Indicator of the Week: Is the 'Death Cross' as Scary as It Sounds?

What happens with the Dow undergoes a 'death cross' near all-time highs?

Senior Quantitative Analyst
Aug 12, 2015 at 6:30 AM
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Just yesterday, a "death cross" occurred on the Dow Jones Industrial Average (DJIA). A death cross is when a "fast" moving average crosses below a "slower" moving average.  In this case, it's the 50-day moving average falling below the 200-day moving average. This technical signal is supposed to be a bad omen for stocks.  Many times we look at popular bearish indicators only to find out they aren't so bearish when you actually run the numbers. This week, I'll take a close look at this indicator to see if it's really as scary as the name suggests. 

Death Cross vs. Golden Cross: The opposite of a death cross is the "golden cross." That's when the 50-day moving average crosses above the 200-day moving average -- supposed to be a bullish signal. Going back to 1950, I looked at how the Dow performed after these signals and compared them to typical Dow returns. I summarized the results -- going out a month and three months following the signals -- below.

Unfortunately, the death cross has had a tendency to lead to some underperformance. A month after a signal, the Dow has averaged a loss of 0.43%, and was positive less than half the time. Compare this to a typical one-month return of 0.67%, positive 60% of the time. Three months after a death cross, the Dow returns have been flat on average, and positive just half the time. A typical three-month return is 2%, with 64% of them being positive. Interestingly, while the death cross lives up to its bad name, the golden cross fails to deliver on its good name. The returns following a golden cross lag the typical returns of the Dow.  

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Death Crosses Near All-Time Highs: The Dow currently sits about 5% below its all-time closing high. A death cross that close to its all-time high has occurred only three other times since 1950 (March 1962; March 1990; November 1999). I decided to break down those 40 previous death crosses by how close they were to an all-time high. The one-month and three-month returns are summarized below. 

More bad news. The closer the Dow is to an all-time high, the worse the returns are going forward. When the Dow is within 10% of an all-time high and makes a death cross, it has moved higher in the next month only 27% of the time, averaging a loss of 0.64%. Looking at the three-month returns, the Dow averages a loss of 1.70% if it's within 10% of an all-time high, and is positive just 40% of the time. Using history as a guide, this does not bode well for the Dow going forward.  

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