Is This an Omen of Doom or a Buy Signal?

Rarely does the topic of technical analysis come up at The Motley Fool. Unless, of course, we're debunking the idea that staring at charts will do anything more for you than contribute to myopia.

It seems like it might be a good time to wade back into the brackish waters of chart-watching, though, since the technical community has been abuzz with the recent appearance of the ominous-sounding death cross. A death cross appears whenever the 50-day moving average crosses below the 200-day moving average, and technicians believe it bodes steep losses for stocks.

Just recently, both the Dow Jones Industrial Average and the S&P 500 experienced the dreaded death cross. So am I ready to give in to the sweet song of the technicians and start selling?

Debunkers galore
Fortunately for me, there's no need to break much of a sweat debunking the death cross, since plenty of other commentators have been crunching the numbers.

Over at MarketWatch, investment newsletter hawk Mark Hulbert took a look at the historical data and found that over the past 114 years, periods following a death cross did underperform the market's results during non-death-cross periods. However, likely as a result of the proliferation of personal computers, there's been little reason to take note of death crosses more recently:

Overall, in fact, there has been no statistically significant difference since 1990 between the average performance following death crosses and all other market sessions.

Blogging for The Wall Street Journal, James Altucher got a bit more cheeky and suggested that investors not "listen to the pundits talking about Dead Crosses, Golden Crosses, or any other technical analysis mumbo-jumbo." Why? Well, at least when it comes to the death cross, it's because it simply isn't profitable for investors. Altucher writes:

I looked at the S&P from 1955 until now. I simulated shorting the market when a Dead Cross occurs and buying the market when a "Golden Cross" (the opposite of a Dead Cross – the 50-day MA goes higher than the 200-day MA) occurs. The net result? You lose money. Not only that, you lose money 72% of the time.

Talking to Matt Phillips at The Wall Street Journal, LPL Financial's Jeff Kleintop took it one step further and suggested that during hiccups in an economic recovery a death cross could actually be a buy signal. He opined:

While much is made of the "death cross" of the S&P 500 50-day moving average falling below the 200-day, it has actually been a buying signal during these periods in the past. A good example of this took place in 2004 when during the soft spot in the recovery the 50-day crossed below the 200-day on August 17, 2004, just as the S&P 500 had completed the low point of its soft spot pullback and embarked upon a double-digit percent gain over the next three months.

Viva los technicals!
Of course, most of us Fools are as interested (if not more interested) in the fate of individual stocks. So, not to be completely lazy on the data-gathering front, I took a look at the performance of some individual stocks following the S&P 500's four death crosses since the beginning of 2000.

Here are a few of the results I came up with:

Company

1-Month Performance Following
an S&P 500 Death Cross

1-Year Performance Following
an S&P 500 Death Cross

Apple (Nasdaq: AAPL  )

1.4%

76.5%

PotashCorp (NYSE: POT  )

7.5%

67.1%

ExxonMobil (NYSE: XOM  )

1.2%

12.2%

General Electric (NYSE: GE  )

(2.5%)

(12.5%)

Citigroup (NYSE: C  )

(3.3%)

(17.9%)

Source: Yahoo! Finance and author's calculations.

Looking at these numbers, I could try to argue that death crosses have been a major boon for both Apple's and PotashCorp's stocks, a small booster for Exxon, and a legitimate sell signal for both GE and Citi. But I won't argue that because it would be downright silly.

The fact is, when talking heads start blabbing about these market-level technical indicators it's best to tune them out when it comes to your portfolio. Over the past decade it's not death crosses, golden crosses, or Fibonacci retracements that have been impacting these stocks, it's been the explosion of iPods and iPhones for Apple, global growth and the need for fertilizer at PotashCorp, and a rising price of oil at Exxon. Similarly, it's been the rise and spectacular implosion of the U.S. credit markets that knifed GE and Citi.

Looking ahead, it'll be more of the same. Apple's success will depend on products like the iPhone and iPad, PotashCorp will be hoping that growing wealth in developing nations will raise food demand, and Exxon will be relying on extracting oil and selling it at increasing prices. The fate of both GE's and Citi's stocks will be determined by the companies' ability to repair the damage wreaked by the credit crisis.

Not that any of this will do anything to stop investors from using technical analysis. The sirens' song is just too sweet. Why spend time getting to know a business and how much it's worth when you can just look at a chart and know whether the stock will go up or down?

So why am I watching the death cross?
The death cross caught my eye because I love a good opportunity to hammer home the uselessness of chart-gazing. Otherwise I couldn't care less whether we're dealing with a death cross, a golden cross, motocross, or Alex Cross.

Meanwhile, while other investors are wrapping themselves up in squiggly lines on charts, I've been ogling the tasty deals the stock market has been offering up. Johnson & Johnson (NYSE: JNJ  ) and Chevron (NYSE: CVX  ) , for example, are trading at forward price-to-earnings multiples of 12.6 and 8.1, respectively. Both are also delivering yields that are well above 10-year Treasuries. It probably goes without saying that both of these are high-quality companies that should continue to be successful well into the future.

So squint your eyes at the charts if you want, but I'm going to keep digging up the deals that Mr. Market has to offer.

There are some good deals available in the U.S., but the biggest opportunities may be overseas.

Apple is a Motley Fool Stock Advisor recommendation. Johnson & Johnson is a Motley Fool Income Investor recommendation. Motley Fool Options has recommended buying calls on Johnson & Johnson. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Matt Koppenheffer owns shares of Johnson & Johnson, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (5) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 12, 2010, at 11:37 AM, gypsywolf wrote:

    Sounds like the Death Cross is really a Double Cross

  • Report this Comment On July 12, 2010, at 3:16 PM, CPACAPitalist wrote:

    Guess i'll "cross" chart gazing of my to do list. JNJ and CVX are definitely worth looking at - I hold both and will probably add to my positions while they are on sale.

  • Report this Comment On July 12, 2010, at 9:13 PM, amatsky wrote:

    jnj is not a buy.

    cvx meh, not too much upside.

    mind your posits

  • Report this Comment On July 12, 2010, at 9:57 PM, TMFKopp wrote:

    @amatsky

    Care to share some more color on why you don't like JNJ or CVX?

    Matt

  • Report this Comment On July 14, 2010, at 3:20 PM, KanataMark wrote:

    It’s understandable that there will be bumps along the way as the recovery takes hold. Market volatility would seem to be in part due to media hysteria and so called analysts making predictions using superficial data that most often turns out to be incorrect. Creating negative sentiment is not going to benefit anyone in the long run.

    Invest in global growth stocks, any slowdown in China and European meltdown is greatly over estimated. These pundits are always going take a chance at the possibility of 10 minutes of fame based on a prediction. Many of them seem to be sheep that can do nothing other than keep repeating the same old stale theories. Buy undervalued stocks and get great dividends while you wait for the rest of the market to catch up with the reality.

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