With Emerging Market currencies, bonds, and stocks collapsing, US corporate debt crashing, and carry trades unwinding everywhere (ahead of the $800 billion liquidity withdrawal that looms from next week's 25bps hike from The Fed), it is no surprise that US equities are beginning to shudder (even the FANGs are not immune). But, as InvesTech Research notes, among its 6 compelling reasons to be cautious in 2016, the so-called Coppock Guide may be close to confirming that a bear market is at hand...
In March 2015, the Coppock Guide was signaling that both primary and secondary momentum had peaked and this continues to be the case today.
The Coppock Guide is a valuable tool to gauge the emotional state of a market index as it transitions from one psychological extreme to another. It was developed more than 50 years ago by Edwin S. Coppock and it measures momentum by taking a 10-month weighted moving total of a 14-month rate of change plus a 11-month rate of change of a market index.
The Coppock Guide is typically most useful at market bottoms, when market indexes reverse sharply as psychology shifts. It signals a “Best Buy” opportunity when the index turns upward from below “0” (see black dashed lines). The last such buy signal came within 60 days after the March 2009 market bottom.
Early in a bull market, momentum runs high and often peaks early. For this reason, the Coppock Guide isn’t as effective in identifying market tops. In fact, the initial peak in the Coppock Guide was seen during the first 18 months of this lengthy bull market, with a secondary peak in March 2014.
When a double-top occurs in an extended bull market without the Coppock falling below “0”, it signals that psychological excess could be at an extreme. And when that momentum finally peaks (see red dashed lines), it usually means a bear market isn’t far behind. This phenomenon was first observed by a market technician named Don Hahn in the late 1960s. Since 1929, there have been only eight instances of a double-top, and each one was followed by bear market losses of 30% or more.
We are currently seeing the likely completion of a double top (yellow shading on upper chart). When the Coppock Guide falls below zero, it confirms that a bear market is in place 77% of the time. The current value is 4.9 – which has resulted in a further drop below zero in 22 out of 24 instances.
Bottom line: If the Coppock Guide continues falling through zero, the probability of a bear market will increase... as will our portfolio defenses.