Mark Hulbert had a piece for Barron’s that says the 200-day moving average (DMA) is no longer a useful market timing tool noting that there have been many false positives. Here’s the chart he used to show examples.
I have no pushback on this point, the indicator is prone to false positives. I have framed how to use the 200 DMA as an effective tool for many years and the points made by Hulbert, not being new, are ones I have taken into account.
First and foremost a portfolio is a series of decisions, any of which could be wrong including when the S&P 500 breaches its 200 DMA. The possibility of being wrong is why when I do take defensive action I start slowly. Back in May, I bought AGFiQ US Market Neutral Anti-Beta (BTAL) for clients after selling their Square (SQ) as a first defensive step thinking that the 2% rule had been invoked. Square had gone from $40 to $70 in a few months and so it seemed prudent to sell, obviously, it is gone a lot higher. When I wrote about BTAL I said I chose that instead of an inverse fund in case the market was not rolling over, I thought BTAL would be less of a drag versus something like ProShares Short S&P 500 (SH), I was less sure about the market rolling over but my process called for defensive action. Since the trade, BTAL is up almost 5% while SH is down about 10%.
The drag from this has been small but I stuck to my process, discipline is crucial.
The reason I like the 200 DMA as an indicator is that it is simple. When an index breaches its 200 DMA it indicates that there is some sort of problem with demand for equities. That problem may be serious or not so serious but it is a problem. The chart above shows that most of the problems turned out to not be serious. There is no way to be certain on day one or two after a breach whether the problem is serious (although there might be some hints related to the slope of the moving average and a couple of other things). What is (almost) certain is that a serious problem will play out over several months. Bear markets start slowly, typically giving several months to get out. Crashes are different, they tend to snap most of the way back quickly, they have tended to be better to buy than to sell. Even if you can’t buy in the face of a crash, at the very least, not selling can be a difference maker.
