"Traders keep anxious eye as key indicator offers 'buy' signal
By Jennifer Hughes, Anuj Gangahar and Michael Mackenzie
Published: June 5 2009 19:51 | Last updated: June 5 2009 22:25
It was not even another green shoot; just a slight wiggle in a long downward line.
But news that the revered Coppock indicator has finally hinted at a “buy” signal in a number of the biggest stock markets was a talking point in equity markets this week.
The global stock rally is edging into its third month, but its future is little clearer, leaving watchers to cast around for clues as to what might happen next. Enter the Coppock indicator, a measure of long-term market sentiment and applicable to any stock index. It signals a buy signal when it turns upwards from a value of less than zero. Traditionally calculated every month, it began hinting at an upturn in May. Followers have now seen buy signals in markets ranging from New York to London to Tokyo.
Measuring the ‘mourning’ period after downturns
The Coppock indicator is a means of tracking market emotion through the extremely unemotional science of technical analysis.
The measure was first constructed by E.S.C. Coppock in 1962. Mr Coppock looked at bear markets as akin to personal bereavements and decided to use the average time it takes to mourn a death (11-14 months) as the basis for his measure.
Accordingly, the Coppock indicator is the sum of a 14-month rate of change in an index and 11-month rate of change. This is then smoothed by a 10-period weighted moving average.
When the curve starts to increase from less than zero, it is a “buy” signal. The deeper the indicator below zero, the stronger the rally. The measure has a strong track record, correctly predicting 16 US rallies from 17 buy signals in the post-war era.
There are fears however that the extreme moves seen in markets last year mean this could be one of those rare false buy signals. Because last year’s markets were so volatile, the curve could tilt higher as data from last year fall out of the measure, even if the market were now to decline slowly for a few months. This would, of course, reflect less bearish sentiment, but that must be measured against the panic mood of last year.
The widespread interest in the indicator, named after its inventor (see below) is a sign, too, of just how nervous watchers have become about predicting short-term moves. In normal times, analysts are happy to discuss their expectations for the next six months and become progressively more vague after that. Currently it is the reverse. There is no doubt there will be a recovery, but analysts vary widely on when they think it will be – and can be very cautious in saying just how well underpinned they feel the recent market moves are.
Not everyone is convinced of the power of Coppock. This week Albert Edwards of Société Générale, known for his bearish stance on the market and economic outlook, noted the upturn in the Coppock but was comfortable ignoring it.
“Momentum investing can be very profitable and perhaps eight times out of 10, these indicators work pretty well. But they’re not foolproof and you can be disappointed,” said Mr Edwards. “If you haven’t got a strong fundamental view as I have, then maybe you should go with the Coppock, but I do think people will be very disappointed in this recovery.”
Even believers in Coppock are urging a little caution. The signal is not yet a strong upturn (see chart) and it did generate a mistaken buy signal late in 2001. “It is beginning to shape up but I’d prefer to give it a little more time,” says Mike Lenhoff at Brewin Dolphin, who has applied it to a number of indices around the world.
The clue for now, says Mr Lenhoff, will be whether the 200-day moving average of each index truly flattens out then follows the Coppock. In 2002, it didn’t. Now, it looks as though it could. Adding both long-term sentiment indicators together, when the moving average flattens should give investors more confidence.
The stock market rally has now seen the S&P 500 rise, with a few blips, 39 per cent since the beginning of March. Over the same period, the CBOE’s Vix index, known as Wall Street’s fear gauge, has fallen by exactly the same amount.
The length of the rally has sparked talk it could force a second wave of funds into the market as investors happy to dismiss the early gains, feel compelled to invest for fear of missing out.
There are signs this is happening, albeit in drips rather than a flood of cash, according to market participants. A survey this week from Barclays Capital said investors reported holding an average of 14 per cent of their portfolios in cash – an historically high level – and that four fifths of them planned to reallocate that money this year.
William Strazzullo, chief market strategist at Bell Curve Trading thinks investors are looking right now to get back into the US markets. “There is more room to go, a lot of people missed the first five to six weeks of the rally and a lot of performance chasing is going on,” he says. “The rally has already exceeded a lot of people’s expectations.”
Adding to the bullishness this week was Duncan Niederauer, chief executive of NYSE Euronext, who said that he was more confident about the three month rally in stocks than he was in April because of rising trading volumes. Two months ago he told the Financial Times that he doubted the March rally would continue as he thought it was being driven by short-term traders trying to take advantage of high volatility. At that point, he said the real money investors were still waiting on the sidelines. This week, he characterised trading volumes as “quite good”.
In spite of the optimism, some markets have struggled to break decisively higher. In London, the FTSE 100 ended the week slightly higher but it did not match the strength of the rally elsewhere. Crucially it failed on Friday – for the fourth time in as many weeks – to breach 4,500, a worrying sign for some index watchers.
The index rallied on the back of US jobs data that were not as bad as feared, but retreated from its highs to close at 4438.56.
“The way in which it was aggressively sold down from 4500 shows yet again that the market can’t maintain the highs,” said Angus Campbell at Capital Spreads. “The bulls still don’t quite have the upper hand at these levels.”
Copyright The Financial Times Limited 2009"