The “death cross” is a term from technical analysis used to describe when the 50 day moving average crosses beneath the 200 day moving average.
The 50 day EMA (red) now appears to be in the process of crossing beneath the 200 day EMA (pink), as highlighted by the ellipsis.
S&P 500 DAILY 15 JULY – 10 AUGUST 2011 CHART COURTESY ANYOPTION.COM 03 aug 10 2343
There are a few kinds of moving averages – simple(SMA), weighted(WMA), and exponential. The exponential moving average, the EMA, is one of the more sensitive to recent price, and thus one of the first to do this.
Note that the death cross does not always spell disaster. As the chart below shows, the last one came in late June 2010 (highlighted by the circle on the left) in the wake of panic following the First Annual Greek Bailout. The decline that followed was neither deep nor long lasting. The 50 day EMA crossed back over the 200 day EMA in mid September (rightmost circle)
S&P 500 DAILY CHART 25 MAY – 9 NOVEMBER 2010 02aug 10 2341
However, as shown in the chart below, the prior death cross, that of early January 2008 (ellipsis in the upper right corner) sounded the death knell of the rally that began in the summer of 2002 and the start of the current Great Financial Crisis, at least as far as this index, as good a barometer for overall risk appetite as any, is concerned. Note the damage in the chart below.
S&P 500 DAILY CHART 23DECEMBER 2007 – 13 DECEMBER 2009 04aug 11 0004
Note in particular:
- The index fell from ~1490 to ~682, a 54% drop at its worst level in early March 2009.
- The death cross did not repair until mid July 2009
- The index, and risk assets in general, have not recovered since then and remain in a long term bear market. The index peaked this past May, and now appears on track to begin the next leg lower, as shown using the monthly S&P 500 chart below for clearer long term perspective.
S&P 500 MONTHLY CHART DECEMBER 1, 2005 – AUGUST 10 2011 05aug 11 00 16
The Big Question
So the big question: is this death cross more likely to be the mild one of June 2010 or the disastrous one of January 2008? Sadly, the latter appears more likely the case, here’s why.
The June 2010 saw a quick recovery aided by
- A Greek rescue package that partially succeeded in deferring the crisis for about a year
- The advent of QE2 in late summer-early fall of 2010, which provided the fuel for the rally that ended this past May.
Neither condition applies today.
After the apparent failure of QE2 to have any lasting positive effects (and leave the US with another 600+ billion of deficit spending) and recent debt ceiling fight, whatever additional stimulus measures may yet be coming, if any, are unlikely to be as large or as influential, even for a short time.
The S&P downgrade of US credit to AA+ has rattled markets, though demand for both US bonds and dollars is solid due to even worse events in Europe.
The Second Annual Greek Bailout has backfired because it included haircuts for private bondholders, scaring away the private sector from further PIIGS bond purchases unless they get much higher yields to compensate for the added and still unknown risk. The crisis is getting worse, not better.
PIIGS bond yields are trending higher and, for Spain and Italy, approaching the “red line” 6-7% yield for 10 year bonds that has for the other PIIGS signaled “bailout time” as credit markets were now too expensive for them. The ECB is currently buying Spain and Italy bonds in an attempt to bring yields down. Let’s hope this works fast, because it’s spreading to both the previously more stable PIIGS, Spain and Italy, and also to the core economies, particularly France.
- Trading in Italian stocks has been repeatedly halted over the past week.
- French banking stocks have been plunging on fears of a French sovereign credit downgrade and exposure to Greek and other PIIGS bonds of dubious worth.
- As of today (August 10) French bank stocks and sovereign credit yields are getting hit due to French exposure to Greece and other terminal sovereign economies. Credit ratings agencies are pricing French CDS at the same level that Italy’s reached just a month ago. Investors now demand around 90 bps of extra yield to buy 10-year French debt rather than German bonds, even though both carry the AAA grade from the major rating agencies. That spread is almost triple the 2010 average of 33 basis points.
Oh yes, don’t forget:
Global growth is slowing as witnessed by data coming out of virtually every major economy
Even the US is finally slowly moving towards austerity, as witnessed by the latest fight to raise the debt ceiling.
Conclusion & Ramifications
The conclusion appears to be that we’re heading for the next leg down of the bear market that began no later than 2007. Actually the market has basically been in a flat trading range since around 2000 and the dot com bust. Note the long term monthly chart below.
S&P 500 MONTHLY CHART DECEMBER 1999 – AUGUST 2011 CHART COURTESY OF ANYOPTION.COM 06aug11 0053
So What Do You Do?
Our overall long term theme is short risk assets, also in the near term, barring some new major government intervention. Target for the S&P 500 would be around the March 2009 lows, though it’s unclear whether it will be a straight drop. If the past is any guide, both the Fed and the ECB will try whatever stimulus measures they can. While both the EUR and USD will thus be unattractive over the coming years (the EUR a bit better in times of optimism, the USD better in panic times), the obvious winner is the classic currency hedge, gold.
For binary options traders, stick to puts on most risk assets, calls on gold. The above trends and fundamentals should work better over longer expirations.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?