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A Time to Buy, A Time to Sell

 

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Difficult to believe but we are now more than one year into the global financial crisis.  Regular readers may recall my warning this time last year that the VIX indicator was registering an all time high.  For new readers the VIX is a fantastic indicator which takes the temperature of the market so “when the VIX is low it’s time to go”. Back in January last year it was reading below 10 indicating that market participants were calm and complacent. Suddenly in March it raced to over 20, reaching almost 40 in September when the markets became panic stricken and seemed to be spinning out of control.

One year on the problems originating in the US have rippled over to the UK and mainland Europe – so much for decoupled economies and rhetoric from the ECB – the fact still remains that when the US sneezes the world catches a cold, only this time it is more likely to be a bout of double pneumonia.

The property market in Spain has been particularly badly hit as a combination of a strong Euro, increasing inflation caused by sky high commodity prices as well as a lack of liquidity have drained confidence and are now causing serious financial pain to thousands of UK expat retirees.  As well as having to suffer with falling property prices, the strong Euro has caused the value of their sterling income to drop by almost 20% in one year.   The bad news is that the Euro shows no immediate sign of weakness chiefly because it is the Germans who are driving economic policy in the Euro zone, and their number one priority is the control of inflation, hence the refusal of the ECB to lower interest rates.   To add to this pain a little known fact about the Spanish property market is that it has a higher percentage of unsold housing stock than the US

The media have likened the current financial state as similar to a hangover following a massive binge.  Fortunately, as with all things in life, nothing lasts forever and just as the VIX could be said to be the harbinger of trouble in the equity market and therefore a signal to sell, we have another interesting indicator which could be used as a sign that the worst may be over and it may be time to buy.  This goes by the name of the Coppock and like the VIX it too measures market sentiment and psychology

The Coppock indicator was developed by Edwin Coppock, who was asked by the administrators of church funds to devise a long term, low risk signal to enable them to know when to increase their equity holdings, and when to stand aside.  Coppock thought setbacks in the financial world, especially the stock market were like bereavements which required a period of mourning before normal spirits revived. He asked the bishops how long it took people to come to terms with stresses such as illness, divorce etc and the answer he got was between 11 and 14 months. From this Coppock developed a series of calculations designed to signal when stock market mourning could be said to be over. The indicator’s signal does not emerge at the bottom of the market, but once a rally is established. In recent times, the Coppock indicator signalled rallies in 1988 and 1994 and investors who acted on the indicator made a lot of money. Just like the VIX the Coppock is not a sign of trend reversal, but shows us when risk factors in the market are low and the herald of a sustained advance. Although the Coppock was originally developed for the Dow Jones it has been shown to work across other indices. However, it cannot be used with intra-day or short term trading or in the forex market. Its use, like the VIX, is to help us understand the emotion behind the market price and so profit accordingly.

At the moment the equity markets do appear to be rallying with the Dow back above 13,000 (with the US presidential elections in November I may even be tempted to place a fixed odds bet on the Dow Jones reaching 15,000 later this year) and even the FTSE is creeping back toward 6400.Ironically all this is happening with oil at $125 dollars and rising. My own view is that the current hysteria surrounding the oil price is probably going to die down towards the end of May when we should see a significant correction. Whether this will necessarily translate into cheaper fuel and energy costs for the consumer remains to be seen.

Finally on a very personal note, as traders and investors we often only view currency strength and weakness as figures on a screen, from which we can make or lose money. For us, the worst that can happen is a losing trade, but in the real world it is far worse. Having just returned from a trip to Sicily, the effects are both immediate and real, with shops and businesses suffering from a lack of visitors. It is all very well for the Germans to take the view that a strong currency represents a strong economy, but for the Southern Europeans, a strong currency can be a short cut to poverty. In the short term the Euro shows little sign of weakening against either the US dollar or the UK pound, although there has been a pullback in the former in the last few weeks from the psychological high of 1.60, and it is currently trading around 1.55.

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