Trader’s Narrative

Last week we looked at the levels of cash and free credits being held in institutional and retail trading accounts in the US: Mutual Fund Cash Levels & NYSE Free Credits. I briefly touched on a research report on mutual fund cash levels by Jason Goepfert, who by the way, runs a great service at SentimenTrader. However, I wrote that:

Unfortunately, Goepfert’s research report does not take into consideration inflation or deflation but simply adjusts the level of mutual fund cash levels according to the 90 day T-Bill rate. I’ve sent him a message about this so hopefully when he’s back from vacation he can update it with this new twist thrown in.

Upon his return, Jason accepted my suggestion and lost no time in whipping up a new indicator which takes into account the added variable of inflation/deflation.

To be able to understand what this new chart is saying, it is helpful to go back to the award winning research report. In it, Jason argues that before we try to use mutual fund cash levels as an indicator, we need to adjust it for the prevailing interest rate environment. For example, in the 1980’s, with interest rates in the double digits, there was ample reward for sitting in cash. Stripping out this effect, therefore, is important because otherwise it is a distortion.

Using statistical modeling, we can determine how much cash should be held by assuming a certain level of interest (90 day T-Bill rate). After that, it is easy to compare the actual cash levels to this theoretical level to determine if mutual funds are overweight or underweight cash. Looked at this way, mutual fund cash levels are neutral, telling us that managers are neither overweight or underweight cash right now.

Alright, so what happens when we also take into account the effect of inflation or in today’s case deflation? In other words, the real rate of interest?

A completely different picture emerges. This isn’t surprising because we are currently experiencing real interest rates close to +6.5% - a far cry from the nominal rate of 90 day T-bills. Here is the inflation/deflation adjusted chart of mutual fund cash levels:
Continue reading ‘Mutual Fund Cash Levels Adjusted For Inflation’

Last week there was a lot of chatter about a technical formation called a ‘golden cross’ which is considered to have bullish implications. This is when a short term moving average (usually a simple 50 day MA) crosses from below to rise higher than the long term moving average (usually a simple 200 MA). Because moving average tend to move in lethargic arcs, these types of formations are easy to foresee.

In keeping with everyone’s watchful expectation, the S&P 500’s 50 day moving average closed at 900.54 on June 24th 2009, rising slightly higher than the 200 moving average (897.19).

Since we’ve compared the current market to the nascent 2003 bull market in many different ways: breadth, wedge formation, flag formation, Weinstein analysis, etc. It is only natural then to take a look at the golden cross that presaged the bull market in 2003:

In the charts, the blue line is the 50 day moving average and the red line is the 200 day moving average. Marked by the green arrow, the medium term moving average crossed higher than the longer term moving average in May 15th, 2003.

But does the golden cross really deserve its bullish moniker? Obviously we can’t base any conclusions on one single observation in 2003.

Vincent Delisle of Scotia Capital looked at 14 previous S&P 500 bull markets (lasting on average 49 months and rising 149%). From these only about 17% of the gains materialized before a golden cross signal was given. After 12 months of a signal the average gain was 23%, implying that a golden cross doesn’t arrive too late to provide forward returns. Delisle adds that a golden cross appears to have more validity when it occurs with a rising 200 day moving average - something we had in 2003 but do not have now.

By the way, a “death cross” is the opposite and can be seen on the above chart marked by a red down arrow.

According to Jason Goepfert of SentimenTrader, any edge offered by golden crosses is minimal. Identifying the same distinction as suggested by Delisle, he looked at only instances where the 200 day moving average is declining.

Goepfert concludes:

…the returns going forward, up to six months later, were little better than random and not statistically significant. In fact, in the shorter-term they were a little worse than random. Only when we look out a year do we see some out-performance.

But he does agree with Delisle that most ‘unsuccessful’ golden cross signals coincide with the early 1940’s and that more recent examples have had much more success. The S&P 500 was positive 11 out of 13 times since 1942 with an average annual return of 18%.

Finally, a reader was kind enough to forward a recent research report from Merrill Lynch on golden crosses. I’ve added it to the Free Trading Resource Section and you can download it from the Articles & Reports folder.

In the Merrill Lynch report prepared by Mary Ann Bartels, it continues to distinguish between golden crosses that happen with a downward long term moving average and those when the long term moving average is rising:

Of the 42 Golden Cross signals triggered since 1928, 20 have occurred with the 200-day moving average in a declining trend or lower than it was 30 trading sessions ago. These signals on average have generated 12-month returns of 13.3%.

The remaining 22 signals occurred when the 200-day moving average was rising or higher than it was 30 trading sessions ago. The returns for these signals were much lower and on average generated 12-month returns of 5.7%.

