Trader’s Narrative

Take a look at these two charts. They are both of the S&P 500 Index (SPX), they both span roughly the exact same time period, from the start of the year to mid April. But only one of them shows the current market. Which one is it?

And what time period is the other one showing?

Hey, no cheating!

Take a careful look at both and notice the uncanny similarities. They both top in early January and then trend down until the inflection point in early March. And then there’s a more or less orderly march upwards:

Have you made up your mind? Give up?

The bottom one is showing the current market. That was the easy one. What about the other?

The first chart is from 2003, showing the bear market in its last throes. Of course, as you know, from then on, the S&P 500 continued to climb higher and higher. Similar to today’s market, the technical pattern appeared to be a rising wedge. But this only threw off the bears even more as they waited and waited for the eventual pullback that never really came (well, until after 6 years that is ).

Honestly I have no idea what significance this has, if any, for the market right now but I’ve never seen this much synchronicity between two exact time periods. What do you think?

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About a year ago I wrote about how the stock market resembles a dog on a leash. Prices fluctuate from the trend, sometimes in extreme spikes which mark important inflection points.

I thought I’d revisit the idea by taking a long term look at the S&P 500 and comparing how it has fared to its own long term (200 moving average). To equalize things and make it comparable over time, I expressed the divergence from the mean as a percentage:

Looking at the data from 1950 to present, here are the rare times when the S&P 500 Index (SPX) traded at an extreme relative to its simple 200 day moving average:

• July 26th 1962 -22.62%
• May 26th 1970 -23.18%
• October 4th 1974 -28.58%
• October 19th 1987 -24.75%
• Sept 21st 2001 -22.11%
• July 23rd 2002 -26.98%
• October 7th, 2002 -23.84%
• November 20th 2008 -39.79%
• March 9th 2009 -36.53%

The dates should be easily recognizable since they correspond to almost every single major turning point in recent market history. The numbers represent the percentage relative to the long term moving average. So on July 26th, 1962 the S&P 500 traded 22.62% below its simple 200 day moving average.

Looking at the data this way, you easily gain perspective on just how epic the recent market action has been. Not since 1929 has the market veered off so dramatically from its long term path. Put another way, if the November 2008 low doesn’t mark a significant inflection point, it will be the first time.

A quick back-of-the-envelope calculation shows that 60 trading days after these dates shown above the market is always higher, sometimes significantly:

• 7.95%
• 10.03%
• 12.93%
• 10.72%
• 6.14%
• 9.54%
• 8.3%
• 20.9%
• I’ll revisit this when 60 days have passed from March 9th, 2009

Even if we assume that the November lows will indeed mark a significant low for the S&P 500, there is no reason to believe that prices would simply climb higher from here onward. We could enter a protracted sideways market, or we could also slowly drip lower, revisiting the previous lows. But it is difficult to argue that what we have just witnessed isn’t but a monumental and rare market event that has characterized important turning points in the past.

Head and shoulder formations are one of the most fundamental technical patterns. They are arguably one of the easiest to recognize on a chart and are almost always found at turning points in price. Right now we are seeing the S&P 500 Index (SPX) carving out what looks to be the right side of a head and shoulder formation:

The defining element of this patterns is not only the striking silhouette it leaves behind on price charts but also the volume that accompanies it. For downtrending reversals, like this one, we want to see heavy volume come in as the right shoulder is created. Ideally, a burst of activity both in price expansion and volume cements the pattern as it decisively breaks through the neckline.

Volume
It remains to be seen how this will play out. But if prices do continue to firm up, we may see this classic pattern play out. If it does, watch for the corresponding volume. You have to be careful to not read too much into the sudden volume collapse at the turn of the year since that is normal.

Neckline
The slope of the neckline is clearly downward, which is normal for an inverse
head and shoulder pattern. Anything from horizontal to downward is fine for such a neckline. An upward sloping one however, would be a bad sign.

Reversal or Continuation
Although most people categorize head and shoulder formations as reversal patterns, it is possible for them to be continuation patterns as well. There is a key difference.

The current pattern developing in the S&P 500 chart above, however it resolves, can not be a head and shoulder continuation pattern because in a downtrend, this would have to take the shape of a head and shoulder top (not bottom).

In other words it would have to look like an M not a W in shape. The other difference is in the required volume pattern. Instead of it showing more volume on the left shoulder and head and less on the right shoulder, a continuation H&S pattern will show diminished volume on the three points.

Meltingpot
The prevailing sentiment is too optimistic right now, which from a contrarian point of view makes it less likely to make this a lasting bottom. But sentiment is just one aspect of the market. There is also technical and fundamental. And some would say fund flows.

So this potential head and shoulder formation is just one more aspect of this crazy market that we have to consider and throw into the pot.

The Present Situation Index of the Consumer Confidence survey from the Conference Board fell to 29.4:

That’s lower than the 2002 bear market bottom. Lower than the confidence level in 1991. Lower than the early 1980’s. Even slightly lower than the darkest days of the 1970’s bear market.

As far as I can tell, the current reading is the lowest that this survey has seen since it was started in the 1960’s!

The Conference Board surveys 5000 US households and their answers to questions about their employment, spending and

From a contrarian perspective this is good news. And this is just another in a long line of extreme pessimism from the average consumer and investor in the US. But from another perspective we need to see at least the start of a change in the doom and gloom before things get better.

If you have a really long term view and don’t particularly care about further declines in the short term, then this is a good signal. But if you want to avoid such potential losses then you have to give up trying to anticipate the market’s exact inflection point and wait for confirmation by giving up some gains to the upside.

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.