In case you hadn't noticed, something interesting is going on in the global equity fund class. The iShares All Country World Equity Index (ACWI) and the Vanguard Total World Stock Index (VT) ETFs are soon about to experience "golden cross" events. There are similar offerings made by other firms such as BlackRock, Aberdeen, Invesco and Oakmark. I think this development is worth thinking about.
Trend followers and other market technicians pay a good bit of attention to golden cross events, which occur when a 50 day moving average climbs above the slower moving 200 day moving average of a stock's price. They do so because historically this been a fairly reliable sign that prices may move higher for a while and that profits can be made from owning the stock.
Beyond the simple review of the reliability and profitability of this indicator, I have spent some time thinking about why it works and how this thinking may help investors to think more long-term about their investment portfolios. Generally I have come to associate golden cross events with market situations where the many uncertainties that investors worry about have probably already been adequately discounted (included) in the stock's current price. I think of this signal as telling me that for the time being, I can worry a little less about potential negative future outcomes, because market participants have already envisioned those and done enough worrying (selling) for the moment. If for a minute you accept that idea as correct, then what would you expect to happen next to the stock's price? Here is the good part. Generally if all the news both good and bad about a stock's future earnings have been adequately discounted into the current price, then the stock is free to begin to appreciate at its discount rate, plus or minus future undiscounted earnings developments.
For an all-world equity index of securities that diversified away specific company related risks, a golden cross may be telling us that the index is free to begin to appreciate at its discount rate, plus or minus future undiscounted earnings developments. In thinking about the future undiscounted earnings developments for the world's collection of businesses, I have to say I prefer to be an optimist most of the time. The world's population continues to grow and the needs of its members are far from being fulfilled and that spells opportunity for businesses. By investing in the world's index of businesses, I really don't have to decide which business to bet on because essentially, I have invested in all of them. Somewhere in there are the companies which are going to succeed in profitably meeting the growing needs of the world's population.
At this point you might be wondering whether the aggregate stock price of the world's companies is reasonably priced. In other words, would you want to be a buyer at the current price of the world index? Looking at some of the standard valuation measures, it would seem that these indexes are indeed somewhat reasonably valued, depending on whose numbers you believe. Based on numbers reported on Morningstar and on Vanguard's websites, the price to prospective earnings for VT is probably somewhere between 11.5 and 13 times. The price to book is probably about 1.6 times. Vanguard shows the average annual 5 year historical growth in EPS for all the companies in its index to be 7.2%. A security with these valuation attributes could probably appreciate at about 20% per year barring some unforeseen negative development. As it turns out the average gain in the S&P 500 during all positive one year holding periods is about 16%. So, if we have a golden cross in the price of the world index of stocks, it is possible to envision a gain in such a broad-based index of 15 to 20% for a one year holding period.
You might be wondering how safe is an investment in a broad-based equity index that experiences a "golden cross" event. I would make a couple of points. Historically these events have had a pretty good reliability, but they are not perfect. So sometimes a loss will develop from an investment made on the date of a golden cross and which is sold on the future date when that signal reverses (i.e. the 50 day average falls below the 200 day average). Also, occasionally and more often a market pulls back a little after the golden cross event before it eventually moves somewhat higher. This happens fairly often, so you need to be ready for a little volatility after initiating a position after the occurrence of a golden cross event. For more specifics, please consult your own advisor. These thoughts are only intended to stimulate your own thinking and you are responsible for your own investment decisions. The ideas in this article cannot and should not be construed as investment advice suitable for your own personal situation.
Additional disclosure: I may mention these securities in newsletters that I publish for clients and members of the investing public.