David Rosenberg: Squashing the Green Shoots

After a week off, David Rosenberg is back, shooting down notions of green shoots and putting our collective economic uphill battle in perspective. Some key excerpts (emphasis mine):

And it does seem like such a complete waste of time.

Let’s see. In April, total stimulus from the federal government to the personal sector, in the form of tax reduction and increased benefits, came to $121 billion at an annual rate. But that month, in nominal terms, consumer spending rose the grand total of $1 billion. Then we found out on Friday that in May, the total stimulus from the Obama economics team came to $163 billion at an annual rate, and consumer spending increased by a measly $25 billion (again at an annual rate). The big story is that the personal savings rate surged again to a new 16-year high of 6.9% from 5.6% in April and 4.3% in March. This is a repeat of the fiscal impact from the tax relief a year ago when the savings rate jumped from 0.2% in March 2008 to 4.8% in May 2008. This is what economists refer to as “Ricardian equivalence” — the money from Uncle Sam goes into the coffee can instead of being used to buy more coffee.

So let’s get this straight, the future taxpayer is being asked to contribute to a policy today that is aimed at perpetuating a consumer cycle — and yet for every dollar that is coming out of Washington to support a 70% consumption/GDP ratio, it is getting barely more than 8 cents worth of new spending activity. In real terms, as was the case with the tax rebates of just over a year ago, the real impact is on the savings rate, and it is very clear that not even the most aggressive monetary and fiscal policy since the 1930s is going to stop consumer spending in volume terms rolling over in the second quarter

…So wages and salaries are down 1.1% from a year ago. Interest income is down 5.2%. Dividend income has fallen 12.4%. Proprietary income is off 4%. The only income source in the green column are government transfers (food stamps, welfare, unemployment insurance) which is a booming industry at over 12% YoY growth. In fact, the share of personal income coming in the form of government handouts of one sort or another rose a full percentage point in May to a record 18%, and has jumped two percentage points in just the last three months, which is without precedence. Imagine that in the mid-1960s when the ‘Great Society’ was signed, sealed and delivered, that ratio of Uncle Sam support was barely more than 7%!…

Most pundits who crow about green shoots and about an inventory restocking in the third quarter giving way towards some sustainable economic expansion live in the old paradigm. They don’t realize, for whatever reason, that the deflationary aftershocks that follow a post-bubble credit collapse typically last for 5 to 10 years. Businesses understand better than the typical Wall Street or Bay Street economist and strategist that everything from order books, to output, to staffing have to now be restructured to adequately reflect a permanently lower level of leverage in the economy…

…First off, short interest is starting to build again — rising 0.74% on the Nasdaq and by 2.33% on the NYSE in the first half of June.

Second, share repurchases by S&P 500 companies have hit their lowest levels in six years — at $30.8bln in the first quarter, down 73% from a year ago and by more than 80% from the $172bln peak of 3Q2007.

Third, dividend payouts are receding sharply — down 16.2% YoY to $51.7bln last quarter. Corporate strategies are clearly still aimed at generating cash.

Fourth, look at what corporate insiders are doing — selling, Mortimer, selling! Share activity by corporate executives so far in June show that selling has outstripped buying by a factor of 22! According to TrimTabs, insiders among S&P 500 firms have unloaded $2.6 billion in shares since the start of the month and have purchased a mere $12 million.

John Hussman: Green Shoots and a Grain of Salt

Hussman’s Weekly Market Comment for this week is aptly titled Green Shoots and a Grain of Salt. He puts some of the recent optimism in context:

The key fact is that we have significant economic headwinds before us, and we should be careful to take our green shoots with a grain of salt. No piece of economic news, even a strong employment figure here or there, is likely to flip the switch that makes the problems all go away. It would be one thing if stock valuations were at a level that deeply discounted significant and ongoing negative news, but on the basis of normalized earnings, the S&P 500 is actually slightly overvalued here, and is likely to deliver long-term returns over the coming decade of only about 7.8% annually. An economy that is prone to disappointments, coupled with a market that requires a lack of them, is not a good combination.

John Mauldin: The End of the Recession?

