October 02. 2016

Market Review

U.S. stocks finished the week with small gains. The Dow Jones Industrial Average added 0.3 percent for the week to end at 18308.15. For September, the blue-chip average finished 0.8 percent lower, but was up 2.1 percent for the third quarter. The S&P 500 eked out a small gain of 0.2 percent from last Friday?s close to finish at 2168.27. For the month, the S&P 500 finished 0.1 percent lower, but gained 3.3 percent for the quarter. The Nasdaq climbed 0.2 percent over the week to 5312.00. The heavy-tech index recorded a monthly gain of 1.7 percent, and a quarterly gain of 9.7 percent. Most key S&P sectors finished higher. Energy was the best weekly performer, while utilities dragged. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 13.3, down about 5.2 percent.

Strategy Review

In our last week’s comment, we highlighted the fact that we remained outright cautious as we had received a growing number of evidences within our indicator framework that the market had entered a corrective distribution phase. To complete a typical top building process, we said that another rally attempt of the market towards the latest record highs looked extremely likely on a very short time frame. And if such a move was accompanied by faltering market breadth, it would be the ultimate piece of evidence for the last burst of strength. As such a (large-cap driven) bounce could easily overshoot in terms of price, we advised our conservative members to wait for a significant negative down-move (towards 2,020) first, before taking any actions. After we had seen the predicted rally attempt last week, no stop levels were triggered so far. Consequently, the big question is if we see further overshooting into fall or if we should use this strength to sell. To answer that question, the quality of the bounce and of the underlying market remains key area of focus right now.

Short-Term Technical Condition

Not surprisingly, the short-term oriented trend of the market marginally improved compared to last week. This is mainly due to the fact that the S&P 500 slightly rebounded for the week and managed, therefore, to close slightly above the bullish envelope line from the Trend Trader Index. So from a pure price point of view, the short-term uptrend of the market remains intact as long as the S&P 500 does not drop below 2,164 (bearish threshold from the Trend Trader Index). Moreover, we can see that the Modified MACD did not turn bearish last week, indicating that the overall trend structure of the market remains somehow supportive. Above all, the gauge from the Advance-/Decline 20 Day Momentum Indicator also increased slightly into bullish territory the last week, indicating some form of positive support. Nevertheless, the indicator has formed an outright bearish divergence, as its gauge is a way too low if we consider the current levels from the S&P 500. Additionally, both envelope lines of the Trend Trader Index are still somehow decreasing, whereas the bullish signal from the Modified MACD is a bit too weak at the moment to take it too seriously (as any stronger down-day could easily produce a sell signal again). According to our investment process, in such a situation market breadth is key area of focus as it will give us guidance if the recent bounce will turn out to be significant or just shallow in its nature.

Despite the fact that the market finished the week with gains, the readings within our short-term breadth indicators have been developing moderately so far. As a matter of fact, most of them are still showing a huge bearish divergence if we consider the current levels from the S&P 500! This applies in particular to the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as the signals from both indicators have not shown any signs of major improvements compared to last week. This is telling us that the underlying tape momentum of the market remains quite weak-kneed and, therefore, the recent bounce still looks quite fragile. The case is slightly different if we focus on the percentage of stockss which are trading above their short-term oriented simple moving averages (20/50). Both tape indicators rebounded quite strongly last week, but nevertheless their absolute levels should be much higher given the fact that the S&P 500 is trading near record highs. Another concerning tape signal is coming from the NYSE New Highs ? New Lows Indicator. This is mainly due to the fact that the total amount of NYSE new highs did not spike at all, although the market is trading only a few percentage below its record high! As a consequence, the High-/Low Index Daily is forming a huge bearish divergence, although it remains bullish from a pure signal point of view.

From a pure contrarian point of view, the picture of the market remains quite unchanged compared to last week. This is due to the fact that the signal from WSC Capitulation Index remains quite bearish, whereas the Smart Money Flow Index has definitely not confirmed the latest bounce from the Dow Jones Industrial Average. Consequently, the smart guys have used the latest bounce to reduce their equity exposure. On the other hand, we can see that the WallStreetCourier Index is still giving some support and, therefore, the overall volatility level will remain elevated.

