Early Warnings

On Friday I snapped my medial calf muscle while racing my 12yr old son up the hill to our house (100m). It actually popped as I tried to take off and forced me to be house bound for 2 days. It is up there with the most painful injuries I have suffered. The question is why on earth did this happen to a 43yr old 105kg gorilla of quivering passion or as my wife said “why did you do such a stupid thing?” If you ignore the fact that I often behave like Peter Pan, there was a very obvious early warning sign to this injury, which probably makes me look even more silly.

The day before the injury my son challenged me to a race up the hill which I gladly accepted and narrowly lost, later that evening I said let’s go again, this time I was the victor. The following morning (Friday) when I woke up my calves were very stiff from the previous days sprinting (this was my early warning). When David and I were walking home around lunchtime, ever the competitor I said lets settle the sprint championships. The rest is all painful history …….

If you look at market behaviour over the last few weeks and the commentary on every financial news site you will notice how everyone is talking about the change in market behaviour, that a new era of volatility has arrived, and some brave souls are even calling a bear market. My point is that not all the time but most of the time before a major injury/drop/crash there are warning signs. That is not a prediction it is simply a warning that “sudden” future events are more likely.

MARKET ENVIRONMENT

Let us give the current market environment some context. The market has been more than 1,000 days without a correction. A correction is commonly described as a 10% drawdown. With the low on Wednesday the S&P 500 has had a 9.75% drawdown so the market has not yet offically “corrected” and has simply experienced a pullback. According to intraday data prepared by LPL Financial Research the table below shows how often corrections and pullback have occured in bull markets since World War II.

GOLD CROSS – ANXIETY

I thought with all this talk about market corrections and possibly a new bear market it would be interesting to whip out my trusted “Gold Cross” trading system and see whether the current market could handle the challenge of staying with the long term trend. In this simple trading system you go long when the 50 day moving average is great than the 200 day, when the 50 day crosses below the 200 day you go to cash. I have run this system on daily Dow Jones Industrial Average data going back to 1889, this system has seen all types of cycles. In summary the “Gold Cross” system is roughly twice as good as a simple buy and hold strategy and it is telling you to stay long. The question is with all this market discussion about recession and correction can you stay long. For sure it isn’t going to be easy. This is an excellent example of no matter how good your system is do you have the psychological makeup to stay with it. If so, like my calf muscle stiffness you need to treat a downward sloping “Golden Cross” as a warning.

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