John Mauldin questions economic statistics and interpretations of ‘green shoots’ in his Frontline Thoughts letter for 6/26:

Last week we began a series on data abuse, about how various commentators twist and torture data to make it say what they want, or fail to look at the details underneath the headlines. Predictably, there is a lot of fodder this week as we forge ahead into this ripe territory. The headlines screamed that US income data went up unexpectedly. Green shoots were everywhere. But if you look at the actual data, you find something much different. And, I keep hearing the insistent refrain that the market is telling us that the recovery is around the corner. Well, the recovery may be, but can the market really tell us that? I have about 25 windows open in my computer, with tons of misleading data. Let’s see how much we can cover in this week’s letter.

Richard Russell Makes Case for Gold

The venerable Richard Russell makes the long term case for gold. Article compliments of Investment Postcards from Capetown:

I often quote Richard Russell, the 85-year-old writer of the Dow Theory Letters, in my blog posts. Although I may not necessarily always agree with his views, they are always stimulating and important to consider when piecing together the financial puzzle. His article on competitive devaluations and the implications for fiat currencies and gold bullion makes for particularly interesting reading and the paragraphs below have been excerpted from it.

“Every nation wants to export. The obsession to export has resulted in filling the world with products, things, and merchandise of every kind. There’s a world overflow of products, and the result is deflation. Just too much stuff being manufactured. Buyers from importing nations can’t handle it all. The result is asset deflation.

“One reason why every nation wants to export is to lift employment. Nothing scares politicians like unemployment. Why? Because unemployed workers VOTE just the way employed workers do. The lesson – if you want high employment, learn to export. Exporting creates jobs. China and Asia learned that lesson, and they captured world export markets with the help of one valuable item – low wages – that along with no Social Security, no medical, no pensions, no anything, just plain low wages with none of the extras.

“Ooops, I left something out. What I left out was the big second advantage – cheap currency. Every nation, particularly the exporters, wants a cheap, competitive currency. The US is no exception. Obama tells the world that the dollar is a strong, hard currency, but the dollar has been weak. The administration’s policy is to talk a “hard dollar” but hope for a soft dollar.

“The result of all this is competitive devaluations. Nations no longer devalue their currencies against gold, they simply print oceans of their own currencies, and with that paper they buy dollars, hoping to raise the price of dollars against their own currencies. The result is a growing sea of fiat junk paper.

“The greater the world ocean of fiat paper, the higher gold goes. You see, gold is the secret, unstated world standard of money. Gold can’t be devalued or multiplied out of thin air. So as the various currencies of the world decline in relation to each other, gold stands alone. It can’t be cheapened or devalued or bankrupted. While the currencies of the world decline in purchasing power in relation to each other, they all decline in purchasing power against gold. In other words, as time passes, it requires more of each currency to purchase one ounce of gold.

“In the meantime, the US continues to spend outrageously, not only running up debts for the present but also for the children of the future. The US deficits and national debt will run into the multi-trillions in coming years.

“How will these monster debts ever be paid off? They’ll be paid off by devalued dollars, they’ll be paid off by additional borrowing, they’ll be paid off by inflation, they’ll be paid off with higher taxes and probably a VAT tax, they’ll be handled by projecting them into the future for other administrations to struggle with.

“As they say in New York, ‘all right already, so what do we do about it?’.
“Short and medium term, you want dollars, as many of them as you can save. Long-term you want gold. Somewhere ahead gold will come into its own. I can’t time gold, but I can identify the time when gold is ready to ‘take off’. When gold climbs above 1,004 it will be the signal for the beginning of the third phase gold rush. What I’m saying is forget quick profits in gold, forget timing gold, just own some.

“The way the world is going, ‘gold will be the last man standing’. Gold will be wanted because unlike everything else, gold can not go bankrupt. Gold has no debt against it, gold is not the product of some nation’s central bank. Gold is pure intrinsic wealth. It needs no nation to guarantee it. Gold is outside the paper system.”

Source: Richard Russell, Dow Theory Letters, June 25, 2008.

Oil/Natural Gas Ratio Update

I faced some skepticism when I wrote on June 12th that the WTIC/Natural Gas ratio was at historically high levels. I was skeptical as well, given the poor fundamentals of natural gas but I thought the technical analysis was worthy of consideration (the ratio has rarely been above 20 since 1976). However, since June 12th when the ratio was hovering at 19, the ratio has retreated closing at 16.85 on June 26th.

