A Time-Tested Stock Market Barometer Keeps Investors from Whipsaws in Volatile Times
If you’re a buy-and-hold stock investor, you’ve tried mightily to ignore the market’s massive gyrations over the last several years. Now that the S&P 500 Index & Dow Jones Industrial Average are finally back at levels not seen since December 2021, it’s time to do some “soul searching” for ways to reduce investment volatility during uncertain times in the future.
Remember, long-term successful investing always comes down to answering two important questions:
- WHEN to buy or sell?
- WHAT to buy or sell?
As a technical analyst and active money manager for over 30 years, there are time-tested & sophisticated stock market barometers I use to evaluate the overall health of the stock, bond, commodity, and real estate markets.
One of my favorites is a reliable tool available on most financial websites that investors can use to gauge the overall trend of the stock market. It is the 200-day moving average (SMA) of the S&P 500 Index.
How to use the 200-day moving average?
As my co-portfolio manager, Stephanie Larson tells our clients, think of a traffic light at a street intersection, if the signal is green the flow of traffic is moving in the same direction as you, and the opposite is true if the signal is red as you wait for signal to change before you safely proceed.
An uncomplicated way for most investors to use this indicator is to simply check whether the current price of the S&P 500 is above or below the price of its 200-day moving average (by at least 2%) at month-end:
- If the S&P 500 is ABOVE its 200-day SMA, then you have a GREEN signal as the market trend is bullish.
- However, if the S&P 500 is BELOW its 200-day SMA, then the signal is RED, and the market is bearish.
As I outlined in my book, “Investment Atlas II” in decades past if a stock-market slump has been serious enough to drive the S&P 500 below its 200-day average, the market’s decline has usually continued or worsened for months or even years. More often than not, it’s better to step to the sidelines while the stock market finds its new lows, then climb back into stocks when the S&P 500 rises above its 200-day moving average and a new bull market has possibly begun.
Does it Work, Yes!
Since 2000, the S&P 500 Index has increased 147% with the index above its 200-day SMA 72% of the time. The investor who exited the stock market during the periods when the index was below its 200-day SMA increased the total return to 187%!
While there have been times when the market can suddenly change direction month to month (like the COVID panic), I think it’s a mistake not to sell equities & raise cash levels during bearish times. If taxes are a concern, then partly hedge your stock portfolio by purchasing shares in a low-cost exchange traded fund like ProShares Short S&P 500 (Sym: SH), an inverse fund which increases in value when the S&P 500 Index declines.
Certainly, I normally select stocks based on things like earnings growth prospects and other fundamentals. But I’ve been at this long enough to know that there are certain economic environments where it doesn’t make sense to own any stocks.
In fact, the U.S. equity markets have posted negative returns 29% of the time since 1900. History supports the fact that a successful investment strategy must incorporate a policy for reducing investment exposure during bear markets.
Even ardent buy & hold stock investors must admit, the predictive data on how the stock market has behaved when the S&P 500 drops below its 200-day moving average is compelling. If the investment lessons of the 21st century (Dot.com bubble, 2008 Great Recession and 2022 massacre) are of any use, prepare now for future events. You will be richer for it in the long term.