This is bullish for today’s market since the long term moving average of the S&P 500 is still falling. The report is full of insight backed by stats so I highly recommend you download it and take a look. Bartels also adds a new overlay by looking at golden crosses that happen during a recession (as defined by NBER). Signals that meet the condition of a declining 200 MA and a recession suddenly produce an average 12 months return of 23.3%.

Not surprisingly, her conclusion is that “the equity market remains in a base-building process that should lead to higher returns.”

Of course, that doesn’t mean that the market automatically heads higher and higher from here. Base building can be soul crushing. Ask any trader that lived through the 1970’s - no wonder everyone started wearing platform shoes

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?):

After reaching an all time low in January 2009, the Conference Board Consumer Confidence Index reached an all time low (again) in February 2009.

Although we haven’t seen such a dramatic fall in this metric for 42 years, historically, such troughs are signs of the coming of better times in the stock market. In fact, along with several other variables, gloomy consumer sentiment is one of the handful of conditions of a new bull market.

Now we are seeing an almost equally forceful recovery with the latest Consumer Index data from the Conference Board:

The last time we saw this kind of jump in the Consumer Confidence was in early 2003 - coinciding with the bear market’s end. The stock market certainly cheered when the surprisingly higher number was released by the Conference Board on Tuesday. And it is confirmed by other sources like the Gallup poll of US consumers showing a marked improvement since February 2009:

Source: Gallup Consumer Poll

So the question is, is such a sharp recovery in consumer optimism bullish for the market? or bearish?

In a recent column, Mark Hulbert argues that it is bearish. He compared the index with subsequent stock market returns (month, quarter, year, and 2 year periods). The relationship Hulbert found was an inverse one, where falls in Consumer Confidence lead to rallies in the market (and recoveries in Confidence lead to lower returns in the stock market). Given the contrarian nature of the crowd, this isn’t surprising.

But it isn’t the whole story.

James Stack, editor of the InvesTech newsletter and Jason Goepfert of SentimenTrader both focus on something entirely different. The Conference Board releases several different sub-sets of data. The one most people concentrate on is the Present Situations number but there is also the Expectations Index, which asks the respondents to look ahead to 6 months in the future:

They both keep track of another variable: the Expectations minus the Present Situation Index - in other words, the difference between how consumers think they will fare in the future and how they are doing right now. And interestingly enough, this net variable is actually positively correlated to the stock market - and a leading indicator.

I highly recommend both sources. To see the net Confidence chart take up their free trial offers:

You can get a free 14 day free trial of SentimenTrader.

And you can get a free sample of InvesTech’s newest report here.

Money market asset levels fluctuate much less than their equity counterparts. The general trend for cash holdings is to increase steadily every year. There are some cyclical effects for bear and bull markets. As people become fearful in the face of a bear market, they horde money and as the become convinced they are losing money by not being invested in a bull market, they reduce their cash holdings.

This bear market has given us a lot of unprecedented market situations. We are now seeing a rare exception to the norm of equity fund assets dwarfing money market assets. This has been caused by a double whammy. As the stock market has been pummeled mercilessly, losing 60% of its value since late 2007, the asset value of equity funds has shrunk. And on the other side of things, retail and institutional investors consistently raised their cash assets. In September 2008 I pointed out that there was an unmistakable stampede towards cash as retail investors hoarded cash. Not surprisingly then, in November 2008, we saw a rare occurrence: more assets sitting in money market funds than in equity mutual funds:

Source: Bloomberg Chart of the Day

The last time this happened was 16 years ago, in September 1992. The data for April isn’t available yet but I’d bet it shows money market fund assets almost equal to equity fund assets. Not because people have put the cash to work but because the market has been able to hang on to gains and thereby increased the value of the equity assets.

But as Jason Goepfert of SentimenTrader points out, this is not an automatic buy signal for the market: A Major Buy Signal! Well, Maybe… All we can definitively say is that there is a massive load of cash just sitting on the side, waiting.

A build up of cash is normal in a bear market but before we can transition to a bull market it needs to be put to work. As people become convinced that the worst is behind us, they start to take more risk and begin to put their cash into the market. So unfortunately, just noticing a massive pile of cash doesn’t really help us unless we can somehow pinpoint when and with what intensity this billowing mass of liquidity will start to be invested in the stock market.

But to give you an idea of the sheer monstrosity of the potential tsunami of cash, consider this: it currently represents 50% of S&P 500 total capitalization. Needless to say, that is jaw dropping. As it is put to work, even in a trickle, it will put an impregnable floor on almost all equity indices and then drive prices higher. When that may be, can not be determined by this metric itself but by other technical, monetary and sentiment measures.

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