Trader’s Narrative

The Coppock Guide. Just a while ago no one knew it even existed. I’m willing to bet even if you mentioned it in a room full of TA buffs, you would get quizzical looks all around.

But now suddenly it is the belle of the ball! Everyone is talking about it. There is a buzz in the blogs, Bloomberg, MarketWatch (WSJ) have stories on it and even CNBC’s Fast Money, which normally has the attention span of a fruit fly gives it a mention (see below for video). To be honest this is exactly what I was afraid of when I first hesitatingly brought it to your attention in Conditions of a Bull Market. I’d rather it remain the esoteric indicator it used to be (hopefully everyone will forget all about it).

The question remains: is it useful?

I tend to think so but some disagree.

Mark Hulbert looks back all the way to 1896 and calculates the success of Coppock Guide signals on the Dow (see article). His conclusion is that the returns are not indicative of an edge.

However, what Hulbert doesn’t point out is that although the Coppock Guide for the Dow Jones Industrial may be a poor indicator, that doesn’t mean that it is for other, more respectable indexes like the S&P 500. What Hulbert does point out in a subsequent article is that even for the Dow Coppock numbers, the two false signals in the 1930’s skew the results and if we look at more recent data, the indicator does have an edge. So the question is how relevant is the 1930’s to the current market?

Guy’s analysis at the Technial Take also falls into the same trap as Hulbert by looking at the Dow Jones Industrial. I don’t want to rehash why the Dow is inferior to the S&P 500 (price weighted vs. capitalization weighing and small sample size of 30 vs. 500). The only time I give the Dow more respect is in the Dow Theory analysis of the market.

On the other side, there are those that see the Coppock Curve as a valuable guide:

James Stack of InvesTech is one of them. Formerly an engineer by training (who worked for IBM) Stack’s whole approach is a blend of quantifiable edges (whether technical or fundamental) and sentiment analysis. But he doesn’t rely on the Coppock exclusively.

Another is Steve Leuthold of Leuthold Weeden Capital Management. He calculates a similar indicator that he calls the VLT Momentum (”very long term”). I consider Leuthold as one of the ‘grey beards’ who get my respect for their successful navigation of the market over decades. Recently Leuthold has turned even more bullish (after nailing the March low).

Next is Jason Goepfert of SentimenTrader. Recently Jason did a complete analysis of the Coppock signals (using the S&P 500) and showed that it has a definitive edge, especially on a risk adjusted basis. To see the data get a 14 day free trial and take a look.

In the end, the headline is rhetorical because I’m not really going to defend this or any other indicator.

First of all, it is just that, an indicator, with all the inherent flaws and limitations. I don’t expect anyone to exclusively trade off it. In fact I think that would be nuts.

Second, one has to just look at the data. How you want to take advantage of the Coppock Curve, if at all, is really up to you. Above you’ll find enough information to make up your own mind. But treat it as a starting place and do your own research. Then drop me a note - whether positive or negative.

Finally, the Coppock Curve is just one of the conditions for a new bull market - I’ll cover the others soon. I pay much more attention to the weight of indicators, rather than just any one in particular, no matter how impressive its historical performance may be.

Here’s an incredibly shallow analysis of the Coppock Guide (what else did you expect from CNBC?):

The last time we saw the McClellan Oscillator at an extreme was in the first week of the new year. Back then, for both the NYSE and Nasdaq, it reflected a very overbought market - so much so that it was a decade high (see long term charts in previous link). We now know that the signal it provided in early January was correct as the S&P 500 index quickly reversed and fell from 940.

Now the McClellan Oscillator has swung to the other extreme and is plumbing depths rarely seen. This indicator, is of course, a measure of internal market health. It is a measure that uses advancing and declining issues in a market to find overbought and oversold oscillations.

Here’s a chart of the McClellan Oscillator (Ratio Adjusted) for the NYSE:

Since there is so much non-common stock securities trading on the NYSE these days, I always look at the Nasdaq data to make sure that they aren’t distorting the picture:

According to this indicator, we are close to a ‘wash out’ scenario in the market. And it couldn’t come at a better time for the bulls because the market is sitting right now at support. The McClellan Oscillator’s extreme low level may help the market to hang on by its very fingernails by buttressing it exactly when it needs the support most.

We are starting to see some shifts in sentiment that reflect the sort of pessimism that usually accompany market bottoms. While the Dow Jones is below the November lows, I’m not convinced because it is not capitalization weighted and it represents a very small sample size of 30 companies. I’m giving much more weight to the capitalization weighted S&P 500 index which has yet to convincingly break support.

Another possible scenario is for the market to pierce the November lows, trapping new bears and crushing them as it bounces up. Always remember that the market is no one’s friend, and it doesn’t owe you anything. In fact, more often than not, it is there to distribute the most amount of financial pain, to the most number of participants.

