Thursday, December 29, 2011

2011 Year End Preview

Based on my year end preview my conclusion is that while there may be an opportunity to buy the All Ords well at current prices there is also a real,significant if improbable downside risk. By improbable I mean that based on past post 1984 performance most of my market indicators are at levels which have only subsisted or been worse about 10% of the time.

There is no buy signal on any of these major markets based on traditional Coppock 14, 11, 10 as at 28 December 2012. My Medium Term MACD 170, 150, 20 indicator shows either no action (line and signal overlaid) oscillation in the last month or continued decline. Please note that all my technical indicators are lagging and will miss the bottom and could lead to significant losses through whipsawing as in the 1998 to 2003 period.



My All Ordinaries Dashboard shows that the market is in a potential buy area (being well below most median periodic growths, oversold and well below previous highs in 2007 and April 2011), but, with the last close lower than all averages and all averages trending down there is a high risk the market could still be in a downtrend. There is, however a possibility it has commenced a very weak uptrend from the 26 September lows which had most characteristics of a median post-1984 low.

My Top or Bottom Analysis shows that the market is currently close to a median bottom as can be seen from the Dashboard, which is why I say we are in a potential buy area.

My Modified Turtle Buy/Sell indicator has been sold and there is no buy indicated or imminent, although this indicator caused whipsawing losses in the 1988 to 1993 volatile market.



My overall conclusion is that while you might like to increase holdings while the market is oversold there is still strong downside risk.

The historical post 1984 maximum loss from a situation like this was 22.3% from today's recovery to 134.7% of the 2009 bottom at day 712 after the 2009 bottom, to only 104.6% of the 1987 low at day 801 after the 1987 bottom. Those losses were fully recovered after day 951. So the 87 recovery was lower than 28 December 2011 close for 951 - 712 = 239 days or about 1 year and 1 month during the lead into and recovery from the 1991 low.

 On the BUY side, of the 5 recoveries since 1984, 4 out of 5 were only higher than the current level after day 712 right through to day 1200. Only 1987 went lower as it approached the 1991 bottom. 1987 was however the only other 50% loss market in our post 1984 data.

Fundamentals
On the fundamentals
1. US house prices are not in an uptrend and many mortgagors are under water, so household credit growth is subdued
2. there is widespread but not quite universal fear of recession in Europe
3. there is some fear of a slowdown in China because of its reliance on Europe and unsustainable capital works spending
4. there is some fear of a US slowdown or recession because of calls by ECRI and John Hussman, although these are largely discounted based on current monthly flows
5. in Australia there has been a marked reduction in building approvals 12 month average
6. in Australia employment growth has flatlined
7. Japan still has the tsunami damage and nuclear contamination to contend with
8. in Australia house prices have fallen widely over the past 12 months and by significant percentages in some markets.
9. there are likely to be ebbs and flows of sentiment in Europe over the sovereign debt crisis.

The fact that all of these are widely known may mean that it is a time when most are fearful and therefore a time to be a greedy contrarian, or maybe you would be better to await a clear upturn or at least only buy at the bottom of the current trading range at around 4100.







Monday, December 19, 2011

Coppock Bottom Picking Performance

Given that the market is again near a median bear bottom it is timely to look at the reliability and performance of the Coppock Indicator as a tool for picking a safe re-entry point. I have used the monthly data generously made available by Colin Nicholson of Building Wealth Through Shares.

In summary, market history since 1960 suggests the Coppock indicator is worthy of consideration as a way of determining a safe re-entry point to the market, but consider selling if the market has a deterioration of more than say 7.5 % or if there are two consecutive months each with lower performance (compared to percentage difference to the index value at the signal month end) compared to the prior month.

First a chart showing the results of all signals since 1960 shows that relying on the Coppock Indicator is generally potentially rewarding (partially depending on the timing of any sale) but not without risk.


Note the two false signals, one in August 1970, the other in April 1974. They would have been avoided by selling if the performance of the market went to -6% or worse at any month end after the signal was given. Two false signals from 15 is quite good performance. Thirteen of 15 signals provided the opportunity for profit.

We can also look at a table of the performance after the signal is given. I have chosen to look at the 24 months after the signal is given but note that 6 of the series considered ran on for over 4 years.



