Swedroe: Beware The Death Cross! Or Not

As if the surprising slowdown in the Chinese economy, the sharp drop in commodity prices, the devaluation of the yuan—along with sharp drops in the value of the Canadian dollar, the Australian dollar, the Brazilian real and the Mexican peso—weren’t enough to scare investors on Friday, Aug. 29, 2015, the 50-day moving average of the S&P 500 Index crossed below the 200-day moving average, and the financial media were filled with warnings about this dreaded “death cross.” The death cross is just another one of those financial myths that, like cockroaches, are hard to kill.

I last wrote about the death cross in September 2010, in a blog post on its cousin, the so-called Hindenburg Omen. Here’s what I wrote at the time:

In August, Albert Edwards of Societe Generale had noted that the indicator may suggest “a savage equity downturn is imminent.” He warned investors: “Equities are tottering on the edge as increasingly recessionary data becomes apparent. It would not take much to tip them over that edge.” Investors were worried: “The Omen has appeared before all of the stock market crashes of the past 25 years. The first observation was August 12, and this has been confirmed by a second Omen on Friday, August 20. On July 6 the Death Cross appeared, in which the 50-day moving average crossed below the 200-day. After a brief rally, the market is now again on a downtrend and the 200-day moving average is rolling over.”

One would have thought that the outcome I reported would have killed off this bit of investment porn. On July 6, when the death cross appeared, the S&P 500 had closed at 1,028. It closed the year at 1,258, an increase of more than 22 percent. On Aug. 20, the date of the key second confirmation of the Hindenberg Omen, the S&P 500 had closed at 1,072. By year end, the index had risen by more than 17 percent.

Thanks to Michael Batnick, we have long-term evidence on the performance of the dreaded death cross. Batnick looked at all 26 episodes of its occurrence in the last 50 years. What he found was that both the average and median three-month return was 3 percent, which is identical to the long-term quarterly average return. He also found that eight of the 26 quarters were negative, or 30 percent of the time, which is actually less than the 32 percent of quarters with losses that we have experienced since 1926.

And there was only one three-month period of the 26 episodes in which the S&P 500 fell by more than 10 percent, which equals about 4 percent of the time. Over the same period, we had 14 quarters when the S&P 500 fell by more than 10 percent, or almost twice as often. Of course, you would never hear that from the financial media because accountability ruins the game.

Remember, the media needs you to tune in (though you are best served by tuning out), and bad news sells more than good news, which is why there’s the saying, “If it bleeds, it leads.”

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.