The 200-day Cross...This Time In A Bad Way

Posted At 9:10 AM EST

Good morning...We begin the day with a mild rebound in the pre-market futures.  We have some major economic releases coming out this week, particularly Wednesday and Thursday, so whatever move we make today could easily be wiped away later in the week.

Back on June 2nd, we took a look at what's happened in the past when the S&P 500 first crossed back above its 200-day moving average after having spent at least 200 days below it.

At the time, this event caused quite a bit of attention in the media, but from the study we looked at, results going forward were a bit better than random but certainly nothing for which we should break out the party hats and streamers.  At the time, I mentioned that I would be more encouraged when the 200-day average finally started to slope up instead of price just crossing above it, and that's still the case.

Now that the 200-day average has "failed" by the S&P crossing back below it yesterday, let's revisit it.  Let's go back to 1928 and look for any other time the S&P crossed above its downward-sloping 200-day average, held above it for at least five days and hit at least a one-month high, then fell back below.

Since the late 1920's, there were five other occurrences:

Well, the precedents here aren't very encouraging.  In the short-term of a few days to a couple of weeks, the S&P was mostly weak but a couple of times (in 1947 and 2002) it managed to rally a bit over the next one to three days.

Looking beyond the first few days after the cross back below the 200-day, it got progressively uglier.  By one month later, every instance was solidly in the red, with the S&P showing negative returns across the board by at least -3.4% and by an average of -6.6%.

Even by three months later, they were all still negative by an average of -12.5%.  In 1960, the three-month loss was only -1.6%, but all the others were down by at least -8.0%.

After those intermediate-term slices down, the S&P did manage to stage a rally three times (showing positive returns six months later of +8.8% in 1935, +11.3% in 1947 and +12.3% in 1960) but it completely fell out of bed the other two (-31.0% in 1937 and -27.6% in 2002).

Perhaps most disturbing of all, in every case but one, the S&P ultimately went on to violate the low that preceded the rally above the 200-day average.  And that one exception, in 1947, we saw the S&P do a "full" re-test of the low, holding just a few cents above the low prior to the big rally above the 200-day average.

With only five precedents, we obviously don't have enough information to draw a statistically valid conclusion.  But these analogs do help show what's possible, even what's likely, under somewhat similar technical circumstances.  In every case, the market was not able to hold up and rally under short-term oversold conditions, and that's what I'm watching most closely for here - a continued inability to respond to short-term positive setups will increase the likelihood that we've seen the end of the uptrend, at least for awhile.

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.  If we can't get meaningful bounces from oversold conditions, and especially if we lose the 880ish area on the S&P, a re-test of the March low looks to be in order.

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

Yesterday in an intraday update, we touched on a few signals that were popping up after yesterday's solid decline.

Big drops on a Monday, declines before an FOMC decision, and large losses following an option expiration all have tended to lead to short-term rebounds going into the middle of the week.  We're also getting some oversold indications in the intraday version of the STEM.MR Model, which has led to at least a temporary halt to the selling pressure lately.

All of these suggest that any additional downside is only temporary and we'll see a rebound over the next 1-3 sessions (especially once the model starts to curl higher).  Really the only exception to that rule is when we're undergoing a trend change on a higher time frame.

There is some danger of that here, as we discussed in the timer charts on Thursday, and again above regarding the cross back below the 200-day.  Also, the S&P didn't respond all that well to the last oversold signal and it has failed to hold well at what should be technical support at 905.

Yesterday afternoon I mentioned that we were seeing most of the signs of a trend day, and thus should see a close at or near the day's low.  If we would happen to get another bad day today that took us down near 880ish, then I'd likely be looking for a long-side trade into the FOMC decision, so we'll see how the early rebound attempt in the pre-market futures holds up.  Ironically, the best bet for those looking for a multi-day rally is probably another decline today, particularly during the morning hours.

All the best,