Seasonality and the 100-Week Moving Average

By Kevin Cook | October 28, 2008 | 5:08 PM | 0 Comments

Last spring I took a look at the old market hymnal "Sell in May and Go Away." I thought it was indeed a good time to sell because in January the S&P 500 had slipped below the 100-week moving average around SPX 1,400 and spent most of the next two quarters fighting to get back and stay above it.

Why did I think the 100-week moving average was important? Because, as I said in my video essay in May, the 100-week m.a. had supported the bull market since 2003 quite well--in fact, the market never went below that line in the sand for nearly 5 years. And as any chartist worth his salt will tell you, when you break these long-term trend indicators, something is changing. Obviously, everyone knew the market was making some investors nervous.

But who knew to sell? Just because Bear Stearns had imploded a few months earlier and banks were going to continue announcing new sub-prime writedowns didn't mean we knew we'd lose Fannie, Freddie, Lehman, AIG, and Merrill too.

Ah, but that's the beauty of charts. You don't have to know every economic fact and fundamental. You just let price tell you what the new trend is. I'm not talking about Elliot waves, or pennants, or oscillators. I'm talking about long-term trend as defined by long-term moving averages. Simple, undeniable indicators of trend. It ain't voodoo--it's statistics.

Okay, so what did I do with this knowledge back in May. I sold my S&P 500 index mutual funds in my IRA when the SPX made one last failed push above 1,400 where the 100-week m.a. was still rising. I didn't want to do it. I wanted to believe in the resilient bull market. As I said here about Bernard Connolly of Banque AIG, I was taking the opposite side of his trade that the "global boom" was over.  But, I could only feel that way in spirit.  Another sign was looming on the horizon that you could see if you looked at the chart in May: the 50-week m.a. was about to cross "bearish" with the 100-week m.a. Bad sign. So, I sold at SPX 1,385.

Good move, as it turned out, because the market cratered in June just as those two moving averages crossed bearish. I bought back a good amount on July 15th, when the financial stocks reached some kind of short-term capitulation level at SPX 1,200. I said at the time the market was destined to rally back up to the 200-week moving average around SPX 1,325 because we were so over-sold.

Again, my definition of "over-sold" is not dependent on fancy oscillators. I just look at how stretched away the market is from long-term moving averages. Just like a bull market gets overdone up, up and away above these, so too the bear must rally back up to them before it can continue the carnage. The SPX rallied back to about 1,312. I didn't sell. Optimism, patriotism, and stubbornness took over. Besides, this was long-term investment capital--I wasn't really trading since I was restricted as part of a media company. Still, I knew buy-and-hold was dead and that you had to "time the market" with at least half your assets.

"Ouch!" was heard round the world when the September Slaughter ensued and took the S&P 500 from 1,274 down to 900 in the first week of October. That was me and millions of other average investors getting clipped for another 29% in five weeks!

Yet I still have been saying for weeks now that the market is a long-term buy at these levels. And it is at least good for a trade back up to 1,100 and possibly 1,200 on the SPX. Talk about oversold! Do you know where the nearest long-term moving averages are? The 400 and 600-week moving averages are up at 1,190 and 1,200 respectively. That's like the 8-year and 12-year moving averages to put it in perspective! I said last week that the market had to hold--and would likely hold-- the 2002-03 lows in the 775-800 area. With year-end mutual fund selling--and hedge fund blow-ups--nearly done, now it's time to launch back up to the 1,100-1,200 area.

Will the big players and smart money sell this rally? Yep, all the way. That's why it could get explosive enough to get up there. You need more shorts to make it happen. Big rally, then test the bear market lows and see what the light at the end of the recession tunnel looks like. Price precedes fundamentals... at least the fundamentals that most of us can grasp before it's time to move.