Are we in a bull market or are we in a bear market? That is the only question investors should be asking themselves as we find the market down nearly 10% since our recent high in mid-October. Is this an opportunity to buy in an ongoing bull market or are we doomed to repeat the not-so-distant past of March’s fate? I prefer to keep things simple. Let’s take a look at the 200-day simple moving average for some answers.
The 200-day simple moving average is the average of the closing price of the last 200 days of data for a stock, bond, index, etc. It has an obvious bias on the past, which should also be married with current events and situational awareness. Investors can derive a lot of information by using the 200-day simple moving average as a proxy for longer-term market sentiment in combination with the current price as a clear short-term point of view.
History is my favorite teacher and what it is telling us right now is that when we look from 1990 to the present and analyze every time the S&P 500 was down 10%, the returns are astounding. Further comparing the annualized returns after 10% pullbacks while in bull markets versus bear markets highlights that investors need only be concerned with one question: What market regime are we currently in?
This study’s differentiation between being in a bull market or being in a bear market is simply that the 200-day simple moving average was either upward sloping or downward sloping, respectively, at the time the drawdown of 10% or more was reached. Take a look at the difference in annualized returns that were realized after these double-digit pullbacks. Of course, hindsight bias is extremely prevalent here, however, we can still use the real time data from the 200-day simple moving average to assume we are currently in a bull market due to its upward sloping nature. The Bull Market average using this technical indicator was even substantially higher than the unconditional average across all time frames.
This doesn’t mean this strategy should be relied on openly. The current macroeconomic landscape is in uncharted territory. Meanwhile, the United States is having a circus of a presidential election where surely both candidates are clowns in the show. Point being, our current situation truly is different than the past and the current pandemic is a real threat. If a major outbreak of COVID-19 cases surges to the point where fear reigns hold of the market once again, then no simple moving average will stop the ensuing decline.
Overall, this strategy has paid dividends in the past and may do so again as we find ourselves amidst a double-digit pullback in many indices and attractive individual stocks. Our current context certainly muddles the path forward and I hope further clarity for myself will come as the election and flu season fade into the distance.
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Copyright © 2020 Ryan Preiss