Obviously, the lower the ratio the more risk any trade involving going long natural gas and shorting oil entails. The ratio appears to face heavy historical resistance in the 19-20 range but is still in an uptrend. Given some of the structural concerns with UNG detailed here by Andrew Horowitz, one may be better served looking to the futures market if looking to trade the pair.

The chart below is a weekly 3 year chart, for more historical context please see my previous article.

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And a daily 6 month chart:

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A Book Review: Martin Pring’s Trading Systems Explained

Martin Pring is a prolific technical analyst and is considered by many a pioneer in technical analysis. It was with this in mind that I read a copy of his Trading Systems Explained: How to Build Reliable Technical Systems. A little bit of background about me: I am not a mechanical trader and have never developed a mechanical trading system for my own use, although I do have an interest and basic knowledge of technical analysis which was helpful in understanding the book.

Overall, this book serves as a great starting point for anyone interested in developing a mechanical trading system. What I enjoyed most about the book was that Pring was not afraid to use very specific examples of trading systems. He shows specific uses of moving averages and oscillators and shares his optimized results. The systems he uses are simple and easy to chart, which is encouraging to anyone new to trading. In addition, he gives four specific trading systems based on intermarket relationships. They are systems based on a) Equities versus short term interest rates, b) The CRB versus Gold, c) Bonds versus commodities, and d) Systems using relative strength. Again, in each example he shares his results for each trading system. Pring also uses the beginning of the book to cover the basics that every trader should be familiar with before risking his or her own capital. Mainly, the tools he emphasizes for risk management including stop losses and and the importance of testing systems prior to implementing them.

The primary drawbacks of the book would be that the results are 7-8 years old. It would be nice to see the out of sample returns on the systems Pring uses in the book. In addition, and this is not necessarily a drawback of the book itself, every trader is going to need a robust software platform to test potential systems and should not expect to rely on one book to provide the “holy grail”. The book’s emphasis in on longer term systems, which I find to be a benefit. However, short term traders should probably look elsewhere. Finally, the book’s title states its limitations: the book explains reliable technical trading systems. A beginning trader should seek out other books, especially ones that have more details on money management (especially as it relates to trade sizes) and the psychology of trading before implementing these systems.

In conclusion, I think Pring’s book could serve as a core book for anyone interested in mechanical trading. The book is specific, helping the reader get inside the head of a master technician and to understand the work involved in testing and optimizing trading systems. As with any book, don’t rely on it as the “holy grail”, but use it to help build your own master trading plan.

Mebane Faber: Combining Rotation and Timing Systems

Great article/update from Mebane Faber on a strategy which combines combining rotation and timing systems into one aggregate system. The article in full below (For those of you who have not read Faber’s book, I highly recommend it).

Also, on separate note related to Faber, his side project Alphaclone.com is offering two of its portfolios for investment via Folio.com Most of the portfolio services on Alphaclone are not free; however, the Tiger Cubs portfolio is available for free on the site’s homepage. You can also view the Tiger Cubs and a Berkshire Hathaway on Folio here.

Now, back to the article:

This is probably the #1 question I receive on email, usually in two forms:

q #1 – “Meb, have you considered combining the two timing systems? Use the rotation system across the 5 asset classes from your book, but sell an asset and move to cash when it declines below its X moving average?”


q #2 – “Meb, have you considered combining the two timing systems? Use a rotation system but move to cash for the whole portfolio when it declines below its X moving average?”

The questions sound similar but are slightly different. I don’t think #1 will make any difference in performance (since I wrote this post I tested it and confirmed that it makes no difference). For the vast majority of the time the asset is already above the moving average until the end when it drops, and the moving average usually doesn’t pick that up.

Q#2 is much more interesting to me. However, you can only test this WITHIN an asset class. Below we take a look at US Stocks. (I see no reason this wouldn’t work in other asset groups like commodities, bonds, currencies, and foreign stocks.)

I used the Fido Sector funds from 1988-5/2009.

I took the top fund, updated monthly, based on the average rolling 3/6/12 month performance.

I then took the top 3 funds, equal weighted and updated monthly, based on the average rolling 3/6/12 month performance.

