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Dow 200-Day Break Could Be Brutal for Stocks

The blue-chip index tends to underperform in the short term after similar losing streaks

Senior Quantitative Analyst
Jun 27, 2018 at 6:18 AM
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The Dow Jones Industrial Average (DJI) has had an eventful week. Last Thursday concluded an eight-day losing streak for the index, just the 25th such streak over the past 100 years. Then on Monday, the Dow’s remarkable streak of more than 500 days above its 200-day moving came to an end. Incidents like these make for good talking points by pundits who often spin it to support their view, whether bullish or bearish. As I often do, I’ll break down past occurrences to see what the actual numbers say.

Interpreting Dow Losing Streaks

A bear might interpret a losing streak as evidence of extreme selling pressure on the index; a bull might call it a healthy, oversold pullback. The first table below shows the data after an eight-day losing streak on the Dow ends, which just happened Friday. The second table is for comparison, showing typical returns since 1926 -- the year of the first signal.

In the short term, the blue chip index has underperformed. It averages a 0.91% loss over the next two weeks with just 40% of the returns positive after an eight-day streak. Typically, the Dow has gained 0.28% over two-week time frames, with nearly 60% of the returns positive. Less than half of the returns are positive even out to three months. By six months, the returns start looking more typical.

IotW Chart 1 Dow Losing Streak

I thought the dynamic of these losing streaks may be different depending on the market environment. So, I narrowed down the signals to only when the DJI was up double-digits over the past year. Again, the data shows underperformance in the short term. The underperformance, however, doesn’t last as long. In these cases, the three-month and six-month returns show outperformance.

IotW Chart 2 Dow Losing Streak

When the Dow Breaks Below the 200-Day Moving Average

Before Monday, the last time the Dow closed below its 200-day moving average was June 28, 2016. Thus, the index stayed above the moving average for almost two full years. It’s just the sixth time we’ve seen this since 1900 (as far back as we have data). There is no good news in the table below showing what has happened after each of these instances. Six months after the break, the Dow was negative every time, while four of the five times, it was down double-digits in the next six months.

IotW Chart 3 Dow Losing Streak

To get more signals, I looked at times the Dow was above the 200-day moving average for a full year before breaking below it. Stocks have tended to struggle in these cases. Over the next year after the DJI broke below the moving average, the index's average return comes in under one percent, with 55% of the returns positive. Compare that to the typical one-year return since 1922 (the year of the first signal), where the typical return is an 8% gain with almost 70% of the returns positive. If history is a guide, based on this signal, stocks could struggle going forward.

IotW Chart 4 Dow Losing Streak

 

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