Mark Hanna on Why the 200-Day Moving Average Signal is Broken

Lots of investors – amateur and professional – began adding some major moving average buy-sell signals into their process in the wake of 2008. When it turned out that relying on PE ratios and forward profit guidance would prove to be lethal to stock pickers in a meltdown, there was a scramble for some kind of fail-safe system that would help managers reduce overall risk in their portfolios.

Many of them settled on the idea that the 200-day (or ten-month) moving average was a good signal to follow.

The idea was that with the S&P above its 200-day, you were safe to add to longs as the trend was your friend and the bulls were in control. With the market below that 200-day, however, the thinking was that it would be a good time to be risk-off. After all, this approach would have saved your ass in 2008 and then gotten you back in during early 2009! Fool-proof!

Only it didn’t work out that way.

In fact, in the post-crash period, this approach worked precisely against you. My pal Mark Hanna of the Paladin Fund picked up on this phenomenon (using commentary from a new John Hussman note in his post):

To put some numbers on this, it’s worth noting that since 1940, the S&P 500 has achieved an average annual total return of 14.5% in weeks where it was above its 200-day moving average as of the prior week’s close, and just 4.4% when it was below its 200-day moving average.

By contrast, since 2009, the S&P 500 has achieved an average total return of just 5.4% annually when it has been above its 200-day average, versus 36.7% when it has been below. Put another way, advancing trends above the 200-day average have repeatedly failed, making limited net progress overall, but declines have been halted and often breathtakingly reversed with each intervention.

So what happened? Many technicians will tell you that there are too many people (and funds) watching and using these levels thus negating their efficacy. Mark blames it on central bank intervention – the Fed and ECB reacting to breakdowns in risk assets with fresh pronouncements and programs.

Either way, it’s a mess.

Time to get a better signal? Or just wait til this one starts “working” again.

Source:

Fascinating Data on Performance of Markets When Above v Below 200 Day Since 2009 (Market Montage)

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