I then took the same portfolios, but moved them to cash when the S&P500 declined below its long term moving average (10 month simple).

Results are below. Note how the rotation system generates about 5-6% outperformance per year. The volatility is high (likely due to the upside volatility), and drawdowns are similar to buy and hold. Using the timing system to hedge the portfolios resulted in declines in volatility (around 20%) and most importantly, a reduction in drawdown from 53% to around 27%. Sharpe #s are misleading due to the high returns. . .


One could simply buy the ETFs or mutual funds when above the SMA then hedge or sell and move to cash when below. Depending on the fund/broker, there could be $$ transactions costs involved (especially if the account was small). One could also just move into a rotation fund when above, then sell when below. (Note: I haven’t looked at ANY of these funds below so no recs either way. Most of them FAIL for various reasons). If I am missing any, add them in the comments and I’ll edit.

PS Anyone wanna take the over under on how long till Barclay’s Blackrock offers momentum ETFs? I say by the end of 2009.

Broad rotation funds (benchmark, 60/40 or diversified benchmark)

FUNDX Tactical Upgrader, (TACTX).

DWA Balanced (DWAFX).

US Stock rotation funds (benchmark, S&P500)

FUNDX Upgrader Fund (FUNDX)

Rydex Sector Rotation Fund (RYSRX)

DWA Technical Leaders (PDP)

VL Industry Rotation (PYH)

VL Timeliness (PIV)

Claymore/Zack’s Sector Rotation (XRO)

Foreign Stock rotation funds (benchmark, MSCI EAFE)

Rydex International Rotation Fund (RYFHX)

Claymore/Zack’s Country Rotation (CRO)

In registration:

AQR International Momentum Fund

AQR Momentum Fund

AQR Small Cap Momentum Fund

IndexIQ Momentum Leaders All Cap Fund



Log and non-log charts of the equity curves below.



Tobin’s Q: An Explanation and Update

First, an explanation of Tobin’s Q, compliments of Trader’s Narrative:

There are many different ways to value the stock market. We are waiting for the Coppock Guide to give us a signal by month’s end (just a few more days left). The usually reliable price earnings ratio has gone haywire, but the dividend yield ratio is still valid.

But what if I told you there is an even better way to sum up the valuation of the stock market in just one number? A method that is both rational and comes with an astonishing track record, having identified every single generational buy opportunity?

Tobin’s Q was created by the late James Tobin, a pre-eminent economist and professor at Yale. His work garnered him a Nobel prize “for his analysis of financial markets and their relations to expenditure decisions, employment, production and prices.” But he’s probably best known for his work on the stock market. Put simply, Tobin’s Q is a ratio of the current value of the market divided by the replacement value of those same assets.

Think of a factory. It has a market price at which it would be bought and sold. And it also has a replacement cost – what one would have to spend to rebuild it from scratch. The ratio of the two is Tobin’s Q. Obviously, that would imply that when the ratio is greater than 1 the market is overpriced because one could theoretically ‘rebuild’ it for a cheaper price than it would take to purchase it. The Q ratio for US equities has fluctuated between 0.3 and 3 in the past 130 years.

It has signaled all the great bear market lows: 1982, 1974, 1949, 1932, 1921. Tobin’s Q moves at such a glacial pace that other indicators – even the Coppock Curve – seem twitchy by comparison. But when it does approach an extreme, it pays to give it the respect it deserves.

The best book on Tobin’s Q is Valuing Wall Street by Andrew Smithers (of Smithers & Co.). It came out at the same time as Shiller’s more famous Irrational Exuberance.

Both books had the same message and both were published at the exact peak of the 2000 bubble, but Shiller’s work got more attention because it was written to be more accessible to the general public while Smithers is more targeted to educated traders and investors. Although both books are good Shiller’s book stole much of Smithers’ thunder. You can pick up a copy from Amazon for less than $4 – which is a steal really.

As you might imagine, calculating the replacement value of such a diverse set of ever changing assets is mind bogglingly complex. Thankfully, the Federal Reserve does the heavy lifting. They provide the data in the Flow of Funds Report (pdf document). Look for the numerator on B.102 line 35: Market Value of Equities Outstanding (on page 103) and the denominator: Net Worth on line 32 (same page).

