Earnings Insights: Do Not Ignore the Golden Cross!

Summary

• Equity market technical analysts noted that the S&P 500 entered a golden cross last Friday – meaning the 50-day moving average traded above the 200-day moving average.
• We crunched the numbers over the past century. Golden cross days occur a few times a decade – but they are often followed by persistent rallies or an upward trending trading range. They rarely reverse within days or weeks.
• We are just a few days into this one, but it is worth monitoring how it develops.

Market Implications

• We doubt equities are poised to rally much, especially given ongoing uncertainties about inflation, upcoming Fed policy, and the prospect that earnings may be softer than the investors expect.
• But investors are clearly confident the end is in sight. Markets may trade off a bit, but only a severe shock will trigger a meaningful selloff.
• We are unsure about upside potential in coming months, but we are becoming less concerned about downside risk for now.

Do Not Ignore This Signal!

I typically pay little attention to market technical analysis; I hew more to underlying economic and company fundamentals. But I came across an intriguing comment on the internet. It said the S&P 500 has entered a so-called ‘Golden Cross’ environment – meaning the 50-day moving average had risen above the 200-day moving average, followed by a provocative lead-on question: what happens next?

I am not a subscriber to that particular blog, so I did not get to read on. But I am curious.

Using daily SPX data starting in 1928, I crunched the numbers to produce Chart 1. In short, golden cross days are relatively rare; they occur about five to seven times a decade. Since 2000, they have happened 12 times.

More importantly, when they happen, they tend to persist, with the 50-day moving average remaining higher than the 200-day moving average for extended periods (Chart 2). Equities often rally strongly after the golden cross, but they also may settle into an upward trending trading range.

Of the 50 golden crosses in our dataset, only a few reversed within a week or so. One was at the end of 2015, as equities sold off earlier in the year, rallied, then sold off again as negative interests and an oil glut weighed on markets and investors turned more defensive (Chart 3).

What About This Golden Cross?

We will not try to parse what past golden crosses might mean for this one. Suffice to say, this is a strong technical signal.

Returning to our fundamental perch, we can debate whether equities keep rallying or remain in a range until it becomes clear that the Fed will win its inflation fight, without precipitating a meaningful recession.

But it will take some sharp negative shock to shake the market’s conviction that the end is not far off.

We currently see limited upside potential in coming months, but we are also becoming less concerned about downside risk.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)