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Deteriorating Price Trends Bear Watching

Wells Fargo Investment Institute - December 7, 2018

Key takeaways

  • The S&P 500 Index’s 50-day moving average moved below the 200-day moving average today, a key short-term market analysis indicator that many market participants use as a sign that an uptrend in equities has shifted to a downtrend. 
  • From a technical market analysis perspective, we see the deterioration in equity price trends leading trend-following investors to sell on equity market rallies, as opposed to buying on equity market dips, which they did while markets remained in an uptrend.

What it may mean for investors

  • We believe that the economy appears solid, and that this is not the end of the cycle or the bull market. We believe that long-term investors should focus on implementing their investment plans, which should include asset allocation, diversification, and rebalancing.

Download the report (PDF)

The ongoing weakness in equities has surprised investors as hope sprang eternal after Federal Reserve (Fed) Chairman Powell seemed to strike a more dovish tone recently with respect to how high interest rates might go, and President Trump and President Xi of China appeared to agree to a halt in trade/tariff escalation. However, markets find themselves right back near the lows, and we believe one of the main reasons is price trends, which have gained popularity as a positioning indicator. Specifically, it is the deterioration in these price trends that are leading trend-following investors toward selling equity market rallies, as opposed to buying equity market dips, which they did while markets remained in an uptrend.

Many market participants (including us) look to crossovers between the trailing 50-day moving average (DMA) of a market’s closing price and the trailing 200-day moving average (DMA) of a market’s closing price as an indication of a market’s overall trend. When the 50-DMA moves below the 200-DMA, it is often referred to as a “death cross,” as it indicates that the trend has shifted from higher to lower. When the 50-DMA moves above the 200-DMA from below, it is referred to as a “golden cross,” as it indicates that the trend has shifted from lower to higher.

Today, the S&P 500 Index experienced a “death cross,” which is causing many market participants to grow more cautious on equity markets. Rather than blindly following an indicator, from time to time it is important to test whether an indicator is useful. That is why we looked at the available historical data to see how markets performed in periods when the markets were in an uptrend (50-DMA is greater than 200-DMA), as opposed to when they were in a downtrend (50-DMA is less than 200-DMA), as measured by the positioning of the 50-DMA relative to the 200-DMA. As shown in the table below, investment performance is much more attractive on both an absolute and risk-adjusted basis when markets are in an uptrend versus when they are in a downtrend.

Table: Historical market performance in uptrends versus downtrends


Source: Bloomberg, Wells Fargo Investment Institute, December 7, 2018. Copyright ©2018 Bloomberg Finance L.P.  *Rolling returns, calculated on a daily basis. **As measured by standard deviation.  

The moving average looks at the average price of a particular stock (or sector, market or asset class) over a rolling time period which creates a smoothed price trend line, which is an indicator used in technical analysis.  There is no assurance that these movements or trends can or will be duplicated in the future.  Technical analysis is only one approach used to analyze stocks.  The S&P 500 is a market capitalization-weighted index generally considered representative of the US stock market.  An index is unmanaged and not available for direct investment.     

While no indicator is perfect, and we prefer to use a multifaceted approach when assessing the attractiveness of any given market, it is important for investors to be aware of the deteriorating price trends in the equity markets and the headwind they may pose over a shorter time horizon. Overall, we still remain constructive on our outlook for equity markets, much of which is driven by good prospects for continued economic and earnings growth. 

We believe that long-term investors should take advantage of the recent weakness by adding exposure to our favored equity asset classes (U.S. large-cap, U.S. mid-cap, and emerging market equities) and sectors (Financials, Industrials, Health Care, Consumer Discretionary, and Information Technology). In our opinion, now is also a good time for investors to partner with their investment professional and ensure that their investment plan is up to date and includes critical components such as asset allocation, diversification, and rebalancing.