So the ratio resolves to:

9554.1 ÷ 15389.8 = 0.6208

Due to the nature of the data, it is only available quarterly with a lag of a few months. The latest report was released March 12th, 2009 which means the above number is for the fourth quarter of 2008. We should be getting the release of data for the first quarter of 2009 soon. But some analysts also guesstimate the number ahead of time. John Mihaljevic, the former research assistant to Tobin says the current value of Q is around 0.43 – which would be extremely close to the historic low of ~0.30. Following the previous link, you can not only get further details but purchase his complete report.

Obviously the market could fall more and take the Q ratio down with it. But this is further evidence that we are much, much closer to a generational buy point here rather than somewhere along the line of a continuing downtrend. Similar to the Coppock Curve, the Q ratio is not only setting up for a bullish signal but one of epic proportions.

Here is a chart of the Q ratio (from 1952 onwards when Federal Reserve data is available):


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Next, an update from June 24th shows that the bear market still has not ended according to Tobin’s Q:

The Federal size:11;" class="IL_LINK_STYLE" >Reserve released its data for the first quarter of 2009 and unfortunately the estimate by John Mihaljevic was not borne out. This bear market is not finished – at least not according to Tobin’s Q ratio.

I’m not really sure how the eggheads at the Fed actually crunch the numbers for the numerator and the denominator but adjustments are the norm. Each quarter we not only have new data but usually small adjustments are made to prior numbers.

This most recent data release was no different with almost all previous data points changing slightly. For example, the 2008 fourth quarter data changed from 0.6208 to 0.6730. The only (thin) silver lining in this cloud is that we are continuing to head in the right direction: lower. But in order to give us a signal, the ratio has to fall precipitously to the 0.40 level. Which is not to say that it can’t do so.

In the size:11;" class="IL_LINK_STYLE" >first quarter of 1974 the Q ratio was 0.58, not far from where we find it now. During the next few quarters, it fell so fast that by the fourth quarter of 1974 it was 0.33 – at an extreme historic low, signaling a generational opportunity in the size:11;" class="IL_LINK_STYLE" >equity markets. You can mouse over the chart below to see what I mean.

By the way, if you haven’t yet, I highly recommend picking up a copy of javascript:pageTracker._trackPageview('/outgoing/www.amazon.com/gp/product/0071387838?ie=UTF8&tag=ug1r3q2-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0071387838');" href="http://www.amazon.com/gp/product/0071387838?ie=UTF8&tag=ug1r3q2-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0071387838">Valuing Wall Street. It is the definitive book on this indicator and at only $10 even a cheap bastard like me can’t resist it. A little trivia: this book came out at the same time as “javascript:pageTracker._trackPageview('/outgoing/www.amazon.com/gp/product/0767923634?ie=UTF8&tag=ug1r3q2-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0767923634');" href="http://www.amazon.com/gp/product/0767923634?ie=UTF8&tag=ug1r3q2-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0767923634">Irrational Exhuberance” but either because it had a useless publicist or because the concept was too dry, it never got the same traction as Prof. Shiller’s book – even though it argued correctly that the 2000 market was about to take a massive tumble.

The Coppock Curve Indicator

I’ve recently been looking at the Coppock Curve as a long term technical indicator for identifying new bull markets. One of the better sites/explanations I have found is from the Trader’s Narrative site. Below is an explanation and introduction to the Coppock Curve from Trader’s Narrative (note that this was posted May 26th 2008):

Continuing with the series, here is the fourth condition of a new bull market as outlined by Jim Stack of InvesTech:

I’ve hesitated to mention this technical indicator since I started writing this blog because it is almost too good. It is one of the few that have an uncanny ability to find the start of almost all major bull markets. So you can understand why I don’t want to run the risk of ruining it by popularizing it any more than it is. And it is not popular at all.

In fact, compared to say the RSI or MACD, the Coppock Guide is an esoteric and rarely mentioned technical indicator. It was created by Edwin S. Coppock some 50 years ago and although it is followed closely by a very small group of technical analysts, its calculation is not complicated at all.

