MIAMI (MarketWatch) — Mark Cook, a veteran investor included in Jack Schwager’s best-selling book, “Stock Market Wizards,” and the winner of the 1992 U.S. Investing Championship with a 563% return, believes the U.S. market is in trouble.
The primary indicator that Cook uses is the “Cook Cumulative Tick,” a proprietary measure he created in 1986 that uses the NYSE Tick in conjunction with stock prices. His indicator alerted him to the 1987, 2000, and 2007 crashes. The indicator also helped to identify the beginning of a bull market in the first quarter of April 2009, when the CCT unexpectedly went up, turning Cook into a bull.
What does Cook see now?
“There have been only two instances when the NYSE Tick and stock prices diverged radically, and that was in the first quarter of 2000 and the third quarter of 2007. The third time was April of 2014,” Cook says.
In simple terms, as stock prices have gone higher, the NYSE Tick has moved lower. This divergence is an extremely negative signal, which is why Cook believes the market is losing energy.
In fact, the Tick is showing a bear market, which seems impossible considering how high the market is rising.
“The Tick readings I am seeing (-1100 and -1200) is like an accelerator on the floor that is pressed for an indefinite amount of time,” Cook says. “Eventually the motor will run out of gas. Now, anything that comes out of left field will create a strain on the market.” Since the CCT is a leading indicator, prices have to catch up with the negative Tick readings.
“Think of a dam that has small cracks that are imperceptible to the eye,” he says. “Finally, the dam gives way. Eventually, prices will go south, and the Tick numbers will be horrific.”
Cook is also concerned that the market is acting abnormally. “It’s like being in the Twilight Zone, he says. “Imagine going outside when it’s raining and getting sunburned. That’s the environment we’re in right now.”
Unfortunately, Cook can’t say when this vulnerable market will crack. “The CCT is similar to the new-high, new-low indicator,” he explains. “As the market goes higher, fewer stocks make new highs. Some people might say it’s ‘different this time,’ but it’s never is. Could the market go higher? Yes, it could, but the extension of time will create an even greater divergence that has to be snapped back together.”
Cook predicts that within 12 months, the market will suffer a 20% or greater pullback. Says Cook: “It may take months and months for the correction to develop. I don’t look at how low the market drops, but how it rallies. I will look for lower highs and lower lows. Every rally aborts before the previous high, and every decline penetrates and accelerates below the previous low.”
One of the reasons that Cook has survived as a trader for so long is his credo: “There is always a way to make money.”
For Cook, that means being flexible enough to change strategies and take a 180-degree turn. “The scenarios we will see in the future will be totally different than what is now,” he says. “You will have to navigate differently. It’s like going through a jungle that ends and becomes a desert. There is only one constant, and that is change.”
In fact, Cook excels in volatile markets. “I’m amazed that we have gone over two years without a double-digit correction,” he says. “Without volatility, you get a complacent environment like we have now, which can lead to devastation. You can’t stay at these complacent levels forever. When there is a correction, it will be very severe.”
Cook says that when volatility gets light (like it is now), traders and investors give up. “A lack of volatility is not good for the market,” he says. “Low volatility begets thinness, and that begets low volume, which equals greater risk.” One day, he adds, volatility will return, and so will the traders.
Another key to Cook’s success is his ability to correctly assess probabilities. Right now, he sees a greater than 75% probability of a major correction, but this could unfold over a long period. Says Cook: “The probability of us going up 5% from here is possible, but there’s a higher probability of us going down 20%.”
Cook also is not a big fan of the Fed’s policies. “The Fed is creating abnormalities which creates stress on the markets, similar to a pendulum swinging. I believe the honeymoon is over for Yellen from this point forward. The magnifying glass will be on her. Typically, within 12 months of a new Fed chairperson, the market gets more volatile.”
Cook knows there will be a catalyst that will “burst a hole in the ship, which is already taking on water, even though stock prices haven’t reflected that. The cannonball that will finally sink it will come from a source that we can’t see. But when the cannonball hits a ship that is already partially flooded, it will sink a lot quicker. I’m not sure the Fed is quick enough or flexible enough to head off a disaster.”
Looking forward, Cook says he wants to see if the S&P 500 is lower in July after the backdrop of a better economy, low interest rates, positive earnings, and a lower unemployment rate. If July is down, that would confirm the significant divergence.
“The tape looks exceptionally tired and heavy,” Cook says. “I see a huge divergence between the weak internals of the Tick and the rising stock prices. The divergence is as wide as the Grand Canyon. It’s incredible.”