Trader’s Narrative

The Coppock Curve or Guide is an obscure indicator which tracks the market over a long term time horizon. The indicator is quite simple to calculate but it moves very slowly. What it takes back through lag, it gives multiple fold through an uncanny prescience in determining significant turning points. For more information, check out my original post introducing the Coppock Guide.

Although originally created to track the US stock market, it can in effect be applied to any index. In fact last month, the Coppock Curve turned positive for the Chinese market. I’m relying on the slightly modified IC/Coppock Curve. Since they don’t exactly detail how their calculation is different than the traditional, I’ve contacted them to inquire. When I hear back I’ll update this.

As you can see from the Shanghai stock exchange index, that was quite a while after it actually bottomed. This the inherent disadvantage of such a long term indicator. But if you were a long time reader you would have caught what I wrote in early November 2008: Time to Consider Chinese Stocks. That’s almost to the day when the Chinese market bottomed. Lots of contrarian sentiment, a little dash of technical analysis and a pinch of luck

Since the day I suggested the long side of the Chinese market, the Shanghai index has appreciated by 53%. The numerous ETFs and securities I mentioned have also gone up - the ones that haven’t, bottomed in late rather than early November 2008:

• Morgan Stanley’s China A-Share Fund (CAF) — 80%
• Taiwan Greater China Fund (TFC) — 5%
• The Greater China Fund Inc. (GCH) — 15%
• China Fund Inc. (CHN) — 21.5%
• JF China Region Fund Inc. (JFC) — 10%
• SPDR S&P China ETF (GXC) — 27%
• iShares FTSE/Xinhua China 25 Index (FXI) — 29%

The plus side to this is that if this is a true Coppock signal (that is not a false one) then we are in for another bull market in Shanghai which could last well into next year and take us back up to at least the mid-point of the two extremes - that is to the 3,800-4,000 level.

Also notice how the March 2009 swing low on the Shanghai index is higher than the October/November 2008 lows. And again, in early January 2009, when the S&P 500 was topping, Chinese equities were carving out another swing low. What we have here is higher lows, higher highs. In other words, a confirmed uptrend. And finally, the medium term (50 day - red line) moving average has turned up in support of price with the long term (150 day - blue line) moving average flattening. If this is what it looks like to be, then a pull back would present another opportunity to get on board a long term ride higher.

If you missed the China call and you’re kicking youself, do yourself a favor and grab my feed if you haven’t already and don’t overlook this next opportunity:

Free Traders Magazine Subscription
Get a FREE subscription to Futures magazine.

Take advantage of this offer right now because it will expire very soon (US address required).

Futures magazine informs the professional buy side and sell side trader about the evolving market structures. It covers trends on market making, globalization, block trading, technology, electronic trading, inter-dealer trading, soft dollars, electronic communications networks and all technology that impacts the trading community.

Once again, the indices are toying with the November 2008 lows and have everyone on tenterhooks about the resolution of this support line: will it hold again? will be broken and cause a cascade down? will it break only to trap the bears?

Yesterday I presented my reasoning why the support wouldn’t hold. Today let’s play devil’s advocate and see why the bulls may just hang on by their fingernails for dear life.

As a reader (Russ) pointed out in the comments section, the very fact that there are now a larger percentage of S&P 500 stocks trading above their 50 day moving may be a positive sign, showing that the components that make up the index are stronger than might seem.

That would imply that the single number that represents the S&P 500 index is hiding the fact that smaller capitalization stocks are doing better than the larger capitalization stocks. Both the mid-cap and small-cap indices are trading well above their November 2008 lows.

As well, take a look at the recent chart showing the number of stocks trading at new lows:

The green arrow points to the spike in new lows that corresponded to the November 2008 low. You’ll also notice that in October 2008 there was a higher number of new lows - that was in early October when the S&P 500 spiked down to 839.80 only to recover and close almost unchanged for the day.

This chart is showing that while the ’stock market’ is once again near its lows, the market of stocks is still holding up surprisingly well.

We can see something similar during the last throes of the last bear market in late 2002:

Once again, the green arrow points to the spike in the number of new lows, corresponding to the low in the S&P 500 index in early October 2002. In July 2008 we saw slightly higher new lows but the market also closed slightly higher. But then, in March 2003, the number of new lows was dramatically lower as the S&P 500 index dove to retest those same lows:

Sentiment Shift
So keeping an open mind, this may very well mean the bulls get a break (finally). At the same time, technical analysis is one layer. The other that I rely on heavily is sentiment. And although in the past few weeks contrarians have little to cheer about, the most recent data from the AAII weekly survey shows a drastic change in the outlook of retail investors.

Whether it is the nerve wracking dance on the edge of the rain slick precipice or the relentless bad news that pounds us all through the mainstream media, the AAII bullishness collapsed from 33% to just 22%. Needless to say this is exactly the sort of extreme sentiment that I’ve been waiting for.

Without further ado, here is the lay of the sentiment-land for this past week:

Investor’s Intelligence
According to this measure, stock market newsletters are on the whole equally split: 35.5% bullish and 36.3% bearish. This is the 4th week that we’re seeing approximately parity between the two camps. And since we are looking for extremes to point out inflection points, this is not helpful.

To learn about the origins of this sentiment survey, see A Brief History of Contrarian Analysis

AAII
The American Association of Individual Investors weekly survey came in with only 25% bulls and 44% bears. This is exactly the same percentage of optimists as last week’s AAII survey results.

More importantly, the allocation of money to stocks continues to be below 50%. If you recall, this metric hit an extreme low at the beginning of the year, falling to 42%. The last time we saw AAII respondents allocate so little equity in their portfolio was in late 2002 and beyond that right after the 1987 crash.

