As most of you know, SMI's strategies run on a set of well-defined, mechanical rules. Things like studying charts and technical analysis don't factor into our investment process, so we rarely comment on such matters.
That said, we do normally point out when the annual seasonality buy and sell signals happen, which has just happened. (Although we've shifted away from those signals as well since our Dynamic Asset Allocation strategy debuted several years ago.) And that provides an excuse to look at some other recent developments.
What follows is a discussion about the current state of the market along those chart/technical lines. So if you're a member who is happy enough just implementing the SMI strategies based on the monthly updates, feel free to stop reading right here. Nothing that follows is going to be necessary to implementing the strategies. It's purely for those who enjoy a little "inside baseball" and taking a deeper dive.
The annual seasonality sell signal triggered yesterday. For those not familiar with this signal, I'll point to last year's article for more detail, including a link to the MACD (moving average convergence/divergence) indicator we base that signal on.
As market timing signals go, MACD is pretty weak. It's primarily useful for really short-term fine-tuning, such as when we're already planning to buy or sell around a certain time anyway (as is the case with the annual seasonality approach) and want to fine-tune that a little more. But sometimes it does lead to interesting observations, and now is one of those cases.
Let's look at the MACD portion of this chart first. That's the bottom section with the crossing black and red lines. You can see at the far-right how the black line crossed from above the red line to below it yesterday. That's the annual seasonality sell signal taking place.
What's interesting here is how MACD has given great signals so far during this bear market. Usually, MACD is noisy and gives lots of unhelpful signals back and forth. You can see that in the way the black and red lines are basically right on top of each other from the beginning of the year (far left of the chart) through the market's high on February 19. But from that point on, we see a sell signal around February 24, a buy signal (black line crossing back up above the red line) on March 28, and now a sell signal yesterday. Again, we don't trade based on the MACD signal, because it normally doesn't work. But selling February 19, buying March 28, and selling again yesterday or today would have just about nailed this bear market so far!
Lines in the sand
Now that I've converted you to the virtues of following MACD (I'm kidding, don't do it — it really doesn't work out like this most of the time), let's look at some of the other important lines in the top section of the chart. Note the red line at 3000, that's the S&P 500 index's 200-day moving average. And the blue line at 2,721; that's the S&P 500's 50-day moving average. The 50-day is often considered a barometer of the market's short-term trend, while the 200-day is a commonly watched barometer of the market's intermediate trend. The shape of those lines on this chart confirms that idea: notice how the blue (shorter-term) line was much quicker to change direction with the market, while the red (intermediate-term) line has been mostly flat.
A couple of things are interesting about the current market setup. First, people who focus on charts and technical analysis were watching the ~2,930 level very closely as the market kept rising from its March low. Without boring you with all the details, there's a well-known market pattern called Fibonacci retracement levels that market rebounds often follow. They're far from perfect, but in a nutshell, chart watchers often look for bear market rallies to run into trouble at the 38%, 50%, and 62% levels of "retracement." For this bear market, retracing 62% of the prior decline happened at 2,930, and sure enough, the market ran up to that level and then couldn't break through.
The other interesting point goes back to the moving averages and the fact that the market now sits directly in-between them. These are essentially the next "lines in the sand" that will give investors a good idea of what's in store. A move above the 200-day moving average would be quite bullish. On the other hand, breaking below the 50-day moving average would flip the trend back solidly to the bearish side and potentially signal a retest of the lows could be in store. But these moving averages often function as "support" and "resistance" as well, meaning the market tends to move toward them and then "bounce" off them. So if the market moves lower, don't be surprised if it finds "support" at the 50-day moving average around 2,720 and at least temporarily bounces along at that level.
A possible signal
SMI readers know that we've been viewing the rally from the March lows as a likely "counter-trend rally" of the sort that occur in every bear market. It's too early to say for sure that's the case. But watching the market rally right up to the well-known 61.8% Fibonacci level, suffer three distinct rejections at that level, followed by the declines of the past two days — that's what we would expect if this was just a bear-market rally rolling over and heading back lower. While we don't rely (at all) on this type of chart analysis, it does signal the obvious next confirmation step, which would be the market eventually breaking down below the 50-day moving average at 2,720.
Just to reiterate, some investors view this type of technical analysis and chart-watching with roughly the same disdain as studying animal entrails. So don't put too much stock in it, and certainly don't start making adjustments to your strategy based on it. But since you've likely heard most of this terminology slung around at one point or another, hopefully this is a helpful explanation at a time when a few of these various patterns have all converged.