The One Chart That Calls Market’s Tops And Bottoms
Jim Cramer on CNBC sometimes highlights a chart from the Fibonacci Queen, Carolyn Boroden. She uses the 5-day (blue line) and 13-day (red line) exponential moving averages or EMAs to show upward and downward trends in the markets. When the lines cross it tends to show that the market has bottomed or topped and could reverse direction. Note that while this chart shows a discernable pattern, no chart is perfect for investing.
When the 5-day is above the 13-day the market is moving higher and tends to stay in that trend until the lines cross. The same goes for the downside. When the 5-day is below the 13-day the market tends to decline.
Currently in a downward trend
On Friday the S&P 500 closed at 4,131.93. It is currently in a downward trend with the 5-day EMA at 4,198.83 (the blue line in the graph below) and the 13-day EMA at 4,249.07 (the red line).
In looking at the graph it appears that the lines crossed on April 20 and 22. One point to note is that even though the lines crossed on the 20th and separated a bit on the 21st, they re-crossed with the 5-day moving back below the 13-day. Just because they cross does not mean a trend has reversed.
On Wednesday this past week when the S&P 500 rose 103 points the gap between the two lines narrowed. However, a down day on Thursday and the 155-point drop on Friday widened the gap again.
When looking at the first four months of 2022 there are about eight upwards or downwards movements that these two lines clearly show.
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It would be very challenging to use the crossing points for short-term trading decisions or an investment strategy, but when a trend is firmly in place it can be helpful with decisions on when to buy, when to sell or when to do nothing.
2019 to 2021 charts show similar patterns
In looking at the previous three years similar patterns emerge.
Short-term support was probably broken on Friday
On Friday the S&P 500 closed at 4,132.93, which is below the February 23 close of 4,225.50. While Friday’s intra-day low of 4,124.28 was not lower than the February 24 intra-day low of 4,114.65, it was higher by less than 10 points or 0.23%. If the 5-day and 13-day EMAs downward trend continues the Index will have lost its short-term support.
Worth Charting believes another gap comes into play
Carter Braxton Worth is founder of Worth Charting and frequent CNBC guest. He follows the markets as a technician and was the Chief Market Technician at Oppenheimer, Sterne Agee & Leach and Cornerstone Macro for almost 20 years before recently founding his own firm.
In a chart he emailed on Friday Worth wrote, “The unfilled gap of one year ago (April 5, 2021) at 4020.63 is “in play.” He emailed it about 11 am on Friday when the S&P 500 was around 4,215. It wound up falling another 82 points. He added, “Our thesis continues to be that said gap will be filled (at a minimum) representing a 16.56% selloff from the market’s January 4th peak.” The blue lines indicate filled gaps and the red line is an unfilled gap.
The chart also shows a heads and shoulders pattern with the three red upside down U shapes, which is not positive for investors.
S&P 500 P/E multiple has fallen quite a bit
John Butters, Senior Earnings Analyst at FactSet, publishes a weekly report on the S&P 500. One of the charts he always includes is the Index’s forward 12-month P/E multiple. This week’s chart shows the P/E multiple has steadily declined from its second half 2020 high’s between 21x and 23x to its current 18.1x.
While 18.1x is below the 5-year average of 18.6x, it is above the 10-year average of 16.9x. It isn’t surprising that the Index’s P/E multiple is still in the high teens due to interest rates still on the low side and decent earnings growth. However, it is worth noting that a handful of large-cap tech names are above this average, and that a large percentage of other companies in the Index have P/E multiples of 15x or lower.
With the Fed about to raise interest rates and shrink its balance sheet, it isn’t surprising that the S&P 500’s P/E multiple has fallen. One of the big unknowns about how much father it could fall is how aggressive the Fed be with its tightening. Unfortunately, it will be at least a few months until even the Fed knows what it will do.