Does a death cross in US stocks signal the start of a downtrend?

Summary:

• Death cross seen in US500 (50 SMA < 200 day SMA)

• However last 3 “death crosses” haven’t preceded big declines

• December the most positive month for US500. Santa rally?

A well known signal that is widely seen amongst it proponents for predicting doom and gloom in the stock markets has occurred today with the US500 printing a “death cross”. This specifically refers to the 50 day SMA moving down below the 200 day SMA and is seen as signalling an increased likelihood for market declines. The rationale behind this is pretty solid as during an uptrend you’d expected shorter term moving average (EG 50) to remain above their longer term equivalents (EG 200) and vice versa in a downtrend.

Looking back over recent years the US500 has enjoyed a strong rally that has been characterised by the 50 SMA trading above the 200 SMA since a positive cross printed in April 2016. Note that although the market pulled back on several occasions during this time, and even dipped below the 200 SMA a few times, the orientation of the 50 and 200 SMAs was always positive - IE 50>200. That is until today.

The rally seen in the US500 in the past 30 months has been characterised by the 50 day SMA trading above the 200 day SMA. However, these have printed a bearish “death cross” today. Source: xStation

As you would expect from a technical signal given the moniker of “death cross” this is widely seen as a negative event, but looking at previous instances when this occurred it hasn’t actually been the case. The most recent event of this nature occurred at the start of 2016, and while price did fall by around 90 points in the sessions that followed, the market bottomed not long after just above 1800 before embarking on the long bull run shown in the chart above. The “death cross” in January 2016 came not long after another, with the pattern also forming in August 2015. On this occasion the market failed to even take out the recent low of 1830 (until the second cross saw price dip below there) and the market actually recovered in the days and weeks ahead.

The last two “death crosses” in August 2015 and January 2016 didn’t actually precede large declines with the market trading higher just a few weeks after on both occasions. Source: xStation

Given the fairly close proximity of the aforementioned “death crosses” one could argue that the market hadn’t really been trending higher and therefore the strength of the signal was weak. The previous occasion where a “death cross” printed was in August 2011 and it also didn’t lead to a major decline. The market traded in a range following the signal and while it dipped below around a month later the market was the bought aggressively and went on a multi-year run higher.

Before 2015 the previous occasion a bear cross printed was in 2011 and this too didn’t lead to a long decline and in fact occurred not long before a large multi-year rally. Source: xStation

So in the knowledge that previous “death crosses” haven’t actually been that negative for the market, is there any positive signs to suggest that price could rally into year-end? The answer is a clear yes. The average monthly performance in December is in fact the best of them all for the S&P500 (US500 on xStation) going back to 1957. Not only has the benchmark ended higher more often than in any month (75% of the time) it also has seen the largest average return of a little over 1.5%.

December has been the best performing month for US stocks in the last 70 years. Will we get another Santa Rally? Source: LPL Research, FactSet

Returning our attention to the here and now and the levels to watch in the market appear to be  pretty clear and obvious. Taking fib retracements from the all-time high of 2947 the recent high coincides nicely with the 61.8% at 2816. If price can get above here then the outlook becomes increasingly positive and the market would quite surprisingly be just over 4% from its record peak. The 50% fib around 2775 may provide some support but the gap from 2756 could be seen to provide a stronger level to look to. While the market remains above the 41.4% at 2746 then the bulls appear to remain in control of the tape and it would take a drop back below there for bears to have a chance at forcing the market lower and cashing in on the recent “death cross”.

Fib retracements of the larger decline could provide key levels to watch going forward with the 61.8% at 2816 and the 41.4% at 2746 seen as potentially key resistance and support respectively. Source: xStation