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In early human history people gave great weight to omens: comets, tea leaves, and chicken entrails could portend anything from fortune to demise. Nowadays we may dismiss these things as silly superstitions, but the very people who laugh off these prophecies often quake in fear when a new market trend emerges. For instance, a few days ago, the financial blogosphere erupted over a peculiar topic, a market signal that some believe could devastate your portfolio: the Ultimate Death Cross.
It all started when an analyst from Societe Generale, the world famous global investment bank, declared that the S&P 500 was heading toward an ominous technical indicator. Albert Edwards, known in investing circles as a super-bear, isn't shy about espousing his thoughts on forthcoming doom. For instance, when Edwards was warning that monetary easing will end in inflation, he said, "that will come after a frenzied orgy of balance sheet debauchment (both Fed and Federal) which will make events over the last three years look like an afternoon tea-party with the Vestal Virgins."
You just don't see that sort of comedic gold very often in analytic notes these days. But don't mistake Edwards' way with words as a smoke screen for ignorance; as the co-head of global strategy at Societe Generale, he's a widely followed investor. So when he made an announcement about the most awesomely named technical indicator ever, people took notice.
Doom and gloom
On July 16, websites started carrying Edwards' most recent memo, which explains the phenomenon of the Ultimate Death Cross: when the S&P 500's 50-month moving average crosses below the 200-month moving average. For those not in the know, a moving average is a frequently used technical indicator that's supposed to show where the price of a stock is heading. However, the use of a monthly moving average is rare, which is perhaps why so many people missed this emerging signal.
At the time of the note's publication, the 50-month average was at 1152, while the 200-month average was 1145, only a 7 point difference. This rare signal will, according to Edwards, initiate a monster bear market; basically, all hell will break loose.
Used with permission from advisorperspectives.com
The signal is so rare that allegedly it has only happened once; in Japan in 1998. Much like Godzilla, the UDC ravaged Japan so terribly that "it is still in the firm embrace of the bear." The U.S. barely dodged this dreadful bullet in 1978, according to Edwards, but a cross during the current market would mean a permanent bear state (and probably euphoria for Edwards).
It's now August, and since Edwards' announcement the panic has worn off and people have returned to their homes peaceably. The gap between the two moving averages has widened to a point where we can once again breathe easily, but in case something like this ever happens I have some advice for you that may just save your portfolio. Are you ready for it? Lean in close, I have to whisper.
Don't do anything
Obscure market signals like the Ultimate Death Cross, the Hindenburg Omen (yes that's a real thing) and even the Super Bowl Indicator (yep, also a real thing) are interesting to read about and impress friends with at cocktail parties, but that's about it. Sure they can be right once in a while, but they can also be wrong all the other times.
In fact, some intrepid writers took a look at Edwards' analysis of the S&P 500 and did some research of their own. When the writers examined Professor Robert Shiller's S&P Composite Index, which uses historical data from stocks that were on the original S&P 500 before the actual S&P began to be used in 1957, they noticed that the two averages crossed several times before 1957. And yet, the US escaped from bear market after bear market to achieve the global dominance it holds today.
Wise investors know that they should focus less on technical indicators and more on the intrinsic value of companies. While traders worry about the imminent demise of the market as indicated by two lines converging, investors know that these lines won't stop good CEOs from improving shareholder value, excellent products from finding a complimentary market, and solid companies from being rewarded with higher share prices.
Check your facts
If we go back in time there are plenty of companies that have survived much worse than "Ultimate Death" and still given great value to investors. Some of these companies include
- Bank of New York Mellon (NYSE: BK ) : Founded in 1784, made loans to cover debts from the Revolutionary War, up 3,360%*.
- Procter & Gamble (NYSE: PG ) : Founded 1837, provided soap and candles to the Union Army, up 3672%.
- Union Pacific (NYSE: UNP ) : Founded 1862, helped connect the east coast to the west coast for the first time, up 3515%.
- Coca Cola (NYSE: KO ) : Founded 1892, provided delicious beverages to the world through two world wars, up 5467%.
- Ford (NYSE: F ) : Founded 1903, survived the Great Depression and the Great Recession, up 770%.
*All % changes adjusted for splits and dividends, all % changes since 1984, the earliest available date for data from all companies
The point is, ignore the doomsday omens; find a company you like with strong business prospects, buy it at a reasonable price, and ride it all the way to the moon. Here at the Fool we follow this advice and focus on companies that we don't just love, but love to profit from. You can learn about four of our favorites by reading our special free report: The Motley Fool's Top Stock for 2012.