PORTFOLIO POINT: The Coppock Indicator, used to track long-term market trends, is signalling we are now at a buy point.
A secular market is a long-term upwards or downwards trend in the share price index that lasts five to 25 years and consists of a series of shorter primary trends of one to five years each.
A secular bear market, such as the one started globally at the turn of the millennium, consists of alternating primary bear and bull markets.
Since October 2009 Australia, like the rest of the world (other than the US), has experienced a shallow meandering primary bear market that has turned investors off shares. But there is reason to believe that this slow slide to hell is over, and that the market has entered a primary bull phase that could last a year or more, even if secular bear conditions persist because of debt deleveraging. (Indeed Alan Kohler in his Saturday email has referred to this possibility … to read more Click Here).
At the end of July my conservative sharemarket timing strategy issued a “buy” signal. That was because the Coppock Indicator on both a daily and monthly basis had turned up while in negative territory. It’s one of two factors that can trigger a buy signal on this longer-term strategy. The other is for the market’s medium-term trend line to cross above its long-term trend line. Trend lines take the form of moving averages of the All Ordinaries share index.
It’s worth observing in the chart below that since the All Ords index came into being at the start of 1980 there have been seven other occasions when the Coppock Indicator turned north while in negative or zero territory. And, on each occasion, it correctly signalled the end of a primary bear market with better times ahead.
The chart shows the indicator on both a daily (Dy) and monthly (Mth) basis. Originally the indicator was always calculated monthly, though back-testing shows that daily calculations also work. I used both for a confirmatory buy signal last month.
So what exactly is the Coppock Indicator? This is Wikipedia’s definition. “The Coppock curve or Coppock Indicator is a technical analysis indicator for long-term stockmarket investors created by E.S.C. Coppock, first published in Barron’s Magazine on October 15, 1962. The indicator is designed for use on a monthly time scale. It’s the sum of a 14-month rate of change and 11-month rate of change, smoothed by a 10-period weighted moving average. Coppock = WMA of (ROC ROC)”
But if maths is not your favourite subject, then skip the formula since all you need to know is that the indicator is a reliable stock index bellwether for the end of a primary downtrend and the start of a primary uptrend.
I particularly like the story about how the indicator came about based on share losses being like bereavements that require a certain period of mourning before investors become chirpy again.
Coppock, the founder of Trendex Research in San Antonio, Texas, was an economist. He had been asked by the Episcopal Church to identify buying opportunities for long-term investors. He thought market downturns were like bereavements and required a period of mourning. He asked the church bishops how long that normally took for people, and their answer was 11 to 14 months. So he used those periods in his calculation.
A buy signal is generated when the indicator is (at or) below zero and turns upwards from a trough. No sell signals are generated (that not being its design). The indicator is trend following, and based on averages, so by its nature it doesn’t pick a market bottom, but rather shows when a rally has become established.
Coppock designed the indicator (originally called the “Trendex Model”) for the S&P 500 index, and it’s been applied to similar stock indexes like the Dow Jones Industrial Average. It’s not regarded as well-suited to commodity markets, since bottoms there are more rounded than the spike lows found in stocks.
I have checked the historic reliability of the Coppock Indicator as far back as data is provided by charting website Incredible Charts for 13 major stock markets worldwide. For Australia and America the indicator goes back to 1980 and 1988 respectively, but for other countries it’s only available from mid-1996.
The results of the survey are shown below. Note that for 11 of the countries, the Coppock buy signals proved correct in a majority of cases, but for India and Spain only half the signals proved right.
For all markets analysed a total of 54 Coppock buy signals were generated over the periods surveyed, of which 38 proved correct (i.e. 70.3%) – a good strike rate for any technical indicator.
A good example of a false Coppock alert that proved a bear trap was that for the United Kingdom FTSE 100 index in May 2002 (see below). Note how the Coppock turned up at that time, signalling the end of a crash, but then turned down again before accurately foretelling the end of the primary bear market in May 2003.
Such a false buy signal is not a concern for me however, because my multiple moving average trend lines and stop-loss limit would have got me out of that market before it crashed again in June-July 2002.
The bottom line is that the Coppock Indicator’s buy signal must be taken seriously, though as a safeguard it’s worth supplementing it with trend-following indicators and a stop-loss limit to trigger a “sell” signal should the buy signal prove premature.
Finally, it’s interesting to note that in the 13 markets I surveyed, the Coppock Indicator recently issued a buy signal in all but two of them. One exception is the US, where the Coppock has not been in negative territory for three years because the market has enjoyed a primary bull run albeit with two corrections.
The other is China which, notwithstanding its stellar economic growth, has been in a primary bear phase for three years with no end in sight for its falling share index.
Australia is torn between China (which props up our resources sector) and America (which sets the tone for our finance and industrial sectors), but the Coppock Indicator’s green light to our local market suggests Australian investor sentiment has been swayed more by New York than Shanghai.
Since the end of July, both my Active and Conservative market timing strategies have been in buy mode, reflecting a more bullish world mood as European leaders become more committed to saving the euro, Americans become convinced they are in for further ‘quantitative easing’ (i.e. money printing) in the lead-up to their presidential election, and local reporting of company earnings continues to beat expectations.
As Jim Rohrbach, the veteran American market timer often says: “There are really only two good feelings in investing. One is being in the market when it is going up, and the other is being out when the market is going down.”
At present the market’s underlying trend and momentum are strongly up, so enjoy the ride. Let’s hope Mr Coppock’s indicator has flagged the start of a new primary bull cycle and that this is not a bear trap.
Percy Allan is chairman of Market Timing Pty Ltd. For a three week free trial of its services go to www.markettiming.com.au