By 720 Global

In this article we highlight a simple technical indicator that has proven prescient over the last 15 years. Currently, this indicator supports much that we have posited regarding equity valuations and what they portend for the future direction of prices.

Moving Averages

Moving averages are the average price at which an index or security has traded over the last number of days, weeks, months or even years. For instance, today’s 20day moving average for the S&P 500 is its average closing price over the prior 20 days. Many investors use moving averages to help gauge where a security or index may encounter support or resistance. Due to the widespread use of moving averages it is not uncommon to see prices gravitate toward moving averages.

Another way investors employ moving averages is to compare them across different time frames. For example, an investor may compare the 20day moving average to the 50day moving average. It is said that when a shorter term moving average is higher than a longer term moving average the underlying stock or index has positive momentum and vice versa. Therefore, when short term moving averages cross to the upside or the downside of longer term moving averages it can signal an inflection point where momentum has changed direction.

20/10

The indicator that is currently catching our attention, and may be worthy of your attention, is a comparison of the 10-month and 20-month moving averages on the monthly S&P 500 index. Monthly moving averages are similar to the aforementioned 20day example but instead of daily closing prices, monthly closing prices are used.

The chart below shows the monthly price of the S&P 500 since 1999 in blue. It is flanked by the 10-and 20-month moving averages in green and red respectively. Note that when the 10-month moving average rises above the 20-month moving average, it has signaled the early stages of a sustained rally in the S&P 500. Conversely when the 10-month moving average falls below the 20-month moving average it has signaled a prolonged decline.