Recently, we issued our market update as one of longer term weekly indicators issued a "buy signal". However, there is another indicator that is rapidly approaching the issuance of another buy signal which is known as the "Golden Cross". This is when the 50 day moving average of the S&P 500 index (the average price of the index over the last 50 days) crosses above the 200 day moving average.
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As we have stated many times in the past - the secret to being a good investor is not to let emotional biases interfere with trading decisions. There are some age-old axioms in investing that should never be broken and one of those is "the trend is your friend."
Regardless of the fact that we expect to see a resurgence of economic weakness sometime in the not-too-distant future, the momentum behind the market is currently positive for whatever reason and that is what we, as investors, must pay attention to currently. With the economic worries in Europe, the U.S. is a much more attractive place to invest capital at the current time. Corporate balance sheets are in better shape than they were prior to 2008 and there are substantial amounts of investment dollars hiding in bond funds and cash which could drive a market rally higher than expected in the short term.
None of this changes our economic outlook in the coming months ahead. There are still many pockets of weakness that could reassert themselves at any time and reverse this signal. It happened in 2010, as we will discuss below. However, as Bill Clinton once stated - "What is - is."
In several of our past weekly newsletters we stated that the trading range that has been compressing the market ever tighter since August was very likely going to resolve itself to the upside. That has been accomplished with the recent rally in January. The momentum and directional trade of the market as a whole has been improving - albeit on light volume, which does reamain a concern. However, there are many institutional traders who are also watching this same indicator which have automatic triggers that initiate the buying of blocks of stocks when indicators like this trigger a "buy" signal.
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My friend, Frank Holmes, who runs U.S. Global Investors Fund (PSPFX), stated:
Over the past 20 years, the 50-day line crossing above the 200-day average of the S&P 500 Index resulted in surprisingly bullish data. Of the nine times this event has occurred in those 20 years, the S&P 500 averaged a 23 percent increase before the market reversed.
One extraordinary example is the golden cross that occurred in September 1994, which resulted in a whopping 120 percent by the time the trend reversed in September 1998!
The lone exception to this trend was the unusual and very volatile market in 2010-2011. Even then, the S&P 500 only lost a third of a percent.
Today, the S&P 500 is only about one and a half percentage points away from the golden cross. With the index already above the 200-day moving average, the 50-day is on a path to continue rising. Perhaps this might encourage investors to “cross the street” now and anticipate the automatic trigger before traders act.
We agree with that sentiment. However, also realize that in the short term the markets are very overbought. Therefore, we suggest adding exposure to equities on pullbacks in the market. As we stated above, you often hear that the "trend is your friend", however, there are rules that go with this axiom that we encourage you to follow:
1) When the trend is positive (up) - buy dips in the rally.
2) When the trend is negative (down) - sell rallies.
Following these two simple guidelines can help you minimize the risk of buying into overbought conditions in the market. Furthermore, by being patient and buying on pullbacks, or selling into rallies, you can avoid making emotional investing mistakes that can lead to future losses.