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Stock Bulls Lock on Momentum Flashing 1st Buy Sign Since '09

Image: Stock Bulls Lock on Momentum Flashing 1st Buy Sign Since '09

Tuesday, 14 June 2016 06:11 AM

Evidence is starting to build that the long-dormant bull market is reawakening.

What has optimists excited is the degree to which stock prices are rising relative to their longer-term history. By that measure, they’re flashing a buy signal for the first time since 2009, the year that kicked off a rally that saw the S&P 500 Index triple by mid-2015 before flat-lining since.

The trading pattern fits with the view of a growing minority of influential strategists who say the path is clear for a new leg higher in stocks even though economists have downgraded their growth forecasts to less than 2 percent this year, corporate profit growth is nonexistent and the S&P 500’s worst ever start to a year is still fresh in investors’ memories.

“You don’t hear a lot of people calling for a bear market anymore,” said Doug Ramsey, the chief investment officer at Leuthold Weeden Capital Management in Minneapolis, which has increased equity holdings in the past three months after predicting a 20 percent plunge as recent as January. “There was a deep enough and lengthy enough decline to clear the decks for a cyclical rise in stock prices.”

Momentum investing has taken a beating in 2016, blamed for hedge fund losses in the first quarter and the S&P 500’s worst start to a year ever. But a trading signal that’s triggered by accelerating price trends over periods of a year or longer just turned bullish.

Known variously as the Coppock Curve or very long-term momentum indicator, it’s a chart system that tracks how fast stocks are rising today versus 11 and 14 months ago -- intervals thought long enough to capture broad changes in investor sentiment. According to a version maintained by Leuthold, the indicator sent a buy signal in May that has forecast gains 95 percent of the time since 1929.

Notwithstanding its byzantine details, the Coppock Curve is supposed to flash when pessimism has run its course and price action is signaling a new appetite for risk. For bulls, that’s the story of the market right now, when shares are rebounding after one of the longest stock retreats ever in a U.S. bull market.

U.S. stocks slipped last week, with the S&P 500 losing 0.2 percent after twice closing less than 1 percent away from its all-time high. About $3 trillion has been added to equity prices since shares completed their second 10 percent correction in six months in mid-February. The index fell 0.1 percent at 9:50 a.m. in New York.

Psychological Reset

The plunges of August and January represented a “psychological reset” to Ramsey, a capitulation in pessimism that has spurred gains in the past. Using a similar model that defines market cycles by the speed of declines, Ned Davis Research views the nine-month rout that reached its low in February as a full-blown bear market, one that is enabling a quick rebound after stirring anxiety among investors.

“The decline looks like a classic non-recessionary bear market,” said Ed Clissold, chief U.S. strategist at Venice, Florida-based Ned Davis Research. “Usually there is a fear of recession that prompts a selloff, which is exactly what happened this time. That fear proved to be unfounded, so it created a lot of pessimism that allows the market to rally.”

While it’s tempting to chase the market as stocks rebound, investors should be wary of the danger of a reversal and confirm any technical signals with economic and company fundamentals, according to Cullen Roche, founder of Orcam Financial Group LLC in San Diego. In the first two months of the year, shares that produced the best gains in 2015 and those beloved by hedge funds bore the worst of the selling.

Fundamental Backdrop

To date, earnings and economic data haven’t been promising. Economists have cut their forecasts for gross domestic product expansion in 2016 to 1.9 percent from 2.5 percent at the start of the year and based on analyst estimates, growth in S&P 500 profits won’t return until the third quarter. That rebound has been repeatedly pushed back. Meanwhile, valuations are elevated. At Friday’s close, the index traded at 17.8 times forecast earnings, near a 14-year high.

It’s “a fairly fragile bull market,” Roche said. “Momentum investing is chasing risk in essence and hoping some short-term trend is going to continue into the longer term. Whether that actually will occur is a coin flip.”

Developed by economist Edwin Coppock in the 1960s, the Coppock Curve is designed to identify buying opportunities after stocks slump. Coppock equated the stages of market sentiment to human bereavement, figuring grief takes 11 to 14 months to overcome, and set up his indicator accordingly. A hodgepodge of weighting calculations gives more emphasis to recent observations, according to Ramsey.

Bull Signal

Leuthold’s very long-term momentum indicator rose to -1.03 in May after a two-year decline sent it below zero for the first time since 2009 in the previous three months. A level below zero suggests stocks have fallen too far, too fast and a buy signal is therefore produced when the measure starts rising from a bottom that’s below that threshold, according to Leuthold.

Because of the indicator’s focus on a time frame close to a year, a bullish reading usually follows a bear market that’s commonly defined as a decline of 20 percent from a peak. The latest buy signal is the first since 1984 that didn’t require one.

“With two scary down legs, the psychological imprint and the fear that’s instilled in investors were certainly greater,” Ramsey said. “To some extent, it corroborated with the view that the public has never got involved in the market in a big way that somewhat it’s enough to get a wash-out.”

Since 1929, the momentum chart has sent 19 lasting buy signals. All but one saw stocks rising 12 months later, with gains averaging 24 percent.

There have been five buy signals that later proved false with the indicator resuming its downtrend without first having crossed above zero. Following four of them, the S&P 500 suffered losses each exceeding 15 percent one year later.

“Stocks have a strong record of rising long-term anyway,” said Jason Goepfert, president of Minneapolis-based Sundial Capital Research Inc. “When you have an indicator that shows that stocks have sold off over the past year and then start to rise, you’re going to almost automatically see strong record of positive returns.”

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Evidence is starting to build that the long-dormant bull market is reawakening.What has optimists excited is the degree to which stock prices are rising relative to their longer-term history. By that measure, they're flashing a buy signal for the first time since 2009, the...
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Tuesday, 14 June 2016 06:11 AM
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