The number of months since the signal is shown in the left hand column, the average outcome (based on the number of continuing performances) is in the far right column. I have coloured some cells in the table. The two heavily pink series of results are the two very dangerous false signals from 1970 and 1974. The orange in the Average column shows that there are even months where the average outcome falls from the previous month. Yellow shows a month where the performance falls from the immediately preceeding month, but is better than for the month prior to that. It can be seen that a fall in performance measured at month end is not unusual, but that most of them pick up the following month. There were 65 such falls in performance. Of those, 27 were followed by a second fall in performance and I have coloured these pink and they could be considered as possible sell signals (although that is not part of the Coppock methodology). I have coloured the next rise in monthly performance green which could be considered as a possible buy signal, again not part of the Coppock methodology. None of this has been backtested other than by "eyeballing" the table.

(As an aside, after the transaction and whipsawing costs of timing systems the results seem likely to be broadly commensurate with the historical returns of a 50/50 portfolio of shares and long bonds and to more than halve the volatility and maximum drawdowns which frighten the life out of many self funded retirees.)

In considering when to sell if you are not buy and hold investor, always remember 1987 when the market was virtually at its bottom before most sell timing signals triggered, other than stop loss signals. From looking at various BEV charts I have done of recoveries from the bottom, there is great danger when the market falls more than about 7.5%. It rarely whipsaws immediately after a fall of 7.5%. After a  bottom the market spends 72% of its time before the next bottom at less than 5% below it's most recent high during the recovery. The risk of frequent whipsawing is very high if you sell the market on a fall since last high of less than 5%. Selling after a fall of 7.5% would have given you a chance to avoid the worst of the falls in 1987 and 2008.


The best summary might be that if you had purchased immediately after the Coppock buy signal was given since 1960 you would have earned on average 24% in the following 24 months, even taking into account two false signals which could have been avoided with a simple rule: sell if the month end performance is more than 6% below the month end on which the signal was given. (but be aware the next time it might reverse after a 7% fall! Whipsawing is everywhere!).

For interest, I also looked at the lead in to the Coppock signal being given.



While there is quite a variation between individual series, on a median basis compared to the month end on which the Coppock signal is given, the month end bottom was two months prior at 5.5% below the closing index value on the month end of the signal. On that basis it seems that a variation of the Coppock indicator which gave its signals a month earlier would, based on median results, have picked up an extra 4% of the upturn over the series reviewed. I am looking at Coppock 11,8,7 as a possible way to generate an earlier signal (but that might result in more false signals and so might not be as potentially profitable because of whipsawing).




Thursday, December 15, 2011

Mid Month Standard Coppock Review

While Colin Nicholson does a month end spreadsheet for the standard Coppock indicator (14,11,10) and, I assume relies only on Month end Signals, I have updated his speadsheet myself to see whether things seem to be improving or deteriorating with this signal. Purists might say that this is counterproductive as we shouldn't mix signals of different timings, but I wanted to see where we might be heading for month end.

See my previous post "Bottom? - MACD and Coppock Review" for historical graphs of the Coppock indicator.

The result is that all major markets covered by Colin's spreadsheet have deteriorated and if they held their current values at month end there would be NO Buy signal, so not a "safe to buy and hold for medium term" bottom in traditional Coppock terms yet. This does not mean that the bottom is not already in on 26 September 2011, or that now is not a lower/better market value than will be available in early January if the month end signal is a BUY.


This is not investment advice, merely educational commentary on general market conditions and indicators, as are all my posts. You pay your money and you take your chances. It's just that the race lasts longer than Randwick and historically you often win in nominal terms (but often not in real terms or in comparison to other common investments or other markets) if you just leave your money on the market.

Note: Australia is All Ordinaries, Shanghai is SSE 180 from http://www.sse.com.cn/sseportal/en_us/ps/home.shtml, not the one shown at http://au.finance.yahoo.com/intlindices?e=asia .


Wednesday, December 14, 2011

Bottom? - MACD and Coppock review

International stock markets have almost universally experienced a bear market over the last 3 to 9 months.

The question for most investors is now "Has it bottomed? Should I buy more shares?"

