Indications from our long-term momentum indicator hint that the present offers a solid longer-term entry for global and domestic equity market investors alike. Our preferred timing gauge, a price oscillator based on the work of economist E.S.C. Coppock, bottomed in April for both the MSCI ACWI USD Price Return Index and last month for the S&P 500 Index. Further, our momentum measure appears slated to improve into the Spring of 2017 for both equity market barometers. Accordingly, we anticipate rising share prices over approximately this horizon.
Monthly momentum for the S&P 500 Index (a proxy for domestic equities) over the last few decades is illustrated in the lower pane of Exhibit 1 below. Notice that of the three occasions where momentum troughed below zero, two coincided with meaningful stock market bottoms. The exception is the failed 2001 signal, which would have delivered 14% six month losses and 23% one year declines to Coppock Guide adherents.
Despite the false alarm in the wake of the bursting of the Tech bubble though, the Coppock Guide for $SPX has proven its worth over time. Exhibit 2 summarizes our examination of S&P 500 data back to 1929 (we evaluated $SPX over ACWI as our dataset for the latter merely extends back to 1988). We found 26 instances, in earnest, where a slide in Coppock momentum was arrested below zero and the indicator rebounded thereafter. Significant excess returns (over six, 12 and 24-month horizons) commonly followed such episodes. In fact, per Exhibit 3, outperformance materialized roughly 70% of the time these conditions were met.
Summary statistics for S&P 500 Index (price-only) performance following Coppock BUY signals as well as for the aggregate 1930-May 2016 timeframe are presented in the table below.
We also observed that the majority of false signals were concentrated in the 1930s and 1940s. From 1950 forward, only two of the 18 Coppock BUY signals corresponded with below average one and two year forward returns.
A noteworthy characteristic of the post-Depression era that might explain the Coppock Guide’s cluster of inefficacy is the largely trendless nature of domestic equities throughout the period. Even after the worst of the Great Depression-related selling, stocks meandered about for years until the 1942 low was forged. In April 1942, for instance, the S&P 500 finished the month 2% lower than the April 1933 close.
This circumstance highlights a known shortcoming of the Coppock Guide and other price-based momentum oscillators: predictive value dissipates during choppy or sideways markets. As price action, per se, defines embedded momentum in such indicators, it intuitively makes sense that these constructs might be flummoxed by flat price action or whippy reversals.
Our perusal through S&P 500 history also highlighted that all but one of the six truly bad signals we show in Exhibit 2 unfolded against a backdrop of significant market weakness over the preceding 12 months. The S&P 500 dropped by an average (median) of roughly 18% (13%)–on a price-only basis–in the year leading up to failed Coppock BUY signals. We take this observation to suggest that the Coppock Guide is more prone to prematurely sounding the ‘all clear’ bell in the midst of bear market declines than in cyclical bull runs (see here for additional aggregate statistics and details related to how each historical BUY trigger fared).
As the S&P 500 has exhibited an undeniable uptrend in recent years, and its level is virtually unchanged over the 12 months ended May 2016, we do not deem current conditions as likely to confound the Coppock Guide. As such, we are fairly confident in the model’s most recent intimation of higher equity prices to come.
The BUY signals emitted for equities broadly fit with intra-market indications we have observed recently. For one, absolute momentum is constructive for seven of the ten GICS global equity sectors, and is expected to bottom for at least two of the three hold-outs this summer. Moreover, momentum has bottomed or is on the brink of bottoming for higher beta cohorts of the global equities complex, such as Emerging Markets and Asia ex-Japan. Also, our models call for continued leadership from global cyclical sectors, namely Energy and Materials. Each of these outcomes are supportive of equities in general.
Several investigations of the topic validate the idea that global cyclicals tend to lead during the later stages of economic upswings. As our thesis holds that the macroeconomic cycle drives risk-asset performance in post-bubble environments (i.e. Japan since the 1980s or the U.S. between the mid-60s and early-80s), it follows that Energy and Materials sector leadership should coincide with positive macroeconomic growth, which, in turn, should be linked with rising equity share prices.
Exhibit 4 below corroborates the notion of a tether between the U.S.’s economic health and stock market returns in recent years. Since 2000, we have observed a very strong, direct correlation (+0.78) between ISM Manufacturing PMI prints and trailing twelve month S&P 500 total return.
The ISM Manufacturing PMI Index bottomed December 2015, and has since reclaimed the key 50 threshold, which separates expansion from contraction. Equity returns followed, turning two months later. Momentum is currently positioned to support further strengthening in the PMI series into next year. Similarly, the Conference Board’s Leading Economic Index has demonstrated improvement since January.
High yield spreads too hint that the cycle likely has some life yet. Exhibit 5 illustrates the S&P 500 Index in the upper pane and the Barclays Capital U.S. High Yield YTW – 10 Year Treasury Spread below (inverted). This measure of credit spreads tends to lead big equity market tops by two or three years (high yield spreads inflected 30 months ahead of the 1999 stock market peak, and 32 months before the 2007 top). So, if history at least rhymes, the June 2014 low in spreads implies an early 2017 expiration date for the current business cycle–in total accord with the forecast for momentum to improve into next Spring.
To date, spreads have narrowed by 291 basis points off the February wide, and importantly, momentum anticipates more tightening into next year. The expectation for a further reduction in excess junk yield also fits with the premise of an improved macro landscape ahead, as research has demonstrated a direct tie between spreads and equity returns.
Bottom line: The Coppock Guide has recently issued optimistic signals for domestic and global equities. The history of this tool suggests S&P 500 and MSCI ACWI USD should deliver above-average returns over the next year or two. Various intra-market momentum studies validate this conclusion, as do prospects for macroeconomic growth. As such, we think risk seekers with one-year horizons should consider adding equity exposure at the expense of cash. More nimble players might seek out entry points in days and weeks to come, as, after the strong advance in effect since mid-February, stocks look increasingly stretched over the short and medium-terms.