Have You Heard of the Death Cross?

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I keep hearing about copper's potential "death cross" and the negative impact the cross would have on the market.

Really? Does copper truly have the predictive power that Wall Street analysts' are hyping? Or is the "death cross" in copper just another useless indicator much like the Hindenburg Omen ?

The so-called universally accepted theory suggests that if copper prices are declining, then that means that demand is slow, the economy will suffer, and stocks will plummet.

Before writing this article I didn't have the answers, but after some diligent research I think I have a grasp as to how valuable the "death cross" is in predicting the next intermediate-term move for the market.

The Wall Street Journal recently reported a possible "death cross" in copper futures . Traders and analysts have been talking about the potential ramifications ever since. According to the article, a death cross would be a negative for copper and more importantly, the overall market.

***A "death cross" is a technical indicator that occurs when the 50-day moving average (50 DMA) crosses below the 200-day moving average (200 DMA). In theory, the crossover indicates a bear market is on the horizon. The chart below shows why technicians are suggesting this could occur in the near future.

I decided to back-test the "death cross" theory. I went back to 1989 (as far as my charting software would allow) and calculated the returns in the S&P 500 after each "death cross" signal in copper and the subsequent push back up through the 200 DMA.

There were 15 occurrences over this time frame, and according to the statistics the S&P 500 was positive 73 percent of the time (11 out of 15 occurrences) from when the 50 DMA moved below the 200 DMA (the point of the death cross), to when it crossed back above the 200 DMA. The table below shows the returns for each occurrence.

The median return in the S&P 500 was 3.1 percent, with 73 percent of the occurrences ending with positive returns by the time copper's 50 DMA crossed back above the 200 DMA.

In short, the death cross pattern is wrong, more often than right, when used as an indicator of future performance for the S&P 500.

Following the signal would have kept you out of the sharp decline in 2001 and 2008, but it also would have kept you out of several large advances, including the 48.6 percent advance in 1997.

So the question remains, is the "death cross" in copper a good predictive indicator as to where the market is headed over the subsequent three months? I would argue - no.

Too often I see individual investors focus their energy on the latest and greatest predictive indicator in the news to make decisions on their long-term investment outlook.

As my esteemed colleague, Tyler Laundon stated in his article, " Is a Correction Coming " the reality is that there are all sorts of strategies that can work to make and PRESERVE investment gains in small cap stocks. But it's the one that investors stick to that will work over time. Based on my research, I wouldn't stick to a strategy based on copper's death cross - unless I was going to get long the S&P 500.

***Now is the opportune time to carefully analyze individual small cap stocks in search of the best opportunities, regardless of whether copper shows the death cross formation or not. A broad market pullback is possible, but I wouldn't use copper's price action as my 'tell' signal.

And if a pullback for small caps occurs you may find your favorite investments trading at a discount, thus presenting a buying opportunity. The trick, as always, is to have your watch list ready and in hand and focus on the quality and valuation of the individual small cap investment.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks

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