Stock market bulls can rest easy as the Russell 2000 index (RUT) shows no signs of dropping below its 200-day moving average.
A Changing Perspective on Bear Market Signals
Breaking below the 200-day moving average has long been considered a significant bear market signal by technicians. However, historical support for this indicator has been minimal, and it has completely vanished in the past three decades.
The Canary in the Coal Mine
While large-cap dominated market averages like the S&P 500 (SPX) remain comfortably above their 200-day moving averages, the Russell 2000 is seen by many as a crucial gauge of the market’s true health. Unlike a few large-cap stocks, the Russell 2000 represents the small- and midcap sectors. Intraday trading on Monday showed the Russell 2000 index sitting right on top of its 200-day moving average, as illustrated in the accompanying chart.
Testing the 200-Day Moving Average
To assess the predictive power of the 200-day moving average, I conducted an analysis using data dating back to 1928. Buy signals occurred when the S&P 500 closed above its 200-day moving average after being below it the previous day. Conversely, sell signals occurred when the opposite pattern emerged. At a 95% confidence level, commonly used by statisticians to determine the significance of patterns, sell signals did not result in below-average returns over the subsequent month, quarter, six-month period, or year. Similarly, buy signals did not lead to above-average returns.
In conclusion, there is no cause for concern among stock market bulls as the Russell 2000 index remains steady above its 200-day moving average. Historical evidence suggests that breaking below this moving average is not a reliable bear market signal. Additionally, the Russell 2000 serves as an important indicator of the overall market’s health, separate from the influence of large-cap stocks.
The 200-Day Moving Average: A Disappointing Indicator
The 200-day moving average has long been referenced as an important technical indicator in the stock market. However, its effectiveness has come into question, especially in recent decades.
According to Blake LeBaron, an economics professor at Brandeis University, an important change occurred in the early 1990s that may have contributed to the diminishing value of the 200-day moving average. The introduction of Exchange-Traded Funds (ETFs) made it significantly easier and cheaper for investors to trade throughout the trading session. This accessibility meant that acting on signals generated by the 200-day moving average became more feasible than it had been before.
Despite its historical significance, the 200-day moving average has produced disappointing results over the past three decades. A closer look at the table below reveals that following sell signals generated by this indicator, the stock market actually performed better over the subsequent month, quarter, and six-month periods compared to buy signals.
| Time Period | Performance Following Sell Signals | Performance Following Buy Signals | |————–|————————————|———————————-| | 1 month | Higher | Lower | | 1 quarter | Higher | Lower | | 6 months | Higher | Lower |
Putting Things into Perspective
Given these findings, it is clear that there is no shortage of reasons to be concerned about the stock market. However, the possibility of the market dropping below its 200-day moving average should not be an additional cause for worry.