The Coppock Indicator was designed to answer that very question on a reasonably conservative basis, that is with few false readings. The MACD (Moving Average Convergence Divergence ) Indicator can also be used for bottom picking, but is more prone to being whipsawn or unclear. Links to the relevant Wikipedia pages for more explanation:
a) MACD
b) Coppock

I use non-traditional settings for both these indicators. I am not trying to pick the absolute bottom, just to ensure I buy comparatively cheaply. Using indicators like these always misses the bottom as they follow the price.

Coppock is usually monthly using 14,11,10. I use 11,8,7 as it gives a slightly faster signal. It was designed only for picking new uptrends after major bottoms, not for picking downtrends from major tops.

MACD is often daily 12,26,9 . For looking for major bottoms I use 170,150, 20 as it reduces whipsawing and provides rare signals that generally indicate major bottoms.

Using Incredible Charts I reviewed most major world markets and have prepared a very simple matrix looking at whether either MACD or Coppock are indicating that it is time to buy.

The answer is clearly that while a bottom might be forming and some markets are indicating a BUY on the basis of MACD, there are NO BUY indications from the Coppock Indicator. I have used Undecided where the MACD has barely crossed its signal line or they are running over one another or are horizontal and for Coppock where it is flat.



Colin Nicholson on his site Building Wealth Through Shares has a spreadsheet available with the Coppock indicator for 6 major markets.

Here are 3 charts derived from that data. The first is the Coppock indicator for the All Ordinaries since the early 1900's.



The second is a bar chart for the recent values so that it is clear when the indicator reverses direction from below the zero line.



The third chart shows the Percentiles of the Coppock for the All Ordinaries. It should be noted that other markets can show a much greater range and a very different distribution.


We are at a point in time where it should be well worth while to mnoitor the MACD and Coppock indicators to identify the point which will likely be the start of a major uptrend. This point could be in the next month or so as it appears a bottom is forming in some markets, or we could follow the 1987 to 1991 pattern in which case the bottom could be substantially lower and many months away.

Tuesday, December 13, 2011

Chart and Statistical Resources for Investors in the Australian Share Market

 The Reserve Bank of Australia publishes charts and statistical tables for Australia.

These would be of interest to investors in the Australian sharemarket, including through superannuation and managed funds.

To me the most interesting things are:
1. Commodity Prices for coal and iron ore (still very high)
2. Trade weighted index (still very high)
3. Housing Prices (very high but declining, generally slowly)
4. Household debt (high but some delveraging)
5. Household saving ratio (high, over 10% and stabilising at that level)
6. FX rates (generally near highs although not so much now against USD and JPY)
7. Export destinations (China is now quite important)
8. Unemployment (may have bottomed)
9. Retail sales (very low growth, reflecting household savings)
10. Interest rates (cash rate has had 2 cuts in consecutive months)
11. Stock market (volatile and way below the 2007 highs but better on USD basis because of AUD/USD rate changes, YTD is better than most developed countries in USD but US has been best of developed markets on MSCI indices.)
12. Federal government debt (very low on a net basis)
13. Bank dependency on foreign source wholesale funds (very high)

Chart pack is at:
www.rba.gov.au/chart-pack/index.html
These are very interesting and easy to browse.

Statistical material is at:
www.rba.gov.au/statistics/tables/index.html

My favourites from the ABS are Employment and Building Approvals, but I find that I have to adapt the information and chart it to really see the information I am looking for..


Comparative Yields as Timing Prompts

Timing the market to miss large falls but benefit from long bull markets is an investors dream, but moving average studies (eg by Doug Short) and of medium to long term returns of active managers show it is not easy to beat the market.

Recent significacnt changes in bond yields relative to earnings yields on shares on the one hand and between 3 month and 10 year bonds on the other hand have been significant and we may have just had a major prompt to watch for buy signals. In fact we have had two potential bottoms already, 8 August and 26 September, although the fear of recession induced by austerity in most major economies and European disruption could cause new lows. Volatiity induced whipsawing from following timing buy and sell signals is a real risk at present, however for those who have been out of the market until now it could still be a time to take on some risk.

