Trader’s Narrative

A few months ago I started to pay special attention to a remarkable but little followed technical indicator called the Coppock Curve or Guide. Peering ahead and assuming that the market would hold firm, I mentioned that by the end of May we would have a definitive buy signal. The market’s strength was impressive, as we all know and the signal did arrive for a new bull market.

Although of course, it remains to be proven beyond a shadow of a doubt that we have seen the low for this cycle, it looks to have been a valid signal. Returning to our hypothetical forward extrapolation of index levels, the Coppock Curve continues to act very bullish as it continues to rise out of the depths it had fallen to:

Source: InvesTech Research

If we assume that the S&P 500 index will close approximately where it is now by the end of August, then the Coppock Curve would continue to recover extremely fast, reaching -344. That is well above its February 2009 level and closing in on its January level.

That’s assuming that the market is unchanged until month’s end. But what if the market trips up from now until then?

In that scenario, the Coppock Curve still has a good chance of continuing to rise. In fact, the S&P 500 index would have to fall more than 200 points, below 780, for the Coppock Curve to stop climbing. That’s a hypothetical +20% decline.

And that is probably one of the positive consequences of this spring rally. Even if we were to give back 50% or even 65% of the advance, the market would still be able to carve out a higher low and a higher high - the very definition of an uptrend. Such a correction wouldn’t be surprising, especially when you consider the over confidence signaled by the various sentiment measures. But it would only wash out the weak hands and allow the market to continue higher.

While the track record of the Coppock Curve is impressive it is not perfect. If you squint hard enough, you’ll be able to make out the rare two times that its upturn did not mark a significant trend change.

But even so, since many are comparing this bear market to the one that came 80 years ago, it should be noted that the Coppock Guide was one of few technical indicators which allowed for the correct navigation of the bone crushing volatility of the 1929 bear market. During the aftermath there were several intense bear market rallies that fooled many. But they were all ignored by the Coppock Guide as it fell unrelentingly into the deepest level it has ever seen historically. Only in 1932 did it correctly give the all clear.

Well, is it?

That’s what a lot of people are wondering (which has the built in assumption that this is a bear market rally and not the real thing). To get some perspective on this, I decided to look at a long term view of the Nasdaq Composite Bullish Percent Index.

If you’re unfamiliar with this type of index, it is created by looking at what percentage of the components of an index (in this case the Nasdaq Composite) are exhibiting a certain bullish pattern according to point and figure charting. To see how I use this as an indicator, check out: How to Time the Market with Bullish Percent Charts.

Here’s the long term chart of the Nasdaq Composite compared to its Bullish Percent Index:

By the way, I used the Nasdaq Composite because it is very broad with about 3000 components and it excludes a lot of the junk found in the NYSE (CEFs, convertible debentures, ETFs, preferred stocks, rights, warrants, etc.) which can skew the index, especially because of their sensitivity to interest rates.

The chart shows the tech bear market and the latest one which started in late 2007. Almost every single bear market rally top was flagged by the Bullish Percent Index (BPI) - indicated by the red down arrows. It also did a good job of finding exhaustion points during the good times - with one important exception.

The red box shows the span of time that the BPI went above 60% and stayed there. During this time, the normal relationship we otherwise see between the two charts broke down. The only argument I could think of to explain this, is that this time period was the start of a new (albeit short lived) bull market. All kinds of indicators, breadth readings and overbought metrics went into the red zone and stayed there as the stock market powered ahead - seemingly oblivious to them.

The other difference between this most recent bear market and the last is that the counter rallies we’ve seen this time around have been much less powerful than before. As you can see marked by the orange down arrows, they don’t even reach 50% BPI.

The latest BPI reached slightly higher than 62% - that the highest since early 2007 and before than, early 2004. Obviously, this latest run up is different from the previous ones. Going back to 1996 (not shown on the chart) it was rare for the Nasdaq Composite Bullish Percent Index to reach or exceed 50%. So this level is clearly significant.

So what we have to consider is, if this is just a run of the mill bear market rally, then it is over. But if it the real thing, similar to what we saw in 2003 (the red box) then the market will confound everyone and keep going higher.

According to the long term market direction guide known as the Coppock Curve, the Nasdaq is already on a buy signal (from last month). But since it tends to whipsaw much more than the Standard & Poor’s 500 Index (SPX), I’m waiting until it gives a signal. There are only 8 more trading days left in the month and if the S&P 500 can stay above 874 (3.74% lower from Tuesday’s close) then the Coppock Curve curls up.

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“I, for one, welcome our new bull market overlords.”

Is this just a really deceptive bear market rally or is it the real thing? While the debate still rages, the market keeps going and going and going… like the Duracell battery rabbit.

