Short-term Outlook (1-5 Days):  Neutral  Since June 24, 1067 SPX

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Equity Indicators - Updates and Extremes

Baltic Dry Index

There has been quite a bit of discussion on the Baltic Dry Index lately, usually because of its recent streak of down days.  According to Bloomberg data, the freight index has dropped for 23 consecutive sessions.

A simple web search will turn up tons of background data on the index, so I'm not going to belabor its construction.  But usually, the bulls will trumpet the indicator as a sign of economic strength when it's doing well, and the bears will herald it as proof of malaise when it's dropping.  Like now.

I haven't written a lot about it over the years because it has been a very inconsistent predictor for stocks.  Sometimes it's good, sometimes it's bad, but historically it's not much better than the hemline on women's skirts as a stock market forecaster.

Anyway, maybe there's something predictive of the Index's latest trend.  The trend seems like a pretty major signal, though it has declined as many as 48 days in a row (in 1995).

The table below shows how the S&P 500 fared going forward when the Baltic Dry Index slid for 23 straight days.

More than it usually does, the streak of down days did seem relatively predictive of weakness in the S&P, at least when looking out a couple of weeks.

Out of all the instances, the S&P managed to sport a positive return less than 25% of the time.  All six of the last instances were negative when looking out over the next 2 weeks to 3 months.

I'm not a big fan of using the BDI as a predictor and I think it's used WAY too much as one, but when it streaks like it has been lately, stocks haven't done well going forward.

The "Death Cross"

Sometimes a technical signal will occur that generates an unusual amount of questions, and over the past week that has been the case with an imminent crossover in some longer-term moving averages.

Last week, we looked at the 10-week/30-week crossover in the S&P as well as the slope of the 150-day moving average.  Both had garnered media attention as imminent sell signals for stocks, though their records were spotty.

The current nail-biter is the horribly-named "death cross", when the 50-day moving average crosses below the 200-day moving average.  We've looked at this in the past, along with its mirror-image "golden cross", and usually we come out un-impressed.

Like usual, let's forget the textbooks and opinions and instead look at history.  Here are the results of going short on a bearish crossover and covering when they gave the opposite signal:

Net Profit/Loss:  +646 points (versus +1,056 for buy-and-hold)

Winning %:  35%

Average Winner:  14.2%

Average Loser:  -7.9%

Maximum Drawdown:  -357 points (versus -889 for buy-and-hold)

Note that this strategy calls for going short, so a positive outcome means that stocks declined.

Most trend-following strategies, especially using moving averages, have a very low winning percentage, especially especially those that sell short, so a 35% winning rate isn't all that unusual.  At least it made money.

But...

Out of the gross 646 points of profit, 589 of them came from one trade (the 2008 bear market).  And 459 of them came from one other trade (the 2001-2002 bear market).  So those two trade alone accounted for 1048 points...which means that the other 44 trades netted -402 points.

That is the great frustration with trend following - you'd better take every trade, and you'd better trade it for a long time (or trade a lot of markets), because you never know when that one trade is going to come along to finally make you profitable.

In fact, if you started trading this system back in 1928, you would have had to wait until 2002 to show a profit (there were some decades that were profitable, but overall the losses from the unprofitable ones ate them away).

Here is the breakdown by decade:

The strategy was piss-poor every decade, until we finally arrived in the 2000s with the wide, steady swings in prices.  Up until the past 10 years, you wouldn't have done much at all by trying to time the market using these moving averages.

Instead of waiting for a bullish crossover, here are the results the given number of days after sell short after the "death cross":

It really didn't make much different at all in the numbers if the 200-day average was sloping up or down at the time of the cross - except for one month later, it was a poor strategy for selling short.

Usually, stocks rebounded in the short- and long-term after these crossovers, though the signals were inconsistent.  That's the problem with these things - they will keep you out of the worst bear markets, and if that's your biggest concern then by all means reduce risk when they occur.  But you'd better have a strategy for getting back in, because more often than not they do nothing but whipsaw back and forth.

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