Here’s what worked and what didn’t in August:
Quality, large cap companies did not perform better than market as a whole.
- Why? Growth is preferred over safety. Investors see this as a correction, not the start of a bear market.
Higher quality bonds outperformed lower quality bonds of similar duration.
- Why? Fear persists that some companies have too much leverage.
Capitalization-weighted indices did not beat equal-weighted indices with the same objective.
- Why? In a sell-off, larger, more liquid companies are easier to sell closer to the last trade.
Europe outperformed Asia.
- Why? China continues to be global issue #1; Greece relegated to back burner.
Frontier markets outperformed emerging markets.
- Why? Both did poorly, but selling was more urgent in emerging markets.
Un–hedged foreign fund beat currency-hedged foreign funds.
- Why? As the correction spread to the U.S., markets preferred the euro and yen to the dollar.
Large company stocks slightly underperformed small and mid-cap stocks.
- Why? Liquidity and foreign exposure were more important considerations last month than business risk.
“New economy” stocks slightly outperformed “old economy” stocks.
- Why? But the edge was dwindling rapidly and over the last week of the month old economy actually did better.
There was no clear performance advantage for “risk off” industries like utilities and consumer staples.
- Why? Utilities really struggled last month, as did real estate, while energy stocks surged in the finally three days. Health care may be breaking down as sector leader. No clear trend right now.
Growth slightly underperformed value.
- Why? Too early to tell, but we may be on the cusp of a major market change.
A Note on Market Leadership
A market without clear leadership that has technically broken through support is a dangerous one in that it is less likely to hold rallies. Be careful.
The Golden Cross
The Golden Cross is a measure of distance between the S&P 500’s 13 and 34 week moving averages. It is a useful tool to determine long term market direction. The level of the spread is also an indicator of the overall tone of the market. Levels greater than zero indicate bullish market sentiment and levels below zero indicate bearish market sentiment.
A bearish signal, known as a Golden Cross” is generated when the 13 week moving average crossed below the 34 week moving average. At that point the spread between the two moves negative. That occurred early last week and was confirmed when the spread remained negative on Friday (a weekly bearish close). This week the spread continues to negatively strengthen; further indicating of bearishness in the market. We look at this technical development as an indication that underlying market dynamics are fundamentally changing.
Chart 1 looks at the history of the Golden Cross back to 1997. The cart at top is the S&P 500 (gray line), the 13 week moving average (dark blue line), and the 34 week moving average (red line). The chart at the bottom is the measure of the distance between the two moving averages. When the black line on the bottom chart crosses below zero (the solid blue line) it indicates a Golden Cross has occurred. As you can see, that happened last week and it very strong indication that the market trend is changing. As of yesterday’s S&P 500 close, the distance between the lines was -12.17. I’ve highlighted in yellow the last three major crosses and, as you can see the indicator has done a reasonably good job of signaling changes in market trend.
Like all technical analysis work, however, false signals (known as a ‘whipsaw’) occur from time to time. In 1998 and 2010 a shallow cross occurred only to snap back as the uptrend aggressively re-asserted itself. In 2011 a more pronounced Golden Cross occurred only to be reversed as the Fed announced quantitative easing.
It’s important to remember that the Golden Cross is a trend following indicator. It is a necessary, but not sufficient condition, of a bear market. It does, however, give us a very strong indication that something about this selloff is different and bears close monitoring. As a result, we are raising cash at the margin and the longer the indicator stays negative the more we will gravitate toward managers with favorable downside capture ratios.
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