A closely watched index established by Dow Jones Indexes back in November 2010 began flashing red on Tuesday, a development that now has investors and their advisors reviewing the back-tested index’s history for signs of what’s to come and what investment strategies they should pursue next.
David Krein, Senior Director for Product Development and Analytics of Dow Jones Indexes, told On Wall Street that the so-called Dow Jones Golden Crossover Index just exhibited what investors call a “dead cross” -- a phenomenon that occurs when a market’s moving 50-day average crosses below its 200-day moving average.
Market analysts coined the term “dead cross” because when it happens, it usually signals the start of a downward trending market.
“We’ve had two recent dead crosses,” said Krein. “The first occurred in December 2007, and the second in June 2010.”
Following the 2007 dead cross, the market stuttered and then crashed with large cap indexes all falling by more than 50%. After the 2010 dead cross, the market “went sideways for more than three months” Krein says.
When the Dow Jones Golden Crossover index fund is confronted with a dead cross, Krein said the equity allocation of the fund is gradually decreased from a normal 100% stock allocation to a 25% stock allocation, with the rest of the assets moved into cash, in the form of short-term Treasuries.
This reallocation process will be completed over the course of the next five business days, he said.
Krein said that an investor who did this in December 2007, following that dead cross event, would have seen her or his portfolio of large cap stocks decline by only 22%, or less than half what the loss of the Dow Jones Industrial average or S&P 500 Index was over this same period. Equally significant, he said, is what happened later.
“Large caps have still not returned to their pre-crash level,” Krein explains, “but those who switched 75% of their assets out of stocks in December 2007 would have recovered their losses within nine months.
Longer term, back-tested results that predate establishment of the index show that as a result of the systematic application of the fund’s Golden Crossover system over the period running from December 31, 1999 through June 30, 2011, the Dow Jones Golden Crossover U.S. Large Cap Total Stock Market Index would have outperformed the Dow Jones U.S. Large-Cap Total Stock Market Index by 4.44%, while reducing volatility by 5.97% on an annualized basis.
In addition to looking for dead crosses, the Index also responds to so-called “golden crosses,” which occur when an index’s short-term moving average crosses above a 200-day moving average.
At that point all cash positions are moved back into equities.