Trader’s Narrative

Last week we reviewed the latest position of Lowry Research on the stock market: Turbulence Ahead, Uptrend Intact. One of the major reasons that Lowry’s continues to believe in the health of the market and a continuation of the uptrend is the lack of selling pressure.

Lowry measures this through their proprietary metric called (what else?) Selling Pressure. It remains low and falling, helping to support the thesis of a healthy market rally. According to Paul Desmond: “Every major market top in Lowry’s 76-year history has been preceded by a sustained rise in selling pressure. With selling pressure recording a new 12-month low within the past two weeks, no such rise is now evident.”

This has got to be frustrating for the bears. But it is also unbelievable to the large number of participants in the market who continue to look at the current price levels as a mirage. The US retail investor is not venturing out into equities, even after watching the stock market climb a wall of worry inch by inch.

This has been and continues to be the most hated stock market rally that I’ve ever witnessed. In any case, it is comforting to confirm Lowry’s proprietary measure of selling pressure with a similar measure from InvesTech.

Click chart to see larger version:

Source: InvesTech

Jim Stack, the writer of InvesTech has a handy checklist for new bull market conditions. One of them is this metric. And along with the rest of the list, it has been flashing a bright green buy signal for a few months.

As well, the month of November has been historically one of the best months for the S&P 500 since 1950. I’m not sure that another 20% rally by year end will convince the retail investors to risk their money in the stock market again. But we may just see that.

When a widely popular site like icanhascheeseburger.com puts this up, it’s safe to say that not only has the concept reached everyone, but that “recession” has seeped into the very depths of our collective psyches:

Source: icanhascheesburger.com

Of course, as a contrarian indicator, the fact that we are in a recession may in fact be a condition of the new bull market.

Continuing with the series, here is the fourth condition of a new bull market as outlined by Jim Stack of InvesTech:

I’ve hesitated to mention this technical indicator since I started writing this blog because it is almost too good. It is one of the few that have an uncanny ability to find the start of almost all major bull markets. So you can understand why I don’t want to run the risk of ruining it by popularizing it any more than it is. And it is not popular at all.

In fact, compared to say the RSI or MACD, the Coppock Guide is an esoteric and rarely mentioned technical indicator. It was created by Edwin S. Coppock some 50 years ago and although it is followed closely by a very small group of technical analysts, its calculation is not complicated at all.

You can keep track of it yourself. Here’s the recipe: you need historical monthly Dow Jones Industrial data. You add the 14 month ROC to an 11 month ROC, then you take a 10 month (simple linear) weighted moving average of the result. That’s it.

If you’re mathematically astute, you’ve already noticed that it is just another oscillator. Here is the chart of the Coppock Guide for the past few years, courtesy of InvesTech:

How is the Coppock Guide interpreted?
The most traditional interpretation is to recognize a buy signal when the Coppock Guide curls up while it is below the zero line.

It can also provide sell signals, although these are less frequent. If the Coppock curve makes a double top formation without first having come down to the zero line (or below it), the market is in for a seriously brutal bear market. You should be able to find one such occurrence in the chart.

So you can see why I think it is almost too good to share. In its history, only 4 false signals have occurred. That’s an 83% accuracy rate.

What is the Coppock Guide saying now?
The good news is that the Coppock Guide is in negative territory projected to fall into negative territory this month. So now any upturn can potentially give us a buy signal. The bad news is that this may happen next week, next month or next year.

The key factor is an upturn. But that can happen from an incredibly low level, like say in 1974 or 1932 (not shown) or it may happen just under the zero line, as in 1994.

Although no indicator can give a full iron clad guarantee, when the Coppock Guide turns up it would totally skew the probabilities towards a new bull market. As always I’m keeping a close watch and now that “the cat is out of the bag”, you can too.

Continuing the installments of what conditions precede new bull markets, here is one that should be very obvious.

Jim Stack says that the Dow Jones Industrial should drop at least 20% from its top. Here’s a chart of the Dow Jones and the S&P 500 from their respective tops to the bottom in March:

Although the Dow is still the most commonly used index for the stock market, I also added the S&P 500 to the chart. Since it uses capitalization weight it is a better index.

The Dow Jones Industrial fell 16.4% from October 2007 to the March 2008 bottom. The S&P 500 fell a bit more: 18.64%.

If we exaggerate the constraints and rather than the close, use the high and the low, we get a 20% drop for the S&P 500. But still not for the Dow - it only reaches 18%.

In any case, the point isn’t to “cheat” to be able to reach some synthetic level. Lets face it, although most people put the classic definition of a bear market as one that has fallen 20% or more, there is nothing really magical about that level.

Much more important is the fact it represents a wash out of sentiment because if a major index like the Dow or S&P 500 falls 20% or more, then weaker stocks will fall much harder.

Conclusion
Technically, this condition isn’t met.

Here is the second installment of the conditions that precede new bull markets, as put forward by Jim Stack of InvesTech:

“Formal” Recession - confirmed (not just feared) by media headlines. Once again, this reveals the importance of being a contrarian investor… buying when no one else wants to. Historically when you see “RECESSION!” in the media headlines, it has often been the time to back up the truck to start loading up on stocks.

According to the data from Google Trends, there was a peak of “recession” headlines or mentions towards the end of January 2008:

I thought there was an increase towards the end of the year in 2007 but that was before the rate again doubled within the first month of the new year. You can see the same chart for mentions of “recession” before the spike in January.

But whether we are or were in a recession depends on who you ask. The most accepted answer comes from the National Bureau of Economic Research (NBER) and they have yet to confirm anything. But they always do so after the fact, which isn’t all that helpful anyways.

According to the Conference Board, the “data certainly reflects a weak economy, but not one in recession”.

The Recession Buy Indicator
The Recession Buy Indicator is an intriguing indicator used the veteran stock market newsletter writer, Norman Fosback. It is made up of four indicators which are “coincident” - that is, neither leading or lagging but a measure that moves at the same time as the economy.

These four are: manufacturing and trade sales, personal income, non-farm payrolls and industrial production. These are the same measures used by the NEBR to pinpoint recessions.

According to Fosback, there is a buy signal when each of the components is below its rolling 6 month high. That is the case right now since the coincident index has not gone up since October 2007.

Coincidentally I wondered out loud back in mid September 2007: Are we in a recession already? That may turn out to be accurate.

This Recession Buy Indicator gives infrequent but very good buy signals. There have only been only 4 in the past 30 years but they provided 30%+ annual returns on average. The validity of this indicator comes from the historic pattern of the stock market hitting a major bottom approximately six months after the economy enters into recession.

Like all historical patterns though, we don’t have a guarantee but a picture from the past that this is what has happened on average. The exceptions are important. For example, this indicator gave a buy signal in February 2001, which if followed, produced a tremendous amount of loss and pain. The stock market bottomed almost two years later in early 2003.

Conclusion
It’s difficult to tick this condition off as being met since the NEBR has not officially labeled a recession. It may or it may not. But going by everything else, it would seem to have been met.