Technical Signals Go Against Common Wisdom

Posted At 8:30 AM EST

Good morning...We begin the day with some modest buying interest in the pre-market futures.  Whatever moves the indexes make for the next few hours are meaningless anyway, at least in terms of likely being wiped out in the minutes following the FOMC rate decision early this afternoon.

I've seen a lot of worry since Monday about the idea that we suffered a 90% down day, the second such occurrence in the past couple of weeks.

Different folks define a "90% day" in their own way, but the concept is usually credited to Lowry Research and defined as a day when 90% of total volume goes into issues that were negative on the day, and 90% of all points gained or lost were lost.

Personally, I find that just using volume is sufficient.  In that case, according to my data we did get a 90% down day on Monday, but we barely missed it on June 15th (that was an 89% down volume day).  But let's just pretend and say that we've now undergone the indignity of  two 90% down days within two weeks of each other.

Even worse (supposedly), this is occurring as prices are coming off of a multi-month high.  So let's go back to 1940 and look for any other time that the S&P hit at least a 3-month high within the past couple of weeks, and also recorded at least two 90% down volume days.

The last signal, in July 2007, preceded the current bear market.  But not before the market rallied for a few months first.  Same with the signal before that.  And before that.  And before that...

If you look at the Average and % Positive fields after the instances, they're not too bad.  In fact, take a peak at the "3 Months Later" column...100% winning trades, with an average return more than three times greater than random.  Returns across the board were better than should be expected under normal circumstances.

Ironically, even though this has in fact been pretty bullish for the market going forward, it's getting nothing but negative press.  But traders are tripping all over themselves pointing out the bullish signal given by the "Golden Cross".

The Golden Cross is defined as the 50-day moving average moving above the 200-day moving average, in this case for the S&P 500.  I've never been a fan of moving average crossover systems, but let's just take a look at the facts.

The instances above are filtered by those that occurred when the 200-day average is declining, like it is now.  Overall, the returns going forward, up to six months later, were little better than random and not statistically significant.  In fact, in the shorter-term they were a little worse than random.  Only when we look out a year do we see some out-performance.

I suppose we could argue that most of the poor performers were concentrated prior to 1942.  Since then, the performance in the S&P three months, six months and one year later was pretty good after these signals, and well above average.  The S&P was positive 11 out of 13 times since then, with average returns of +5.9%, +9.0% and +17.8% respectively.

Overall, I would not be using the Golden Cross, or any other moving average crossover, as a signal in the broad equity indexes.  There is just very little evidence that they provide any additional value.

And I would not be too concerned about the multiple 90% down days.  I agree that heavy selling pressure *can* be a sign of a top, but obviously from the chart above that's not always the case.  I'll be more concerned if we cannot rally well from short-term oversold conditions (there has been some initial signs of that, but not definitive), and we cannot bounce from technical support levels (880ish is probably the biggest test).

Bottom line - Intermediate-term Outlook: Neutral (since April 9, SPX 843)

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.

During mid-April, several of our measures like the Indicator Score and Dumb Money Confidence reached levels that usually result in either a flattening out of the price rally, or an outright decline, especially during a bear market.

But the market held up extremely well in spite of some of these overbought types of indications.  This is very rare during an ongoing bear market, and is important to keep in mind especially given many of the "this time is different" kinds of studies we reiterated in early May.

While there have been - and continue to be - many reasons to consider this rally something different than we'd seen previously in the bear market, I've been looking for the S&P to run into trouble if it traded into 940-950, which it happened earlier this month.  I wasn't expecting any kind of waterfall decline to new lows, just more of a pullback than we'd seen.

What's made this juncture so difficult is that despite so many signs of "this time is different" and the market doing nothing wrong, there are some troubling signs out there.  We touched on a couple very recently, like the surge in speculative trading and the return of bullish opinion.  Because of that, I've been leery of the S&P's chances to hold a breakout above 950.

With the most recent surge in the spread between the Dumb Money and Smart Money Confidence, and the tendency for initial breakouts from volatility coils to be "false", I was looking for the first breakout above 950 to be beaten back.  Now that that's happened and we're nearing the opposite end of the May - June range, we need to see how the market responds to short-term oversold conditions, especially now that we've seen a "failed" rally above the 200-day average.

The recent 90% down volume readings when coming off of an intermediate-term high aren't necessarily a sign that the trend is changing, but if we can't get meaningful bounces from oversold conditions, and especially if we lose the 880ish area on the S&P, then a re-test of the March low looks to be in order.

Bottom line - Short-term Outlook:  Neutral (since June 3, SPX 924)

Today the FOMC announces their rate decision, which doesn't carry a lot of weight in terms of their target rate, but their accompanying statement will be torn apart faster than bloody meat in a piranha tank.  Any hint at decelerating their easy money operations will likely be met with a resounding thud from knee-jerk futures traders.

We often see a meandering move higher during the morning hours on these days, then two or three violent whipsaws after the announcement, following by a more trending move into the close.

There have been 11 times the S&P futures have gapped up +0.5% or more on the morning of a scheduled FOMC rate decision.  The futures closed higher than the open 10 of those 11 times, by an average of +1.2%.  If the gap was +0.25% or more, then they closed higher 19 out of 26 times by an average of +0.5%.

As we discuss every time, however, extreme reactions to economic events like the FOMC meeting tend to lead to counter-moves in the day(s) following.  For example, on the 11 occurrences that the S&P gapped up +0.5% on these days, from the day's close to two days later the S&P showed a positive return only 2 times, with an average of -1.5%.

Yesterday's chop worked off a few of the oversold signals that had triggered after Monday's selling pressure, so that's less of a factor now.  Mostly we're at the mercy of the looming economic reports and the FOMC announcement, and the best trade is probably nothing ahead of time, and perhaps a "fade" trade if we see an extreme reaction either way heading into today's close.

All the best,