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How Important Is the Dow Jones Death Cross?

The history of the Dow Jones illustrates that we ignore 'death cross' signals at our own financial peril

   

Brian Sullivan of CNBC fame is clearly not a believer.

In his Power Lunch segment, the usually agreeable on-air personality mockingly referred to the dreaded death cross in the Dow Jones Industrial Average as a “life cross” instead.

I wouldn’t be so quick to agree.

From a pure numbers perspective, a death cross occurs when the index’s shorter-term, 50-day moving average drops below its longer-term equivalent, the 200-day MA. Theoretically, the Dow Jones death cross forewarns volatility, but to Mr. Sullivan’s point, the harbinger was denied the last two times the cross was flashed.

To be fair, the CNBC anchor was only looking at data going back to 2010 — hardly enough information to establish statistical accuracy considering that the Dow Jones death cross is in fact a very rare phenomenon. Since Sept. 9, 1901, until the most recent occurrence on Aug. 11 of this year, the 50-day MA crossed below the 200-day a total of only 81 times.

To put this scope into perspective, there have been nearly 31,000 trading sessions between the aforementioned dates. At the oldest end of the spectrum, U.S. President William McKinley had been shot days earlier by anarchist Leon Czolgosz. The right for women to vote was roughly two decades away.

The relative infrequency of the Dow Jones death cross confirms the general stability of American markets.

But when this harbinger does ring out, investors ought to pay attention. Here are the stats, courtesy of a slew of data from Measuring Worth:

  • A month after the initial onset of the death cross, the markets have moved lower 55% of the time.
  • Three months later, the Dow is in the red 62.5% of the time.
  • After 180 days have passed since a Dow Jones death cross, the markets begin to recover, but are still negative 55% of the time.

While a maximum accuracy rating of 63% may not sound like much, this is only a broad statistic. If we impose conditions into our analysis — via Bayes’ Theorem — it is possible to extract higher probabilities.

For example, when the markets are negative a month following the Dow Jones death cross, there is a 68% chance that by the next 150 days (or 180 days after the Dow Jones death cross), investors will still be seeing red. Furthermore, when the 30-day mark is strongly negative — by -3% or beyond — the markets are behind a whopping 84% of the time by the half-year mark!

Dow Jones, death cross

Significantly, every instance when the 30-day mark was negative by double-digit percentage points occurred prior to 1940. Post-World War II, the markets have rarely flashed so strongly negative immediately following the onset of the Dow Jones death cross. The eight recorded crosses between 2004 and 2012 actually led to average market gains of 1.61% a month later. But on Feb. 4, 2008, the Dow Jones was down -3.23% after flashing death 32 days prior, leading to one of the worst financial calamities on record.

Bottom Line

While no guarantees can be made regarding the Dow Jones death cross, there is ample evidence to state that when a cross fails to produce prolonged bearishness, odds are that the phenomenon is an aberration.

However, if the markets are significantly bearish a month after a death cross, history veritably screams its advice — run, don’t walk, for the nearest exit!

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, http://investorplace.com/2015/08/dow-jones-death-cross/.

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