The dreaded Death Cross appears

The S&P 500 Index shows an unholy crossover between the 50-day and 200-day averages. What does it mean?

By Kim Peterson Jul 6, 2010 2:00PM
Arrows © Photographers Choice/SuperStockDeath cross! A market phenomenon that was apparently forged in the fires of Mount Doom, judging by the way some investors are quaking in their boots.

This particular death cross has appeared in the S&P 500 Index, and shows the 50-day average crossing below the 200-day average. This is a fairly rare occurrence in the S&P 500 -- some say it's only happened four times in the last decade.

So after a bit of fingernail biting and underwear changing, investors are starting to debate what this death cross actually means. Market now bearish? Check. Investors skittish? Check. Has the death cross actually told us anything new, or has it merely confirmed the general freaking out of the investing masses?

Let's examine the death cross through a few different lenses:

History: So what happened in those four previous death crosses? You'd expect the index to spiral downward, and that did happen -- twice, according to the Dynamic Wealth Report newsletter. In December of 2007 and October of 2000, the S&P 500 dropped 12% and 8%, respectively.

But the other two times, the index went up. Granted, it was only by 3% in 2006 and 2.5% in 2004, but momentum had turned around.

Those odds stay the same going back to 1970. Since that time, about half of the death crosses in the market actually resulted in a pullback, one analyst told The Wall Street Journal.

"The death cross IS nonsense," said the analyst, Pierre Lapointe at Brockhouse Cooper. "They're no better than a flip of a coin to predict future returns."

Fear. OK, fine. Discount the death cross as a market predictor. Give technical analysis a big pfft if you want. But there's no denying that this death cross reflects one sentiment in particular: fear.

There's more than enough data to support that fear, too. Friday's employment numbers were discouraging. Factory orders dropped for the first time in eight months. Pending home sales are down, as is manufacturing.

A strong uptrend. Since its turnaround in March of 2009, the S&P 500 has had three big waves up, reports Futures Magazine. That momentum has gotta break, and it's typical for a large correction to follow, writes Toni Hansen.

And if you look at the pace of the selloff heading into the current death cross, you'd notice it's been stronger than the normal short-term market correction, Hansen writes.

So what to take from all this? Obviously, things are very grim, and investors need to be extremely careful at this point.

"Caveat emptor is all we can say, as last year's whippy bear market rally in cyclical and beta securities undergo a correction that should come as little surprise to students of economic and financial history," one economist told CNBC recently.

Corey Williams of Dynamic Wealth Report cautions that the death cross doesn't guarantee that a new bear market has begun. Anything can happen at this point, perhaps some sideways or range-bound trading or even a new bull market creation.

"If you’re a long term investor, use the dips to build positions in your favorite dividend paying blue chip stocks," Williams writes. "And if you’re a trader, take profits quickly. And for your own good, don’t pay any attention to the Death Cross."
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