Jim Stack, InvesTech

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Bear market signal: Coppock curve and killer
Thursday, 02 August 2007

When the Dow recently hit its record high, Jim Stack was not impressed. Rather, he warned, “We are moving to a full bear market defensive mode.”

Here’s the latest outlook from his InvesTech Market Analyst – uncannily written just before last week’s decline – in which he warns of a rare “killer wave” signal from the Coppock Curve, an 50-year old technical indicator that helped him exit the market in 2000.

“When the DJIA scores a new record high, yet there are twice as many stocks closing down for the day (as the number closing up), then something is wrong. Declining stocks overwhelmed advancing stocks by a 2:1 margin, an ominous divergence that has never occurred in the past 75 years of market history

“When the DJIA closes higher in 7 out of 8 days, but breadth is positive (advancing stocks outnumber declining stocks) on only 1 of those days, then something is wrong. That ‘wrong’ confirms that fewer stocks are participating and investors become more selective in stock purchases.

“Meanwhile, the housing outlook has gone from dismal to dire. To a slowing economy, this could be the catalyst that ultimately triggers the next recession. In fact, the starting point may even be backdated to this month.

“Outside the crumbling housing sector, there are a number of warning flags that we are carefully watching at this time. Our Monetary Model gauges both monetary climate as set by the Federal Reserve, as well as the monetary climate established by the bond market .

“Both are now back into the negative or bearish region. So even though bond yields have softened a bit in recent weeks, this is considered a hostile monetary climate for stocks. In short, this is when bear markets can –and often do– start.

“We also note the Coppock Curve which was developed 50 years ago by Edwin S. Coppock. This indicator has a remarkable track record when it comes to signaling the start of a new bull market for stocks.

"It has been described as a ‘barometer of the market’s emotional state.’ As such, it moves very slowly and methodically from one emotional extreme to another. Its historical value lies in signaling or confirming the best, low risk buying opportunities in history.

“However, the Coppock Guide has never been noted for timely sell signals. Except, that is, in a few cases. And that’s where the carnage comes in.

“In the late 1960s, a technician named Don Hahn observed that when a double-top occurs without the associated decline in the Coppock Curve, it identifies a bull market that hasn’t experienced any normal, healthy washouts or corrections. That’s a runaway bull market usually headed for disaster.

“This double-top pattern has occurred only 6 times in 80 years – with 4 of them accompanying the start of the most notorious bear markets of the Twentieth Century: 1929, 1969, 1973 and 2000. So there is a critical historical aspect to double-tops: They can result in nasty bears!

“Those resulting bear markets reveals why the double-top in the Coppock Guide has been nicknamed a ‘Killer Wave.’ The average decline (excluding the -86% loss in 1929) was almost -40%! And we now see that Coppock Curve has been developing a second peak (double top) over the past few months.

"This raises the odds that what lies ahead may be severe. At this point, the inherent danger that accompanies a double top or ‘killer wave’ in the Coppock Guide suggests that discipline and patience are warranted now, as we wait and watch this double-top formation play itself out.”