A hint of bull

The Coppock Indicator has fallen below zero, indicating the next bull market lies ahead of us.

The what? I realise few readers will have ever heard of this indicator. That's not so strange given the Coppock Indicator is rather seldom used and referred to. This is not because it's unreliable, or too esoteric – in fact the Coppock Indicator has a solid reputation – it's just that this particular indicator was originally designed to help long-term investors in deciding when to step into the sharemarket; it signals when a new bull market is being established and as such, as everyone will understand, this indicator only becomes useful every six years or so.

The last time the Coppock Indicator signalled the birth of a new bull market was in May 2003. We all know now that was when the commodities-driven uptrend of the past four years found its origin. The second last time was in 1995: back then Australia was climbing out of the doldrums of the "recession we had to have" and banks were at the early stages of what would ultimately become a golden era for the financial sector.

Although the Coppock Indicator, calculated from the rate of change in the index, was originally designed for the US sharemarket, at the time of its original inception in the 1960s, it has been successfully applied to many other sharemarket indices, including the All Ordinaries index in Australia, with technical analysts finding the indicator has withstood the challenge of backtesting data up to 100 years into history.

If you look at the chart below you'll see the indicator also successfully flagged the previous steep bull market from 1982 to 1987. Since then it has successfully flagged the next wave up five more times and only the sharemarket movement between 1988 and 1989 appears a bit "wishy washy" (though still accurate).

As I said above, the indicator has now started to signal that the next sustainable uptrend is coming. It will be number seven since 1982.

So how does this indicator work? The Coppock Indicator, also referred to as the Coppock Curve and the Coppock Guide, was first published in 1962 in the US financial newspaper Barron's. It was developed by economist Edwin Sedgwick Coppock who, at the time, had been asked by the Episcopal Church to develop a tool for longer-term oriented investors. As the story goes, Coppock thought sharemarket downturns were comparable to bereavements and thus a natural period of mourning was required. (I am not making any of this up).

According to the legend, Coppock asked the church bishops how long people usually mourn. Their answer was 11–14 months, so he used those periods in his calculation. Without going into too much detail, the indicator is specifically designed for longer-term signals (Coppock originally used monthly periods for his base calculations). It has a solid reputation for not confusing the next bear market rally with the start of a new sustainable uptrend, and as said above, it tends to pick the correct signals for when a new bull market is being established.

Others have fine-tuned the original setup; the Financial Times offshoot Investors Chronicle developed its own modified version, which generates sell signals as well as long-term buy signals, but it is widely recognised that the Coppock Indicator is best used to pinpoint the next sustainable uptrend in the sharemarket.

A buy signal is generated when the indicator falls below zero, reaches a bottom and subsequently starts trending upwards again. By then you are likely to have missed out on the early gains in the share-market (two to three months), as the indicator takes its time to establish whether we have something sustainable in place, but at least you know it's genuine, and not the next bear market trap.

So where are we now according to this indicator? Well, as I said above, the indicator has turned negative this month, for the first time since 2002, not only for the All Ordinaries but also for the main indices in the US, Japan and the UK. But investors should not get excited just yet; last time it took 11 months before the indicator gave a buy signal after it first fell below zero (July 2002–May 2003), but in 1995 and in 1992 it only took five months.

It's probably fair to say we are still months away from the indicator's next buy signal, but at least we know it's coming (as opposed to between December last year and June this year).

Personally, I always try to match these indicators with the fundamental picture and the likely news flow ahead. Maybe it is no coincidence the Coppock Indicator only fell below zero in July; the global finance sector is likely to generate many more negative events, as will the slowing of global economic growth. At some point most of the negative news will truly have come out, and the worst of the worst will have been priced into equity markets and into securities analysts forecasts. I suspect that soon after all this has happened the Indicator will start trending upward again.

Highlight stocks

ANZ Banking Group (ANZ): A billion dollars here, another two billion dollars there: Australian banks are rapidly tearing apart the idea they should remain insulated from financial problems elsewhere. More confessions, and provisions, by National Australia Bank (NAB) and ANZ have led to stockbroker changes in sector recommendations (mostly negative), earnings forecasts (all negative), lowered dividend estimates and mostly downgrades in individual ratings. Especially the impact on price targets for NAB and ANZ has been severe, with the lowest price targets for both now below their current share prices (even after the recent carnage). The overall feeling among securities analysts seems now to expect more bad news is likely in the months ahead. One characteristic of Australian banks is believed to remain in place: all banks are believed to stick to their current dividends and this means investors and shareholders will be able to fall back on unusually high dividend yields.

Commonwealth Bank (CBA): Banking stocks surging past their average price target means the market is getting ahead of itself. Last week, the temporary re-rating of global banking stocks pulled CommBank (CBA) shares significantly past their average target. This has been swiftly corrected ever since: not only did the average price target for the bank come down to $43.22, the share price fell from above $46 to below $40 again, creating a gap of nearly 10% with the average price target during the process and this means there's enough room to manoeuvre again. CBA's prospective yield is about 7% at these price levels and its price/earnings multiple is 11. The stock has maintained its position as leader of the sector throughout the recent correction.

Centro Properties (CNP): The bottom three of lowest recommended stocks in the Australian sharemarket currently consists of Centro Properties, Ten Network (TEN) and Minara Resources (MRE); in other words highly geared listed property, traditional media and nickel, None of them should be a surprise. With regards to nickel, some specialists have already started to anticipate the closure of nickel mines as ever lower prices and higher costs are making life difficult for many producers. Of course, as such the present situation in the nickel market is sowing the seeds for the next uptrend for the sector.

Macquarie Leisure Trust Group (MLE): A long time ago, Macquarie Leisure and News Corp (NWS) both bought a multi-season ticket for a seat among the most highly rated stocks in the Australian sharemarket. Their entourage has now changed with the company of Beach Petroleum (BPT), Gloucester Coal (GCL) and Hastie Group (HST). Investors should be aware that having a perfect buy score from all major brokerages in the country is no guarantee for share price appreciation. Emeco Holdings (EHL), Boom Logistics (BOL) and Perseverance (PSV) have been here as well.

National Australia Bank (NAB): This doesn't happen very often in case of a large-cap stock, and certainly not when we're talking one of the big banks in Australia, but National Australia Bank (NAB) saw its reading on the FNArena Sentiment Indicator drop from 0.25 to –0.25 this past week, a reflection of the fact that many bank analysts did not take recent confessions by both banks well, but more so in the case of NAB than for ANZ. There is a suspicion that NAB will have to write down some of its corporate loan portfolio, with a ballpark figure of $450 million often mentioned.

Rudi Filapek-Vandyck is editor of FN Arena, an online news and analysis service.