Richard Jennings, Titan Inv Partners
Markets are, by their very nature, forward looking beasts. They are largely unconcerned with what has been and gone, rather they want to look to the future – be it 6, 12 or 24 months out. This is essentially the reason that if a company beats earnings estimates when it reports, then it may still get beaten up. If the outlook for the next period suggests that the trend won’t continue, then the “red pen” will often come out.
Of course, markets are just the aggregated effect of the behaviour of participants within them, many of whom have short memories or little interest in history, preferring instead to look for “the next big thing”. However there are some who prefer to take a more measured approach and who are happy to look back and see what lessons can be learnt from the price action of the past. We are one of those.
Over the past couple of years a series of historical indicators have been wheeled out for the markets consideration. In the summer of 2013 we saw the emergence of the rather ominously named “Hindenburg Omen” – an indicator that had made few appearances over the previous decade but which, by mid-August 2013, had triggered 11 times in just a 50 day period. The dire predictions of the grandly named indicator (which effectively measures volatility of Stock quoted on the NYSE) did not come to pass however and we did not see a sharp correction in US equities until early January 2014 and that we flagged almost to the day, even then it was a fleeting move lower (see here – http://www.spreadbetmagazine.com/blog/titan-investment-partners-why-we-have-moved-to-a-maximum-net.html)
More recently, in February this year, much was made of a chart of the Dow Jones index drawn from 1929 (in the period preceding the market crash) and that was overlaid onto the chart of the current market. It’s true to say that there were striking similarities between the two charts but once again the anticipated cataclysm failed to materialise.
One of the reasons that these indicators predictions have failed to materialise is the prevailing macroeconomic winds, which in modern times, has been dramatically influenced by the long-term use of Quantitative Easing or QE, by the Federal Reserve and its central banking allies creating artificially low interest rates, distorting asset prices and flattening the yield curves across the globe. As we heard last week however, the Federal Reserve is happy to continue its present tapering or paring back of its support for the market and as such the end of central bank life support is in sight.
With that thought in mind it is very interesting to see another long term indicator being brought to the fore by two widely read US finance blogs, Zero Hedge & Of Two Minds. Both have commented on the Coppock Curve and its relationship to the current S&P 500 index.
The Coppock curve, named after its creator ESC Coppock is a very long term momentum indicator designed to operate over a monthly time frame or scale. It is effectively the sum of a 14 month rate of change added to an 11 month rate of change which in turn are smoothed out into a weighted 10 period moving average.
Coppock, a Texan and the founder of Trendex Research, was an economist by profession who was asked by the Episcopal Church to identify buying opportunities in equity markets for long-term investors. Coppock believed that market downturns were akin to bereavements and proceeded to turn the tables on the bishops of the church in asking them how long parishioners took to recover from the death of a loved one. The answer that came back was 11 to 14 months hence the time frames for the indicator. This methodology might sound odd at first but given that as we stated above, that markets are the sum of the behaviour of their participants, most of whom are still human, then it’s not a stretch to see how their emotional psychology would influence their investment behaviour.
The indicator was first noted in public by the respected Barrons magazine on October 15th 1962 and so it has been around for a considerable length of time. Designed to identify trend changes/buying opportunities, the indicator does seem to have an uncanny habit of predicting market corrections. However in order for it to identify an entry point to position for this, the market will need to have pulled back sharply from a prior peak.
The chart below (sourced from the blogs mentioned above) plots the S&P 500 Coppock Curve starting in 1996 against the Coppock Curves for previous secular & deflationary bear markets drawn over the past 150 years, including that seen in the Nikkei since 1986 .
The authors postulate that financial engineering (Central Bank intervention) limited pull backs in the S&P Coppock Curve (the broken red line) in 2005 and again in 2011. But, interestingly, do not see this a preventing a pull back into what they term an intermediate trough in the early part of 2015 and which would of course be the entry point that the signal was designed to predict.
Readers may like to note the sharp decline in the S&P Coppock curve that was seen in 2007/2008 and the rally that followed from 2009 once Central Banks had tuned on the metaphorical printing presses.
One interpretation of the data in this chart is that we could see a correction of some 30% in the S&P 500 between now and March 2015 with potential for a rally into the first half of 2016 thereafter. Given the five year bull run that US Equities have enjoyed and the almost unprecedented gains made by many investors over this period they would do well to consider the validity of this chart and heed its message – “Markets are both cyclical & emotional and corrections like death are an inevitable fact of life.”