Article first published on Advisor Perspectives August 20, 2012
In my article The Ultimate Death Cross – False Harbinger of Doom I showed that the spread between the 50-month moving average (MA) and the 200-month MA of the S&P will form a trough before the end of this year, irrespective of the level of the S&P over the next few months. This event provides a positive outlook for the stock market and could herald a new bull market to 2025.
Most of us are not familiar with Terrence Laundry’s T-Theory, which is a method of analyzing general investment trends using a time symmetry property. It basically states that the duration over which investors can obtain “superior equity returns” will always be equal to the previous time period in which returns were subnormal. The practical purpose of the theory is to anticipate the runs of “superior returns”.
The left side of the T represents the period when investors are shunning equities and putting their assets into money-market-fund-like reserve – the “Cash Buildup Phase”. The longer this period lasts, the more money is transferred from the stock market to the bond market and cash. As a consequence long cash buildup periods provide the potential for longer bull markets for stocks (the right side of the T), once the tide turns.
T-Theory is very useful to estimate the time period of any advance, but the initial move can be missed. The main problem is finding the buy point – the location of the center post of the T.
This is where the ultimate death cross’ moving averages come in handy. Figure 1 shows the S&P composite together with the spread of the moving averages. The inception of the four major bull markets (since 1880) was always indicated when the spread formed a trough after periods of subnormal returns lasting more than 10 years and when the level of the spread was close to, or below zero. (The 1936 trough does not count because the preceding cash buildup period was too short.)
The next trough of the spread will occur at the end of this year, which would make the preceding cash buildup phase about 12 years long. Thus according to the T-Theory we can expect a 12 year long bull market for equities to start at the beginning of 2013.
According to Terrence the greatest profit opportunities come at the end of the longer cash buildups and one must manage ones affairs to be mentally ready, and financially healthy so as to be 100% invested at this key juncture.
Note: Values of the spread were increased by 3.3 to make them all positive. Negative values can’t be plotted on a log scale.