncomfortably so.

But they never really do cross. In fact, the 30 day simple moving average starts to lift again off the 50 day simple moving average, and now you have the shorts getting their shorts squeezed. They cover, moaning with disgust, and on cue, the markets blasts higher.

This story is unfolding across virtually all equities markets around the world. Many ETFs tell the story - EEM, ILF, EPP, EFA, GWL, SPY, DIA. The list just goes on and on. The homogeneity of this technical posture on all these global equities markets is unusual. Lots of flashing green lights here, and it appears to be a massive tide, indeed.

Do you hear some mooing? Yes, oh yes, too much mooing, in fact, but the cows aren't focused on The Big Squeeze. I think some technical traders are drooling with greed at the moment, but maybe for the wrong reasons.

Disclosures: The author is plodding along, cowbell clanking, holding long positions in ILF, EEM, EPP, and EFA, trying not to be nervous about those guys with meat hooks, aprons and heavy rubber boots standing right around the corner.