Don't Sweat the SPX's 200-Day Gap

The S&P 500 Index (SPX) has rallied over the past few months, and now, relative to its 200-day moving average, it’s the highest it’s been in about two years. Specifically, it’s now 10% above the moving average. The last time it reached this level it did not go well. The S&P 500 peaked on January 26, 2018 at 14% above the moving average and less than two weeks later it closed 10% below that peak. This week I’ll look at the longer-term historical data to see if this indicates an overbought market or if that last incident was an anomaly.

Going back to 1950, I looked at each time the S&P 500 got to 10% above its 200-day moving average for the first time in at least a year. Doing this gives 19 prior signals. The table below summarizes the returns after the signals. I also have a table showing typical returns since 1950 to use as a benchmark.

Despite the bearish return after the 2018 signal, this has historically been a bullish indicator. Stocks have a better average return and percent positive across each of the time frames I looked at. For example, six months after a signal, the S&P 500 has averaged a gain of more than 8%, with almost 90% of the signals positive. Typically, you would expect a 4.35% return over six months with a 70% chance of a positive return.

Based on this, it’s not an indication of an overbought market. In fact, it has been a buy signal, and with the two-week average return 3.5 times higher than the typical average return, it doesn’t suggest waiting.

Here’s another way I looked at it. Going back to 1950, I broke down the six-month forward returns based on where the S&P 500 was relative to its 200-day moving average. I created five brackets with an equal number of returns (each bracket has about 3,500 returns). That’s why the ranges are odd numbers.

Note, we are in that very bottom bracket where the S&P is farthest above the moving average. This method supports what we saw above. The S&P 500 relative to its 200-day moving average indicates momentum in that direction. In those bottom two rows, where the S&P 500 is at least 5.5% above the moving average, the average S&P 500 return over the next six months is 5.1% and 5.6%. Otherwise, the returns are around 3.6%-3.7%. Also, the percent positive is highest in those bottom two rows. Furthermore, the low standard deviation and low average negative numbers actually indicate less risk at these levels as far as six-month returns go.