Global markets, including Hong Kong, have posted some increases since Feb. 12.
However, the equity market outlook remains unclear. When will the market bottom out?
The Coppock Indicator might offer some clues.
Various market conditions indicate that the turmoil is not about to end yet. The global economy still faces mounting pressure, and US dollar remains very strong.
Meanwhile, capital continues to flow from equities to safe-haven assets.
Also, risk-off assets like the Japanese yen and long-date government bonds have spiked despite stabilizing equities. That’s quite rare.
As I’ve noted before, the key issue is when the Federal Reserve will abandon its rate normalization process or launch another round of quantitative easing.
Without such a scenario, the market would stay on a shaky ground.
The Coppock Curve is a momentum indicator developed by economist Edwin Coppock. Coppock introduced the indicator in Barron’s in October 1962.
The goal of this indicator is to identify long-term buying opportunities in the S&P 500 and Dow Industrials.
The signal is very simple. Coppock used monthly data to identify buying opportunities when the indicator moves from negative to positive territory.
The indicator is designed as a monthly scale. It is the sum of a 14-month rate of change and an 11-month rate of change, smoothed by a 10-month weighted moving average.
Coppock thought market downturns were like periods of bereavement that required a period of mourning.
It is said that he even asked bishops how long it would normally take for people to mourn, and their answer was 11 to 14 months.
So he concluded that market sentiment would reverse after 11 to 14 months of market decline.
When will the indicator send a sign that the market has bottomed out? When the gauge drops below zero, that’s a buy signal.
The formula has proved to be quite accurate.
The Coppock Indicator has actually sent 17 buy signals for the S&P 500 since the Second World War. And market statistics show that it gave out only one false signal.
How has the US benchmark fared recently? As of Feb. 23, the Coppock Indicator has dropped below zero again after it rebounded to positive territory in January 2010 and sent a buy signal in May 2009.
That means the US market may trend downward in the future unless it posts a sharp rally in the next four trading days, which would push the indicator back to positive territory.
A buy signal is triggered when it crosses into positive territory while a sell signal is triggered when it crosses into negative territory.
Following this strategy, one would make a profit of US$674 for every US$1 dollar they invested in 1954.
By contrast, if one uses the buy and hold strategy for the US$1 dollar investment in 1954, they would only make US$524.
Nevertheless, the annualized returns of both strategies stand at 10.6 percent and 11.06 percent respectively.
That’s because the Coppock Indicator has always lagged behind the buy and hold strategy between the early 1990s and 2008.
How does the benchmark work on Hang Seng Index?
Since 1970, the Coppock Indicator has sent nine buy signals, and there was only one mistake in 2003.
However, more time is needed to determine whether the gauge can also be applied to the Hong Kong market.
The Coppock Indicator for the Hang Seng Index has already fallen into negative territory since November last year and has kept hovering near the bottom.
As such, the Hong Kong market may continue to face downward pressure unless the indicator moves into positive range.
This article appeared in the Hong Kong Economic Journal on Feb. 25.
Translation by Julie Zhu
[Chinese version 中文版]
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