Gartman: I Was Wrong on Gold

What a difference a few days and weeks makes in the stock market game. If you will recall, it was just one short month ago that economists were shaking in their boots about the prospects for the economy. It was one short month ago that the S&P 500 had broken down from a classic head-and-shoulders top formation. And it was one short month ago that the bears seemed to be in complete control of the game.

At the end of June, we went so far as to publish a chart that seemed to paint an ominous picture for the future of the stock market. We put up one of our favorite long-term trend-following indicators, which unfortunately had given only its fourth sell signal since 1995. And given that our magical indicator would have produced a total return of +175.14% during the period of 1/1/00 through 6/30/10 versus a loss of -29.13% for the S&P 500, we felt this signal deserved your attention.

Going back a little farther, the system had produced returns of +1,390.43% from 1995 versus +121.34% for S&P (which is more than 11 times the return of the buy-and-hope approach). In dollar terms, this means that a $100,000 investment in the S&P 500 index is now worth $221,340, while the same $100,000 using our trend system would be worth $1,490,434. Thus, a sell from this “magical” trend following indicator seemed to be worth noting.

Now for the good news. That sell signal from our trend indicator (which is simply a 15-month weighted moving average and moved forward two months) turned out to be a false alarm. In fact, after just one month, the S&P 500 has moved back above its moving average and as such, the signal is back on a buy! (See chart below)

S&P 500:

We offer two observations from this situation. First, as was the case in 1998, our system may have been faked out by what amounted to a bad news panic and may now be ready to lead the chorus of “Happy Days are Here Again.” In ’98 it was the emerging markets crisis triggered by the collapse of LTCM (Long Term Capital Management – remember those whiz kids?). And just last month, it was the fear that the economy was going to stop on a dime again that sent stocks down far enough to breach our long-term trend indicator. But now that the signal is back on a buy, well, it just might continue to head higher. It has seemed to work that way in the past.

The second scenario that we could see unfolding from here is a replay of what appears on the lower left of the above chart. We’re talking about a period in which the market goes sideways in a range and thus, moves above and below our trend indicator a number of times before one team finally claims victory.

Should the second scenario begin to unfold, we will advise that it is time to “turn off” any and all types of trend-following indicators such as the one shown above. After all, anything that has worked so well for so long is bound to screw up now and again, and this just might be one of those times.

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