What is a Death Cross?

What is a Death Cross?

Posted on August 17, 2015

Canterbury Weekly Update

August 17, 2015

Market State 2 (15 Days): Long term: Bullish – Short Term: Bullish/Neutral.

Canterbury Volatility Index (CVI): CVI 55 – The market’s volatility remained virtually unchanged for the week. The most recent peak in volatility was CVI 59 on July 13th. It is important to note that volatility is not only low but is decreasing. Low and decreasing volatility is a primary characteristic of a low risk environment.

Our studies show that the systemic (market-specific) risk has been limited to a normal bull market pullback, which is a correction of -5% to -10% during Bull Market States 1 through 5 when volatility is at CVI 75 or lower.

The Overbought/Oversold indicator closed the week at 55% Overbought (Short Term Neutral).

The financial media was all-over the “Death Cross” on the Dow last week. If you were a TV producer looking for a way to hold viewers through a commercial break, then throwing out a term like “Death Cross” should keep the viewers in their seats.

So What is a Death Cross and Should We be Concerned?

A Death Cross occurs when the 50-day moving average drops below the 200-day moving average. The Death Cross didn’t always get as much attention as it does today. That all has changed over the last 15 years. Look at the chart and you will see why.

The Death Cross typically gives an indication of a change in the primary trend of the market. Throughout most of the last 20 years, the markets have been in a trending mode; either strongly up or down. Recently, the Death Cross has been an excellent indicator of pending doom and gloom.

Historically, markets tend to spend a larger percentage of the time in sideways trading ranges. In a trading range, getting the 50 and 200 day moving averages to cross back and forth can be like turning the Titanic. In such cases, a Death Cross may be too slow to shift from bullish to bearish. As a result, it could in fact be considered bullish.

A “trading range” market environment will tend to have shorter cycles. The following is a chart that shows why the Death Cross is not always as bad as the name suggests.

About the time a Death Cross occurs, the market may be oversold and ready to go back up. It would have been difficult to get investors to believe that the Death Cross justified its name or had any meaningful predictive value.

The Evolution of Evidence Based Portfolio Management:

Markets are much more dynamic and ever-changing than what most believe. Just because one finds a stand-alone indicator that works several times over a period, it does not mean that it will always work in the future. This is why one must use several confirmation indicators to match the type of market environment that exists today.

Investors are subject to an emotional flaw called “recency bias.” We humans are experts at finding patterns from past observations. As a result, many believe that because something occurred in a certain sequence in the past, it is likely to continue into the future.

Bottom Line:

The Dow Jones Industrial Average has seen 84 Death Crosses since July of 1929. These moving average crossovers have occurred during many different market environments. Canterbury’s studies show that in an environment such as today’s, when the Dow’s 50 DMA breaks below the 200 DMA and volatility is at CVI 60 or lower and the price remains below the 200 day moving average, the maximum decline experienced was -7.34%.

It is important to note that the Portfolio Thermostat’s Market States are based on the S&P 500 which has not yet experienced a Death Cross.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.