Distance from Moving Average Indicator and SPX Peak
Stocks are hovering at or just above their record highs once again across most U.S. stock market indexes including the benchmark U.S. large cap S&P 500 Index (SPX). Even the prospect of war in the Middle East, continued geopolitical uncertainties, unresolved trade war, impending impeachment hearings have no impact on the stock market. Investment sentiment and consumer confidence numbers have all turned decisively bullish. Street Strategists are rushing to raise their year-end 2020 SPX forecasts. So, what is there not to like in today’s marketplace. However, the pertinent question is how will we know when the 10-year bull rally have finally reached its major peak?
Fundamental Analysts tend to value securities by evaluating financial ratios such as Price Earnings (PE) and Earnings Per Share (EPS). On the other hand, Technicians tend to use technical indicators such as moving averages to help determine the extent of a major rally. One popular technical indicator is the distance from the moving average (DMA). It is basically a moving average indicator that measures the distance (in percentage) of how far above or below a security is from its key moving average (i.e., 200-day). The objective is to determine if a price move is overextended or if momentum is accelerating.
Remember moving averages are lagging indicators and are useful for removing the noise and fluctuations in the market by comparing the data over a period time. It gives an indication of the strength of a trend rather than predict the movement of the security or market in question. The distance from moving average indicator (DMA) is a great indicator, primarily because of its simplicity. However, it has great value in helping to better understand the following market conditions: (1) determine the primary trend in play (uptrend, downtrend, sideways trading range); (2) decipher whether the trend is trading at an overbought or an oversold level; and (3) alert traders and investors to an impending retracement, reversal, or continuation trend based on the relationship between the distance between its moving average and the price of the security.
Many point to the fact that moving averages are lagging, and as such are not useful technical indicators. Yes, moving averages by design are lagging in nature but it is also a very useful indicator when deployed with other technical indicators (MACD) and different technical disciplines (i.e., pattern recognition analysis, price breakout projections, Fibonacci retracement etc.).
Enclosed below is a chart showing the distance from moving average (DMA) indicator applied to S&P 500 Index (SPX). We have alluded to the fact that the recent Nov 2019 technical breakout is like the prior 2-year technical base breakout. For instance, the breakout above 2,122 in 7/5/16 suggests +296 points for a minimum SPX target of 2,714. SPX quickly exceeded its technical projection trading to a high of 2,872.87 (1/26/18) before finally transitioning to a 2-year consolidation phase via a broadening top/bottom and/or head/shoulders bottom pattern from 2018-2019. It is important to note the distance of SPX price from its 200-day moving average traded to an extreme high of 12.96% during 1/26/18. At the same time, MACD price momentum indicator also peaked at an extreme high of 48.67 on 1/26/18.
As we fast forward to the current timeframe, a recent technical breakout above 3,053 on 11/1/19 confirms a 2-year broadening top/bottom and/or head/shoulders bottom technical pattern. Since the height of the technical base is nearly 616-points it renders a minimum SPX breakout target of 3,669. Although SPX is technically extended from a near-term basis, the intermediate-term technical outlook remains favorable. Why? SPX has yet to achieve its minimum 2-year breakout target of 3,669. Under a bullish market environment, SPX can overshoot its minimum technical target and trade to as high as 3,884 (+5.85%). In addition, the distance from its 200-day ma is currently at 9.5%. If SPX replicates the prior bull rally from 2017-2018 then it is reasonable to expect the DMA indicator to again retest the extreme level of 12.96% possibly during 2020 resulting in the above SPX price objectives. Does this then answer the question of when is the peak in SPX?