Mid-Term Technical Condition

Over the last couple of weeks, we have been quite worried about the strongly deteriorating readings within our Global Futures Trend Index since a drop below its 60 percent threshold would have told us that the risk of a fast paced correction was extremely high (of course only in combination with weak or bearish readings in mid-term oriented market breadth). Therefore, it was good to see that the recent bounce from last week caused a small recovery within that reliable indicator. Consequently, the gauge from the Global Futures Trend Index is now trading in the middle part of its bullish consolidation area and, therefore, the immanent correction risk has slightly diminished. Despite the fact that this can be seen as a quite positive development, we should not forget that the upside potential of the market remains also quite capped in such a situation (if we do not see any further positive momentum within that indicator). Therefore, the future development will be quite crucial to monitor as a new high from the S&P 500 in combination with readings below or slightly above 60 percent within the Global Futures Trend Index would be a clear indication for a suckers rally. However, if we focus on the WSC Sector Momentum Indicator, we can see that from a pure price point of view the mid-term oriented up-trend of the market remains intact. This indicates that most industries within the S&P 500 remain in a mid-term oriented uptrend at the moment. Nevertheless, if we have a closer look at our Sector Heat Map we can see that the momentum score of most sectors remain weak while the score of riskless money market remains quite elevated. This is also a quite concerning technical signal, as it indicates further signs of fatigue among the broad market.

This exhaustion can be also seen if we focus on our mid-term oriented market breadth indicators. Apart from the fact that the percentage of stockss which are trading above their mid-term oriented simple moving average (100/150) kept trading at quite bullish absolute levels, they did not show any signs of strength last week. This is telling us that the latest recovery was not really broad based in scope. Moreover, we can see that the bullish gap from the Modified McClellan Oscillator Weekly continued to narrow, which is another indication that the overall tape momentum of the market is slowing down. Basically, the same is true if we focus on the Upside-/Downside Index Weekly and the Advance-/Decline Index Weekly. Both indicators still remain bullish from a pure signal point of view, but their bullish readings continued to deteriorate last week. As a matter of fact, both indicators still remain somehow supportive but if this trend continues it might be just a question of time until we receive a bearish crossover signal within those indicators. Consequently, we will monitor their development quite closely within the next couple of weeks as bearish readings of those two indicators in combination with a mid-term oriented trend-break mostly led to a stronger correction in the past. So from a pure mid-term oriented tape perspective, it looks like the market does not have enough power to break substantially above its old record high. On the other hand, the downside potential of the market also looks a bit capped at the moment and, therefore, further top building/distribution looks quite likely.

Long-Term Technical Condition

The long-term uptrend of the market remains intact and, therefore, our long-term bullish outlook has not been changed so far. As a matter of fact we do not think that a correction should lead to a new bear market at the moment. The Global Futures Long Term Trend Index is still indicating a technical bull market whereas the WSC Global Momentum is telling us that 80 percent of 35 local equity markets all around the world (which are covered from our WSC Global ETF Momentum Heat Map) are still in a long-term oriented up-trend at the moment. As a consequence, the global trend structure still looks extremely supportive for the time being. On top of that we can see that the relative strengths of most risky markets remain positive. More importantly, this long-term oriented uptrend of the market is still widely confirmed by long-term market breadth. This is due to the fact that the readings from our entire long-term oriented tape indicators remain bullish (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stockss which are trading above their 200 day moving average).

Bottom Line

The technical situation remains almost unchanged compared to last week. Although the market only trades a few percentages below its all-time high, we remain cautious. This is due to the fact that most of our indicators remain quite weak-kneed/non-confirmative and, therefore, we received further evidences that the market has entered a corrective top-building process. However, as we have not seen further bearish crossover signals within our mid-term oriented indicators yet another rally attempt towards the latest record high still looks possible (to complete a text-book like top building process). Consequently, it might be a bit too early to pull the trigger immediately. Nevertheless, we would advise our conservative members to keep/place a stop-loss limit around 2,020 as the risk of a fast paced pullback can also not be ruled out in such a non-confirmative technical market environment. This stop loss limit should be in place until our mid-term indicator framework turns positive again! Aggressive traders should go short, if the S&P 500 drops below 2,020 and should increase their exposure if we see further down testing below 2,010/2,000. Stay tuned!