A reliable but somewhat esoteric long term indicator is ready to pronounce the birth of a brand new bull market. Just as long as the stock market can hang on to most of its gains by the month’s end.

If you’re not familiar with the Coppock Curve I introduced it last summer as one of the pre-requisite conditions for a new bull market. Click the previous link to learn more. The other conditions (recession, a 20%+ decline, easy monetary policy, etc.) have all been fulfilled. The stage is now set for the last piece of the puzzle.

In January I wrote a Coppock Guide forecast:

In that hypothetical scenario, the Coppock curve would turn up by the end of February 2009 by the minimum. And in March, it would turn up significantly.

I wasn’t trying to predict what the indicator would say and when so much as to show that we would need to see one hell of a rally for it to register a change of direction in the Coppock Curve. And did we ever! From the March bottom the S&P 500 rocketed up 36%. That not only surprised almost everyone, it was finally enough to force the Coppock Guide to curl up:

S&P 500 Index
Probably the most important of all the indices, the Coppock Curve for the S&P 500 Index is about to give us a new signal to indicate a new bull market. But before it can do that, the S&P 500 will have to close at or above 874 at the end of the month. That is a fairly small buffer area of 3.35%. If it can manage that, then we’ll see something like the zoomed in chart shown above.

As the 2002 false signal shows, while this lagging indicator has a fantastic track record, it is far from perfect.

Of importance is not just that we are about to see a respite in the continuous drop in the Coppock Guide but that this upturn (when it comes) will be from an extremely deep level. As you can see from the chart, we haven’t been here for a long, long time. According to the Coppock Guide, a new bull will be proportional to the bear market that preceded it. So a recovery launched from such an extremely negative level means that the new bull market will be powerful and long lasting.

Nasdaq Composite
The Coppock Guide for the Nasdaq Composite already gave us a signal at the end of April 2009. But I hold it with suspicion since in the past the indicator has not been too trustworthy. For example, going back to the last time we transitioned from a bear market to a new bull market, the Nasdaq Coppock Guide was off by a lot. It first turned up in December 2001. But that was a false signal. Then there was another signal in August 2002 and December 2002. Both were again false.

Finally, it curled up yet again in late March 2003, just as the nascent bull market was sprouting its horns. So you can understand my reticence in rushing to accept the Coppock signals from the Nasdaq index. The good news is that because the Nasdaq Coppock Curve has already turned up, it needs to do much less to prove itself and confirm the signal. In fact, we could see the Nasdaq Composite fall 7.7% to 1587 by the end of the month and it would still be enough to keep the Coppock Guide headed upwards.

Dow Jones Industrial Average
The Dow Jones Industrial Coppock Curve is also ready to curl up after topping in October 2007. If it can manage to close at or above 8210 by the end of this month (about 2% from here) a valid signal would be given.

Caveats Galore
So while, “I, for one, welcome our new bull market overlords.” we’ll have to wait at least until the end of the month to get a definitive signal from this trusty indicator. And as a final caveat, while the Coppock Guide has an enviable track record, like anything else, it isn’t foolproof.

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:

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Since the last time we looked at the Coppock Guide indicator, a few readers have been asking me about updates for it. So here it is:

Since this indicator needs monthly data, with the end of December 2008, we have another data point. The latest Coppock level is -286 which is even more extreme than the last. And it is only second to levels which we last saw in the brutal bear market of the 1970’s:

But what does that mean? Well, first, the extremely negative level means that when the signal arrives, it will be powerful. And since the Coppock Guide foretells bull markets by curling up, we are watching for an increase - even if it as small as +1. Although we’d prefer a more decisive signal, of course.

To give you an idea of how the Coppock guide responds to the market, let’s propose that for the next few months we see the following S&P 500 levels:

• November 2008 — 896.24 (actual)
• December 2008 — 903.25 (actual)
• January 2009 — 1000 (hypothetical)
• February 2009 — 1100 (hypothetical)
• March 2009 — 1200 (hypothetical)
• April 2009 — 1300 (hypothetical)

In other words, the S&P 500 goes up by 100 points each month for the next 4 months. In that hypothetical scenario, the Coppock curve would turn up by the end of February 2009 by the minimum. And in March, it would turn up significantly (+20).

You can see this on the chart at the extreme right - light blue.

Put another way, if by the end of this month the S&P 500 by some miraculous device ends at 1128, it will be enough to cause the Coppock curve to turn up the minimum +1 for a signal. That would be an astronomical 25% rise in one month. Crazy, I know, but that’s how much it would take in a short time to move the Coppock guide to a signal.

So that gives you an idea of how slow this indicator works. On the one hand it lags the market significantly but on the other hand, its signals have been very accurate historically.

Of course, this is assuming that the market doesn’t fall or tread water but rise. And it assumes that the signal given as a result is not a false one.