Rydex Nova/Ursa Ratio
A reader commented on last week’s sentiment overview that I should feature the Rydex Nova/Ursa ratio because it has given few and accurate signals. I’ve mentioned this sentiment metric before but as Wes said, the signals have been infrequent. The last time it appeared here was for the sentiment overview of November 7th, 2008.

As you can see on this chart, that was an extreme level and since, we haven’t seen anything remotely interesting from the Rydex Nova/Ursa Ratio:

To put that spike in sentiment in perspective, it was much lower than the pessimism that accompanied both the darkest days of the last bear market and the immediate after math of the tragic events of September 11th, 2001. So no doubt that what we saw was significant. But bear in mind that around the same time last year, almost every single needle was hugging the red line for dear life.

CBOE Put Call Ratio
The ‘traditional’ put call ratio measure fell to 0.71 on Friday and the equity only ratio reached 0.60 - that’s not so low to worry the bulls but if we continue to see a few more days like that next week, things would change.

ISE Sentiment
Once again, on Wednesday February 4th, the ISEE sentiment index fell below the magical 100 number (to reach 97). As was mentioned two weeks ago, this is something that has happened only a few times since January 1st 2008 - surprising, when you consider just how volatile and intense this bear market has been. With this weeks incidence, we now have only 9 occurrences where the call put ratio on the ISE has been below parity. As with the other times, the ratio quickly recovered above 100 to finish off the week at 132.

Hulbert Stock Market Newsletter Sentiment
Finally, returning once again to the newsletter editors, the subset of stock market timing newsletters followed by the Hulbert Digest shows that there are surprisingly few bears out there. The Hulbert Stock Newsletter Sentiment Index (HSNSI) finished the week at -7.4%; meaning that the average market timing editor out there is suggesting a small short position to their clients.

That might seem bearish but once you consider that the lowest it descended was -42.9% in July 2008 (not October nor November 2008!). And that just two weeks ago the HSNSI was -20% with the S&P 500 barely 60 points lower at that time, it is clear that this sentiment measure is not showing any type of capitulation or pessimism.

Magazine Cover
Energy shorts beware!
Business Week’s cover this week is a picture of Exxon as a ship’s hull with a leak. While most magazine covers are fodder for contrarian analysis, Business Week is a repeat offender so this is especially significant. Who knows, maybe it says more about Exxon’s stock price than the price of crude. But the two are more or less intertwined so I suspect if this has any contrarian value, it also applies to the commodity.

Also see:

• Sentiment Overview: September 2007 (Forbes, Fortune and Economist covers)
• When Magazine Cover Indicators Clash
• Magazine Cover Curse Strikes Akamai (AKAM)

Here is the sentiment overview for the last week of the month (in terms of returns, the worst January ever!):

AAII
The American Association of Individual Investors’ weekly sentiment survey had 47% of respondents bearish and only 25% bullish. That may seem like good odds for a rally… except that we’ve been hereabouts before (in late 2008) and yet the market weakness continued.

Investor’s Intelligence
This week’s II sentiment survey shows the bears at 38% and the bulls at 34.8%. This is a continued amelioration of the exuberance that we’ve seen for the past several weeks, but it still leaves the two camps, more or less, equal to one another.

Fund Flows
Yesterday we talked about the lack of IPOs which are in a sense, supply of “paper” to the market. On the other side stands the fund flows which measure the demand for equities through the purchase or sale of mutual funds.

Not surprisingly, mutual funds have undergone a scorched earth scenario where for more than a year, we’ve hardly seen net inflows:

Source: Data by AMG Data and chart by SentimenTrader.com

Although this data has a contrarian tinge to it, there is nothing bullish about seeing a continuous erosion of mutual fund flows. A sudden and sharp decline is far different than what we are seeing now. Eventually, for the market to be able to find its legs again and push forward, we will need to see people willing to pour billions and billions of dollars into new mutual fund purchases.

Options Sentiment
Neither the CBOE put call ratio or the ISEE call put sentiment ratio are significantly different from last week’s sentiment overview.

Here’s an up and coming sentiment tool that I discovered recently. It is released weekly by the National Association of Active Investment Managers (NAAIM), a non-profit association of registered investment advisors formed in 1989. Since the (200 or so) member advisors provide active money management services to their clients, as opposed to buy and hold, they position their portfolios according to their opinions of the market’s future. In reality every portfolio is actively managed because there is no way to be passive.

In any case, each week on Wednesday, the advisors communicate their equity exposure by choosing one of the following answers:

• 200% — Leveraged Short
• 100% — Fully Short
• 0% — 100% Cash or Hedged to Market Neutral
• 100% — Fully Invested
• 200% — Leveraged Long

Their answers are then averaged to produce the NAAIM Trend Survey of Manager Sentiment:

Although we only have two and a half years of sentiment data and a relatively small sample size, this sentiment indicator shows promise. To start its extremes correspond to tops and bottoms in the S&P 500. For example, when active managers reduced their exposure to “neutral” in late August 2007 and July 2008, we saw the S&P 500 find its feet again.

But the latest active managers sentiment is somewhat troubling because even as the market weakness has continued for several months, they have positioned their portfolios more and more aggressively long. Once again we are seeing that we do not have a “wash-out” or complete capitulation. On the contrary, everyone it seems is even more hopeful… as the market falls even lower!

Although the NAAIM data is weekly, it comes out with a delay. The latest result is for January 14th 2009. I’ll update the chart when the new data is released or when it tells us some other interesting things about the market.

If you want to get more information or download the raw data to play around with it, you can do so at the NAAIM website.