Coppock, Farrell indicators suggest financial market downturn underway

Coppock Oct15

They don’t ring bells to warn of financial market tops and bottoms.  But there are 2 very good substitutes in terms of the Farrell and Coppock Indicators, as the above chart for the UK stock market since 1973 shows:

  • It is based on the Financial Times All-share Index (FTA), as the FTSE 100 only began in 1984
  • It shows the Coppock Indicator for buying moments on the left (black line) with BUY signals marked
  • It also shows the annual percentage change for the FTA on the right (green line)
  • This is overlaid with Bob Farrell’s 20% and 40% Indicators for market peaks in dotted red lines

The Coppock Indicator was developed to try and identify when markets were bottoming.  As Wikipedia describes, Erwin Coppock had the profound insight that people reacted emotionally to a financial market collapse, making it parallel the response to having a death in the family

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, their answer was 11 to 14 months and so he used those periods in his calculation”.

Coppock was clearly right with his insight, as the chart confirms.  It has given real-time BUY indicators for all the major rallies, and only 2002′s signal was relatively early.

Bob Farrell began his career studying famed value investors Graham & Dodd, and then analysed how sentiment could also move markets alongside the fundamentals of company earnings.  He developed 10 legendary rules for successful market investment.  One key insight was that markets that moved too quickly would normally correct.  As he described this:

“Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways”

Working at Merrill Lynch, he became the leading “technical guru” on Wall Street, where he observed that market rallies of more than 20% in a year were normally followed by a major correction.  Those that rose by 40% would inevitably be quickly followed by a correction.  The chart confirms his insight.

If we look at recent history:

  • It shows a BUY signal in May 2009 for the Coppock Indicator, followed by a 48% Farrell peak in March 2010
  • After the correction, there was a new Coppock BUY signal in July 2012, and a 26% Farrell peak in May 2013
  • Since then the Coppock Indicator has been in steady decline, and went negative in September

Both indicators, of course, were developed in a world where the US Federal Reserve would never have dreamed of trying to boost the economy by pumping up financial market prices.  Instead, it saw its role as being “to take away the punchbowl, just as the party is getting going“:

  • We therefore cannot rule out the potential for “one last hurrah” in financial markets via a massive and globally co-ordinated central bank stimulus programme
  • But China seems unlikely to support such stimulusagain, as it focuses on its New Normal policy direction

Central bankers would, of course, deny that their activities have simply provided the stimulus for an exponential rise in financial markets, as defined by Bob Farrell’s Rule. We can only hope they are right, as the downside over the next few years – if they are wrong – could be considerable.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 54%
Naphtha Europe, down 49%. “Asian arbitrage volumes will be the main outlet for European naphtha in Q4 as other sources of demand dry up, including demand from the domestic petrochemical industry and the US gasoline sector”
Benzene Europe, down 57%. “Downstream markets have also seen some margin erosion, as prices start to weaken in the fourth quarter”
PTA China, down 41%. “Demand from the downstream polyester sector is still sluggish, especially in November and December, which is usually the lull demand season”
HDPE US export, down 35%. “Prices for domestic exports held steady”
¥:$, down 18%
S&P 500 stock market index, up 6%

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