For illustrative purposes, we will walk through a simple hypothetical model and how it made unbiased decisions during the debt ceiling scare. The simple system uses one moving average; the 20-day exponential moving average (EMA) on the S&P 500. Good things tend to happen when price is above the 20-day EMA and the slope of the moving average is positive. The odds of bad things happening increase when price is below the 20-day EMA and the slope of the EMA is negative. The table below outlines the “rules” for making allocation changes.

As the threat of a possible catastrophic U.S. default was still lurking, it was prudent to reduce risk in our portfolios. The simple model based on the rules in the table above would have moved to 100% cash on October 4 or six days before the fear subsided and stocks stabilized.

By October 10, the market was beginning to realize that a debt default was not in the cards. The simple system moved back into equities as the observable evidence improved to capture 44 S&P 500 points. The moving average is one way to monitor the battle between bullish economic conviction and economic fear.

If you would like some model-building ideas and another example of monitoring investors’ convictions, thisvideo clip compares the S&P 500 on Friday, October 11 to the topping process in 2007-2008. The takeaway was 2013 looks much better. The analysis was helpful; the S&P 500 has tacked on an eye-popping 41 points since the video was published.