Linear regression is one of the numerous statistical tools to help predict future prices based on prior data. It is commonly used in conjunction with other technical indicators to better identify the underlying trend and most importantly, to evaluate the sustainability of the trend.
A linear regression line utilizes the least square method to plot a straight line through prices to shorten the distances between the straight line and the price. The slope of the trendline can be rising, falling, or sideways/flat.
The linear regression line or slope helps to determine the prevailing trend based on the number of periods (i.e., 20-months, 20-weeks, 20-days, etc). Although it may resemble that of the moving average indicator, unlike a moving average trend – which is often curved and conforms to price over a specified range, a linear regression line is just linear.
By taking the current price and the price from x periods ago and drawing a straight line between the two it tends to be a simpler way to quantify the general direction of price over a past specified period and can be extremely helpful when there are volatile, and extreme swings in the marketplace.
It is interesting from the Mar 2009 market bottom in SPX at 666.79, the monthly linear regression line has been useful in uncovering the underlying trends of SPX. That is when the monthly linear regression line is rising in a powerful and steep uptrend this has led to strong SPX price rallies. However, when the monthly linear regression line has declined it has led to either SPX trading ranges or downturns.
Since Jan 2020, the SPX linear regression line (20-month period) continues with its downtrend. This suggests that from a longer-term perspective (monthly basis) SPX remains in a corrective phase. Note the monthly line chart also shows a potential 2-year head and shoulders top. Although a neckline breakdown has yet to be confirmed this technical pattern warns of further consolidation is necessary before the next sustainable SPX bull run.
The ability to clear its left/right shoulders would negate the distribution top and suggests a retest of the all-time Feb 2020 high. The h/s top pattern suggests the current Feb-Mar 2020 SPX bear decline and the subsequent Mar-Apr 2020 oversold rally probably needs more time to solidify the required technical base to launch into the next major rally. Remember, in the past when the SPX linear regression line trend turned decisively higher this reaffirmed the next sustainable SPX bull rally.
Because the S&P 500 Index (SPX) and the NASDAQ NDX 100 Index (NDX) are both market capitalization-weighted indexes the top five (5) largest market-cap-weighted names will directly impact the underlining trend of the indexes. The collective market capitalizations of MSFT, AAPL, AMZN, FB, and GOOG/GOOGL comprised over 20% of overall SPX and over 45% of NDX.
Enclosed are the monthly linear regression studies on the top five market-cap weight names. The primary reasons why SPX and NDX have outperformed domestic and international equities since Mar 2009 market bottom is the market leadership roles of these five names. It is also reasonable to expect SPX and NDX structural trends depend heavily on the outcome of these five stocks.
MSFT – The monthly price trend continues to trend higher to new all-time highs. Since last Spring 2019 the linear regression slope trend has also begun to transition toward a steeper uptrend. The above two technical developments further support the basis of MSFT’s leadership role in the marketplace.
AAPL – AAPL's monthly price trend has been cyclical as it has risen sharply and then fallen sharply every couple of years. AAPL is very close to recording new all-time highs. The monthly linear regression slope has also begun to turn decisively higher since last spring as it sets new higher-highs. If this trend continues then this would support the basis for the next outperformance cycle.
AMZN – The monthly price trend has recently recorded new all-time highs. However, the monthly linear regression slope has declined from its Sep 2018 high to its Dec 2019 low. The recent sharp reversal over the past quarter is now signaling AMZN emerging to resume its market leadership role.
FB – A consolidation over the past 3-years via a large technical base is promising. It may be nearing a critical phase of its move. A breakout to new all-time highs hint of the next outperformance cycle. The monthly linear regression line is also nearing its 2018 reaction high. A convincing breakout to new highs would further confirm the emergence of its leadership role.
GOOG/GOOGL – These two names have both lagged its Technology peers over the past year. However, this may be changing as evidenced by the sharp reversal in the linear regression trends from downtrends to uptrends. Convincing breakouts to new all-time highs would further re-establish these two technology names as market leaders.