When you look at a graph of the stock market, or, more specifically, an index of stocks—like a global stock market index—you notice that it tends to travel in trends over time. Sometimes it trends up, and sometimes it trends down.
Coming out of the pandemic lows in March 2020, the stock market went on a monster run. The trend, to say the least, was up. However, as I’ll explain in our featured indicator below, that trend has tired out.
On the chart above, we have an indicator that measures the stock market’s movements relative to itself over the past year to determine if its trend has reached a point where a reversal is likely to occur. Specifically, it measures the 6-month average price of global stock prices (gold line, middle clip) and compares that to standard deviation brackets about its 1-year average.
The part of the graph that I want to focus on is the lower part. Here, we show what I just discussed in the previous paragraph but in a slightly different form. The orange line shows how many standard deviations the 6-month average global stock price is above or below its 1-year average. The way to think about this is the higher the standard deviation gets, the more likely “gravity” will pull it back down to its average. And vice versa, the lower the standard deviation gets, the more likely it will get pulled back to its average.
The key is to identify when that shift is about to occur. For example, around the beginning of 2021, the 6-month average of global stock prices reached a high of roughly 2.5 standard deviations above its 1-year average. Again, stocks were on quite the run at this time.
But, as you can see from the graph, the orange line representing the number of standard deviations from the mean has been falling ever since. You could say gravity started to take over. And now, this year, it has fallen below the upper standard deviation bracket representing 0.25 standard deviations. Historically, this has been the key level that triggers a warning that stocks are starting to trend lower.
The performance boxes show that returns for the global stock/bond ratio (green line, top clip) have come in negative after a sell signal from this indicator. Returns after positive signals, however, have been much better.
Viewing the market through the lens of this indicator, then, the message so far this year is clear: The trend has tired out.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.