Comparative yields between stocks and bonds and also between long and short dated government securities can be useful prompts, particularly where large changes take place relatively quickly. It is often said that the inversion of the yield curve has predicted 10 of the last 5 recessions, but rapid significant change is a useful prompt to be looked at with employment growth changes and the indicia of market tops and bottoms discussed in recent posts. I have previously done work on these issues based on Robert Shillers research of ├índ data for US markets and published on Seeking Alpha  I have now found data by Colin Nicholson which has enabled me to do a similar exercise for the Australian markets. The emphasis in each chart is on both the relativity and the significant changes in that relativity.

The two charts show comparative yields and rates of change in the ratios between the two yields being compared.

The first chart deals with 3 month and 10 year government bonds. The annotations to the chart tell the story, although I should emphasis that the change in direction from around or above 1.2 or from around or below 0.8 is really the start of the prompt. I understand from my reading that the futures markets are pricing in further rate cuts next year which if they come to fruition will likely bring the both the pink and blue lines above 1.2.



The second chart deals with the relativity between 10 year bond yields and the earnings (not dividend) yield of shares and with significant sharp changes in that relativity. Again, the annotations to the chart tell the story. Other than the depths of the GFC the ratio of bond yields to earnings yields have not been this high since before 1974. Only 1974, 1987 and 2008 have had such a dramatic relative increase in share yields over long bond yields. This is a reflection of extreme fear of recession, unemployment, falling earnings and/or stock market crash. Remember the dictum to "be greedy when others are fearful and fearful when others are greedy'? Well these relativities show others are fearful right now!


10 year bond yields in Australia are at around 4% and have not been at such low levels for a very long time, other than during the GFC. This could be a very bad time to buy bonds or we could be going Japanese. My suggestion is buy on your favourite timing buy signals but be prepared to be whipsawn because you may well get a sell signal within a few months given the situation in Europe and continuing austerity in many countries.



Employment Growth Already Stalled

Recessions and stock market downturns always have stalled or falling employment. Employment falls because demand has fallen, revenue is down, inventories are up so production/purchasing must fall. That means less employment.

I have previously written about falling building approvals and noted that "as go building approvals, so goes the economy" (generally speaking) and shown the fall in building approvals.

Employment growth has now stalled. The rate of growth in full time workers on a "change on same month last year" basis is effectively zero for November. Rarely does full time employment  stall without going negative. unemployment can be stable while growth in employment slows, but because of population growth and demographics, once it slows below the growth in the workforce, unemployment grows too.

My focus is on employment rather than unemployment because growth in the number of people working is the best indicator of likely growing GDP. This can be seen by looking at US growth in spite of still very high unemployment because employment has been growing for well over a year. Growing unemployment adds to the concern but you can have employment growth without falling unemployment because of workforce growth.

Two charts show the need to focus on the cycles of full time employment growth. (The pattern for total employed persons including part time workers is very similar). The first is persons employed full time. It shows a barely perceptible flattening over the last few months, partially obfuscated by monthly noise and seasonal changes.


The second shows growth from the same month last year which does away with seasonal noise and highlights the cycle more dramatically.


 The significant correlation of growth in employment slowing from around 3% or more and breaking down through the moving average and the commencement of significant stock market downturns is obvious. Upturns breaking through the moving average has also been a significant indicator of a major upturn in the stock market although a much shorter moving average would likely provide a more timely signal of upturns.

It may be that once employment growth falls through -0% you should be watching for buy signals (including very bad 2 month performance and a significantly oversold market) although with the risk of being whipsawn. In general purchases on a buy signal after a fall of more than 18% and then being "buy and hold" are more successful within 12 months than selling again, but of course there are some notable exceptions where the market has fallen 50%, but there have sometimes been multiple whipsaws costing say 20% of the fall. Most bear markets don't stay below 15% for very long.

My next post will look at changes in relative yields between stocks and 10 year bonds and also between 10 year and 3 month government securities. Looking at the signals from those relativities together with the employment signals will provide some very useful, but not perfect, timing signals. 1987 was unusual in that employment growth did not go negative although there was a very obvious trough. Mid 1999 and mid 2006 troughs were less significant.

These two posts could be read together with the post on market tops and bottoms for further indication of whether it is likely a good time to increase of decrease exposure to the stock market when clear price signals are given  eg moving average directions, moving average crosses, breach of trailing buys and sells (Turtle Trader" "style signals).

Both charts above are derived from Australian Bureau of Statistics (ABS) 6202.0 - Table 12. Labour force status by Sex - States and Territories.