Trader’s Narrative

While we were in the thick of the 2008 bear market, I looked ahead and provided a road map for the conditions of a new bull market. Among them was the Coppock Guide.

At the beginning of the year I provided a hypothetical projection to demonstrate that the stock market would have to go on one hell of a bullish rampage to pull the Coppock Curve up from its death spiral. A few months later, a rally that almost no one foresaw took us 40% higher.

Then at the beginning of May, I reiterated that a Coppock buy signal would be arriving by the end of the month, as long as the market held it together and didn’t fall any further.

Well, we are finally here and the Coppock guide has provided a definitive signal by turning up - this is the buy signal that we had been anticipating:

I know, I know, it is impossible to see on the chart but believe me, it is there. To see a zoomed in view of the chart, check out the previous links. The S&P 500 Coppock Curve stopped going deeper into negative and actually increased from -417 at the end of April to -409 at the end of May 2009. All it would have taken was a one point increase but we got 8 points.

Now that we have a signal, what does it mean?

Well, obviously, it means we have the wind at our backs. The Coppock Guide has been a reliable indicator of the long term market trend. But, like everything else, it isn’t full proof - as you can see from the false signals. So with that in mind, here are three major observations:

First: The signal isn’t just for one index or market. We are seeing the Coppock Curves for many different markets around the world turn up at the same time. The Australian All Ordinaries, the Nikkei, the FTSE and all 3 major US market indexes: S&P 500, Dow Jones Industrial and the Nasdaq.

While most of the signals are occurring concurrently, some like the (Chinese) Shanghai market and the Nikkei gave signals last month. Check out all the major world markets to see how just how much confirmation we are getting from them.

Second: Valid signals are those that turn up from under the zero line. And historically, the deeper the level at which the signal arrives, the more strength the following bull market has. This most recent signal is coming from a deeply oversold level - the most since 1938 (-417 to -400) and even further, 1932 (-643 to -616).

Of course, that doesn’t mean that from now on the market has only one direction - up! Based on the sentiment and technicals covered before (Wedge Formation), I think it is probable that we will head down, but won’t break the previous low. This will allow for the long term moving average to flatten out and begin to support, rather than hinder prices from going higher.

Third: Although the Coppock Curve has given its share of false signals, we haven’t seen any occur when the metric has curled up from such a deeply negative level. There are very few examples of this, so it is difficult to extrapolate a rule but so far, this has been the case.

The last time I revisited the Chinese stock market, it was in the throes of a major bear market. Fast forwarding to now shows things have only intensified with the Shanghai composite trading at less than half of its top in October 2007:

While we quibble about a percentage point here and there to see if our market decline fits into the classic definition of a bear market, there are no qualms regarding that in China.

Support?
The scary thing is that even after falling so much, the index is still far from major support areas. If you look at the link above, you’ll see a long term chart of the Shanghai composite going back to its founding. According to that chart, significant support is somewhere in the vicinity of the 2000 level. That would put a potential fall to almost 70%!

I have no idea if that will happen but the Chinese stock market certainly has precedent. It is not for the faint of heart. The Shanghai Composite can go ballistic: rising as it going ten fold in the span of a year (1991-1992) but it can also lapse into deep stagnation, as it did from 2000 to 2007, treading sideways.

Dire Portents
But what interests me more is the portent of such a dramatic decline for the price of crude oil. From what I read, China holds significant responsibility for the current price of oil because of its voracious appetite. But if the stock market is a forward discounting mechanism, that means that the Chinese economy is about to decelerate or even go into a tailspin.

The corollary of that is lower demand for oil and, if I remember Economics 101 correctly, that would mean a lower oil price - all things being equal.

According to Peter Brimlow from Marketwatch, the last bullish newsletter has abandoned China. The newsletter, Cabot China & Emerging Markets Report, has been the biggest bull riding the bull market in the far east to a stunning 90%+ gain in the past 12 months.

Editor Paul Goodwin recently wrote:

We’re a little self-conscious about calling ourselves BRIC (Brazil, Russia India, China) investors when all of our current recommendations are based in China…A buying panic! That’s exactly what’s been unfolding. [But] The bears have taken control! After a tremendously profitable run from the August lows, the Halter USX China Index (HXC) finally gave way to selling pressures, decisively breaking down through its 50-day moving average last week. This turns our China-Timer negative …

He recommends only one China stock right now: Suntech Power Holdings (STP). Which just happens to be one of the handful of solar power stocks that I highlighted a few months back. Since I mentioned it, STP doubled (from $35 to $70).

China’s stock market ignored all that talk in the summer about a bubble and continued to climb higher. Even a stamp tax increase imposed at the beginning of June this year didn’t impede its meteoric rise:

Usually the increase in transaction costs have been an effective way for the Chinese government to control rampant speculation in their stock exchange. See a history of previous stamp tax increases and their effect on the Shanghai market.

By reaching 6000 in mid October, the index has now multiplied itself 6 times (off its low in 2005). Yet that is still not as impressive as its last bull market in the early 90’s.

If you’re still holding on to the bearish thesis on China you have a new vehicle with which to short China: the UltraShort FTSE/Xinhua China 25 ProShare (FXP). This new ETF provides you with twice the inverse of the Chinese market. But keep in mind that that is merely its goal. It also comes with a hefty 0.95% MER. And remember, you’re going long to establish a short position!

As well, the UltraShort FTSE/Xinhua China 25 ProShare (FXP) isn’t really exposing you to actual Chinese shares. The only way I know that you can get real Chinese equity exposure through North American exchanges is through Morgan Stanley’s China A-Share Fund (CAF).

A “stamp duty” or “stamp tax” is an archaic form of tax which is basically a prerequisite for a document to become legally binding. For example, where levied, you would have to pay a stamp duty when you buy a house to have the deed reflect the new buyer’s claim on the property. Or when you buy stocks, to reflect the new owner.

Only a few developed places levy such taxes anymore: UK, Ireland, Australia and Hong Kong (now part of China). Usually the level of the tax is left untouched. In England for example, it has been at 0.5% since 1986.

But in China not only is it levied, stamp duties are one of the dials that the communist beaurocrats love to tweak up and down. The latest “tweak” was the announcement last week that it would be tripled to 0.3% effective this Wednesday (June 6th 2007).

I showed this graph before to demonstrate that there had been an even crazier bull market in China in the early 1990’s. In this new version it shows the dates of the previous stamp duty or stamp tax changes:

I think it is fairly probable that this increase in transaction costs will greatly reduce the mania in the Chinese equities market. It may not cause a full blown crash - although the market is down overnight as I type and is at a five week low. If you want to play the Chinese market here’s how to play it from the US.

The real question now is, where will all that money flow next? You can’t dam capital. It will find its way out, one way or the other. All you can do is try your darndest to channel it.

If they ask me (and they haven’t) I would say open the gates so that the Chinese can invest outside China.