Believe it or not… welcome to the new bull market. Calculating from the depths of the November spike down (741.02) the S&P 500 has now rallied 20%+. Which means that technically, we are now in a very young bull market. The bear market lasted around 408 days and cut the index by more than half (52%).

Whether it survives to become a powerful bull or dies stillborn as merely an especially strong counter rally, is another question. One that at the moment no one can truly answer. But we’re seeing more and more signs that things look ok:

• historical 10 year returns
• Ford valuation model
• previous bears coming on board: Fleckenstein, Leuthold, Ritholtz, Kass
• etc.

Here’s another: the McClellan Summation Index has now curled up to form a bottom. And from a level last seen in 1998:

We may get confirmation of this nascent bull market in a few months time from other sources like the Coppock curve. But until then, only the brave (or foolhardy) should apply.

The picture shows one of the famous “Osborne” bulls that dot the landscape in Spain. They were originally used as massive billboards to advertise a sherry made in Jerez (a region in Spain) by the name of Veterano. After a law prohibiting the advertising of alcohol the government tried to take them down but there was an outcry from people who had by then come to see them as a cultural icon. A compromise was reached were the red lettering of “Veterano” was covered with black paint.

Interesting factoid: many of the statues have a couch or mattress directly under them as the folklore goes that couples that um… couple, under the sign will receive the fertility of a bull and conceive a child.

Just got word that Tony Oz is thinking along the same lines and believes the market is near a significant bottom here. He bought a bit over $500,000 worth of SPY today and will buy more if the market declines again.

His reasoning includes the market having seen capitulation, pessimistic sentiment and he also points to the RSI which has fallen below 20. Watch the 9 minute video for more:

I’m glad to see someone like Tony Oz confirm my own thinking that we are close to a bottom - otherwise, we might as well just flee to the hills and look for a nice cave to hunker down in. Unlike, Jim Cramer, Tony Oz makes infrequent public market calls, so when he does, it merits attention.

Poor Cramer, he just may come to regret his somber advice for people to get out. But then again, knowing him, he will have no problem in sweeping that under the rug, along with all his other unprofitable calls which he never revisits.

I took a few days off (hope you didn’t miss me too much). Let’s catch up by looking at the important sentiment developments:

ISE Sentiment
I mentioned the ISEE during last week’s sentiment overview when it increased slightly as the market fell, showing that retail option traders were seemingly not worried. Even more bizarre, during the past shortened trading week as the market staged a strong recovery, the ISEE value actually fell.

Part of the explanation for this aberrant behavior may be that I’m looking at the “All Securities” data for the ISEE, rather than the “Equities Only”. The latter measure showed no similar increase for the week of May 23rd.

CBOE Put Call Ratio
Again, in contrast to the ISEE’s behavior, the CBOE equities only put call ratio showed this past week that traders became more bullish as the market rose. Although not the ideal, this is the normal pattern.

The put call ratio fell to 0.59 - approaching levels of bullishness which have previously caused stock market rallies much difficulty.

Hulbert Newsletter Sentiment
According to Mark Hulbert, the Hulbert Stock Newsletter Sentiment Index (HSNSI) has almost doubled from +16.2% to +31.2%. And it did so from mid May to the end of May 2008. Although this is an significant increase, I don’t think it presents us with a situation commensurate with market top.

To give you an idea, during mid to late April 2006 the HSNSI reached +73.2% - when the S&P 500 index soon after fell from 1325 to 1225. And during the bear market bottom in October 2002, it fell below -60%. So all I can say from the current reading is that more newsletter editors are jumping into the bullish camp but still not enough to cause serious problems.

AAII
According to the American Association of Individual Investors’ sentiment survey, there are now 31% bulls, down 15% points from last week’s 46% bulls.

This is a welcome reprieve, especially as it is accompanied by a lower market. Had this key sentiment survey remained unchanged or actually increased in bullishness, the sentiment tone would be definitely different.

Investor’s Intelligence
Similar to the AAII survey, the II sentiment measure fell from 47% bullish to 37.9%. I was worried about this since last week’s number was almost 50%. The keepers of this measure, the editors of ChartCraft, Burke and Gray agree with my general take on the market’s sentiment:

“While the sentiment is moving away from a bullish reading it is not yet close to calling for a market top”

I continue to see a lot of long term positives for the market and continue to believe the March bottom to be a major one. What I suspect we are seeing is a (hopefully) shallow pull back or pause before the next leg up.

Magazine Cover Indicator
Uh oh. Anyone long crude oil or any traditional energy related equities should be worried.

The Economist isn’t the most widely read publication but their cover stories still do carry weight - in a contrary sense most of the time. The price of crude has already tapered off and I suspect this will be either a significant top or at minimum a longish pause.

There are, of course, other signs that the whole energy rally has run its course. There are several technical signs, including the increasingly sharp slope of the trendlines as well as ominous candlestick formations.