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Capitulation - A 'BUY' Signal

Capitulation is that rare event in markets where sellers are overwhelming buyers as investors give up in reaction to consistent bad news and share prices decline in rapid succession. As we have signalled many times before, history teaches us that when markets capitulate it is either the bottom of that particular correction, close to it or it is the beginning of a bottoming process.

The capitulation indicator we track is Jack Schannep's proprietary capitulation indicator. As long-standing subscribers know, Jack Schannep is the editor of The Dow Theory newsletter (and also author of the book Dow Theory for the 21st Century).

Schannep Capitulation Indicator Definition: From his book Dow Theory for the 21st Century the actual definition of the Schannep Capitulation Indicator is:

'A short-term oscillator is utilised which measures the percent of divergence between the three major US stock market indices (Dow Jones Industrial Average, S&P 500 and the New York Stock Exchange Composite) and their 10-week, time-weighted moving averages. Market bottoms are identified when the divergence between the three major (US) stock market indices is 10% below their respective ten-week, exponentially time-weighted moving averages'.

In GillenMarkets, we have tended to use the percentage deviation in an index from its underlying 30-week moving average to highlight potential capitulation events. Indeed, we successfully used this technique in a Featured Article in early October 2016 to flag a potential bottom in the sterling exchange rate, and that subsequently proved to be the bottom of the sterling sell-off following the Brexit vote at end June 2016.

Jack Schannep's capitulation indicator is a little more complex, but also more useful, we feel, for two reasons:

  • It uses a time-weighted moving average so that it gives greater weight to more recent data compared to earlier data (similar to how our Coppock Indicator works), and;
  • It has a history of good calls dating back to the start of the S&P 500 Index in 1953.

Since 1953, using the Schannep Capitulation Indicator, US equity markets have capitulated on only 16 occasions including the latest signal on 24th December 2018, and we emailed subscribers at the time to signal a likely 'buying' opportunity.

Returns Following Capitulation in US Equity Markets
Date S&P 500 Level Days from Bottom % From Bottom Returns 6 Mths Later

Returns 1-Year Later

22-Jun-62 53 2 1% 19% 33%
25-May-70 70 1 1% 21% 42%
23-Aug-74 72 28 13% 16% 18%
30-Sept-74 64 3 2% 32% 32%
19-Oct-87 225 0 0% 15% 23%
3-Dec-87 225 1 1% 18% 21%
23-Aug-90 307 34 4% 19% 28%
31-Aug-98 957 0 0% 29% 38%
20-Sept-01 985 1 2% 17% -7%
19-Jul-02 848 57 8% 6% 17%
09-Oct-02 777 0 0% 12% 34%
07-Oct-08 996 32 20% -18% 12%
12-Nov-08 852 6 9% 7% 30%
23-Feb-09 743 10 8% 31% 47%
08-Aug-11 1,119 39 1% 14% 25%
24-Dec-18 2,417 0 0% 22% 26%
Averages     13 4% 17% 26%

As the table highlights, following a Schannep capitulation signal, the average return over the following six months from the S&P 500 Index has been 17% with only one period where a loss was recorded over the subsequent six-month period (-18%).

The average 1-year return following a capitulation signal has been 26%, again with only one period where a loss was subsequently recorded (-7%). In our view, these are excellent odds and are the reason why capitulation is a 'Buy' signal, on average.

In deep bear markets, markets can capitulate more than once. So, it's safer to describe capitulation as signalling either the bottom (which it did on four occasions since 1953), close to the bottom or the start of a bottoming process.

In late 2008, for example, during the Global Financial Crisis, US equity markets capitulated three times in succession - in October 2008, again in December 2008 and then for the last time in February 2009. So, on the first capitulation signal in October 2008, it was to prove subsequently that it was the start of a bottoming process on that occasion.

It is also worth noting that Schannep's Capitulation Indicator gave its 'Buy' signals on average 13 days from the actual market bottom and on average within 4% of the actual bottom (see the above table).



1st March 2020