You can keep track of it yourself. Here’s size:11;" class="IL_LINK_STYLE" >the recipe: you need historical monthly Dow Jones Industrial data. You add the 14 month ROC to an 11 month ROC, then you take a 10 month (simple linear) weighted size:11;" class="IL_LINK_STYLE" >moving average of the result. That’s it.

If you’re mathematically astute, you’ve already noticed that it is size:11;" class="IL_LINK_STYLE" >just another oscillator. Here is the chart of the Coppock Guide for the past few years, courtesy of InvesTech:

coppock guide chart investech

How is the Coppock Guide interpreted?
The most traditional interpretation is to recognize a buy signal when the Coppock Guide curls up while it is below the zero line.

It can also provide sell signals, although these are less frequent. If the Coppock curve makes a double top formation without first having come down to the zero line (or below it), the market is in for a seriously brutal bear market. You should be able to find one such occurrence in the chart.

So you can see why I think it is almost too good to share. In its history, only 4 false signals have occurred. That’s an 83% accuracy rate.

What is the Coppock Guide saying now?
The good news is that the Coppock Guide is in negative territory projected to fall into negative territory this month. So now any upturn can potentially give us a buy signal. The bad news is that this may happen next week, next month or next year.

The key factor is an upturn. But that can happen from an incredibly size:11;" class="IL_LINK_STYLE" >low level, like say in 1974 or 1932 (not shown) or it may happen just under the zero line, as in 1994.

Although no indicator can give a full iron clad guarantee, when the Coppock Guide turns up it would totally skew the probabilities towards a new bull market. As always I’m keeping a close watch and now that “the cat is out of the bag”, you can too.


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So, where does the Coppock Curve say we are at today? As of June 1st, it says we are in a new bull market, according to Trader’s Narrative:

While we were in the thick of the 2008 bear market, I looked ahead and provided a road map for the conditions of a new bull market. Among them was the Coppock Guide.

At the beginning of the year I provided a hypothetical projection to demonstrate that size:11;" class="IL_LINK_STYLE" >the stock market would have to go on one hell of a bullish rampage to pull the Coppock Curve up from its death spiral. A few months later, a rally that almost no one foresaw took us 40% higher.

Then at the beginning of May, I reiterated that a Coppock buy signal would be arriving by the end of the month, as long as the market held it together and didn’t fall any further.

Well, we are finally here and the Coppock guide has provided a definitive signal by turning up – this is the buy signal that we had been anticipating:

Coppock Curve chart 1920 May 2009

I know, I know, it is impossible to see on the chart but believe me, it is there. To see a zoomed in view of the chart, check out the previous links. The S&P 500 Coppock Curve stopped going deeper into negative and actually increased from -417 at the end of April to -409 at the end of May 2009. All it would have taken was a one point increase but we got 8 points.

Now that we have a signal, what does it mean?

Well, obviously, it means we have the wind at our backs. The Coppock Guide has been a reliable indicator of the long term size:11;" class="IL_LINK_STYLE" >market trend. But, like everything else, it isn’t full proof – as you can see from the false signals. So with that in mind, here are three major observations:

First: The signal isn’t just for one index or market. We are seeing the Coppock Curves for many different markets around the world turn up at the same time. The Australian All Ordinaries, the Nikkei, the FTSE and all 3 major US market indexes: S&P 500, Dow Jones Industrial and the Nasdaq.

While most of the signals are occurring concurrently, some like the (Chinese) Shanghai market and the Nikkei gave signals last month. Check out all the major world markets to see how just how much confirmation we are getting from them.

Second: Valid signals are those that turn up from under the zero line. And historically, the deeper the level at which the signal arrives, the more strength the following bull market has. This most recent signal is coming from a deeply oversold level – the most since 1938 (-417 to -400) and even further, 1932 (-643 to -616).

Of course, that doesn’t mean that from now on the market has only one direction – up! Based on the sentiment and technicals covered before (Wedge Formation), I think it is probable that we will head down, but won’t break the previous low. This will allow for the long term moving average to flatten out and begin to support, rather than hinder prices from going higher.

Third: Although the Coppock Curve has given its share of false signals, we haven’t seen any occur when the metric has curled up from such a deeply negative level. There are very few examples of this, so it is difficult to extrapolate a rule but so far, this has been the case.