Top SocGen analyst warns: "Killer wave" forming in stocks

Über bear Albert Edwards has abandoned his empirical approach for (shock horror) the mystical world of technical analysis.

Behold the killer wave.

For those of you not familiar with the Coppock indicator here’s a quick primer, via the authoritative source that is Wikipedia:

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.

A buy signal is generated when the indicator is below zero and turns upwards from a trough. No sell signals are generated (that not being its design). The indicator is trend-following, and based on averages, so by its nature it doesn’t pick a market bottom, but rather shows when a rally has become established.

And Edwards says it a reason to be afraid, very afraid.

For those looking for a reason or a technical signal that the cyclical bull market has ended and that we are firmly back in the icy grip of the structural bear market, we would highlight the analysis of Dominic Picarda of the Investors Chronicle and the FT. He identified the S&P as having just made a “killer wave”. He has identified eight killer waves in the S&P 500 over the last 83 years. All have been followed by substantial losses. The average fall following a killer wave has been 40 per cent over 20 months.

Here’s why for all you rune watchers.

As Dominic Picarda explains in his article, a killer wave is formed as follows. The Coppock indicator gives an initial sell signal (which it did last summer). However, the indicator subsequently turns up once more, without first having registered a reading of below zero. This happened in April 2011. The killer wave is then completed once a further sell-signal occurs, forming a sort of “double-top” pattern in the Coppock indicator (for Dominic’s article click here for a little video explaining the signal click here – you might have to click more than once)

Not convinced?

OK. Here’s Edwards on more familiar ground:

Gavyn Davis, in another well-argued article, highlights that the IMF has shown conclusively that G4 monetary easing has in the past transferred itself almost completely to the emerging economies, whether or not their own economic circumstances warranted it (link). EM foreign exchange intervention is the key mechanism for this transmission.

Inevitably, the monetary effort to maintain a dollar peg ebbs and flows with the strength of the dollar (see chart below). Hence when the dollar is weak the monetary pump is at full stretch and conversely in periods of dollar strength (as in H2 08) that monetary pump is effectively switched off. Back in H2 08, the monetary consequence of the dollar’s strength massively caught out those who thought EM and commodities could de-couple. And if, as many believe, the dollar has once again broken upwards, EM and commodities are set to slide again.

You have been warned. US dollar strength will drain liquidity from emerging markets.