admin No Comments

May 29th 2022  |

Key Takeaways

  • We upgrade our strategic outlook from cautious to bullish
  • New uptrend is establishing but expect high volatility
  • Short-term-oriented indicators critical to watch within the next couple of days
  • Time to get back into the market buy building up exposure (especially on weak trading days)

Market Review |

U.S. stocks posted strong gains for the week with the major averages notching their best weekly performance for months. Closing at 33,212.96, the Dow Jones Industrial Average finished up 6.2% for the week and snapped its longest losing streak, eight weeks, since 1923. The S&P 500 finished at 4,158.24 and rocketed 6.5% this week. The Nasdaq jumped 6.8% for the week and closed at 12,131.13. Both indexes ended seven-week losing streaks. Still, the averages are well off their highs, with the Nasdaq still solidly in bear market territory and the S&P 500 having briefly dipped more than 20% below its record last week. All key S&P sectors succeeded to close in positive territory for the week, led by the discretionary sector. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 25.7.

Strategy Review

Despite the fact that the market was just trading less than 3 percentages points below its all-time high in early January weeks ago, we received a growing number of evidences that the market regime was getting increasingly corrective back then. This was based on the fact that our indicator framework showed that the underlying trend quality was faltering quickly, although major indexes were still holding up quite well. Although not every weak trend quality market environment lead to a correction/bear market in the past, every correction/bear market started exactly that way. As a result we said it would make sense to place a stop-loss limit at 4,531 (since the situation had the potential to escalate within days). In fact, the gauge of the Big Picture Indicator jumped into the bearish consolidation quadrant in mid-January, whereas also our suggested stop-loss limit was also triggered back then. In the following weeks, the S&P 500 corrected significantly to 4,173 before a stronger recovery rally from mid- until late March brought some relief. In the beginning, the trend quality of that relief rally looked quite high and, therefore, our strategic outlook turned positive again in mid-March. Shortly after we suggested to place another stop-loss limit at 4,450, the recovery rally lost some steam again. In fact, the S&P 500 hit our suggested stop-loss limit by the end of March. Afterwards the S&P 500 dropped into a bear market by falling to 3,800 by the end of May before the bounce from last well brought some relief again. After the strong counter trend rally, the big question is if it is time for a bargain hunt or will the market face further declines?

Short-Term Technical Condition

Not surprisingly, the S&P 500 was able to get in a strong short-term-oriented uptrend last week. From a purely price point of view, the S&P 500 managed to close 80 points above the bullish envelope line of the Trend Trader Index. In addition, this positive price trend is now also backed by strong momentum (Modified MACD and the Advance-/Decline 20 Day Momentum Indicator). That is definitely a sign, that the latest gains could have, indeed, the potential to be the beginning of a more sustainable uptrend rather than being just a short-lived oversold bounce. To verify that view, the participation rate within that short-term-oriented trend (also known as trend quality) will give further guidance (since a healthy and sustainable uptrend should be always broad-based in its nature).

Analyzing the quality of the recent gains (hence, the upside participation rate) shows a quite broad-based demand all across the board. Thus, the latest gains could have the potential to be the beginning of a longer-lasting recovery rather than just being an oversold bounce. The latest rally was supported by a strong number of advancing issues (Modified McClellan Oscillator Daily) and high advancing volume (Modified McClellan Volume Oscillator Daily), plus the volume in advancing stocks has significantly exceeded the volume of declining stocks (Upside-/Downside Volume Index Daily). Consequently, the latest recovery was driven by the whole market and not only by a few heavy weighted stocks in the index (which is a quite healthy trend quality signal for the time being). This can also be seen if we focus on the percentage of stocks which are trading above their short-term-oriented moving averages (20/50). In addition, the stocks hitting a new yearly high overtook the ones hitting a new yearly low for the first time in this correction cycle (NYSE New Highs minus New Lows Indicator). This is definitely a quite positive signal as it shows that the latest gains were also driven by the broad market and were not only the result from short-covering (since short-covering just reduces just the number of new lows but does not increase the number of new highs). Still the number of new highs could be much stronger if we consider the weekly performance of the broad index. Consequently, the averaged new highs and new lows (High-/Low-Index Daily) remain bearish from a purely signal point of view. All in all, the current short-term-oriented trend of the S&P 500 looks quite strong in its nature. Therefore, the latest gains could have definitely the potential to mark the start of a new and sustainable uptrend rather than just  being an oversold bounce (like the one in early February and mid-March). Nevertheless, we should not forget that some of our short-term-oriented trend quality gauges could still be a bit stronger from an absolute level and, therefore, we would not be surprised if the pace is likely to slow down a bit in the next couple of trading sessions.

On the sentiment side, we can see that the market is heavily overbought (Advance-/Decline Ratio Daily, Upside-/Downside Volume Ratio Daily and the WSC Timing Indicator). Thus, we would not be surprised if the pace is likely to slow down in the next couple of trading sessions. Apart from that we can see that most of our option based indicators remain bullish AII CBOE Put-/Call Ratio, AII CBOE Call-/Put Ratio Oscillator, Equity Options Call-/Put Ratio Oscillator, WSC Put-/Volume Ratio) plus market sentiment remains quite pessimistic (AII Bulls & Bears survey). As a result the recent recovery still could have legs (from a purely contrarian point of view).  On the other hand, we can see that Smart Money has not fully confirmed the rally from last week, whereas the WSC Capitulation Index is still indicating a risk-off market environment for the time being. Thus, there is still a good chance left that the current rally might get faded at some point in time.

Mid-Term Technical Condition

Although we saw a quite encouraging rally last week, the mid-term-oriented condition of the market looks a quite weak-kneed at the moment. On the one side, the gauge of the Global Futures Trend Index has started to bottom out recently but it is still trading at the lower area of the bearish consolidation area. As long as this is the case, the current correction cycle is far from being over – at least from a purely formal point of view. On the other side, as long as this gauge shows positive momentum the recovery is highly likely to continue. Thus, the tilt between positive and negative is quite narrow at the moment. A fact, which can also be observed if we focus on the WSC Sector Momentum Indicator, which has not shown any improvements so far. This signals that still many sectors within the S&P 500 are underperforming riskless money market on a relative basis. This view is also supported by examining our Sector Heat Map. It exhibits that the momentum score of riskless money market strengthened significantly to 62%. In addition, already seven sectors are trading below the riskless money market. All in all, the recent recovery still looks quite fragile in its nature – at least for now.

The trend quality on a mid-term-oriented time frame shows a quite intermingled picture. Although our entire advance-decline indicators significantly increased for the week (Advance-/Decline Volume Line, Advance-/Decline Line Daily and the Advance-/Decline Line Weekly), the percentage of stocks which are trading above their mid-term oriented simple moving averages (100/150) are still far away from being confirmative at the moment (albeit they have shown stronger sings of improvements on low levels recently). Moreover, the numbers of mid-term-oriented advancing issues and mid-term-oriented up-volume remain weak. As long as we do not see major improvements here, the recent recovery can still be classified as bear market rally. Therefore, it is not a big surprise at all that the momentum of mid-term-oriented advancing stocks has not shown any signs of a major recovery yet (Modified McClellan Oscillator Weekly). Currently this is not an imminent showstopper, but if we do not see a stronger recovery here, the risk that the latest recovery will be faded again would remain high.

Model Portfolios

As it was the last Friday of the month, we received a new allocation advice from the WSC All Weather Portfolio, the WSC Inflation Proof Retirement Portfolio and the WSC Dynamic Variance Portfolio. Thus, the WSC Model Portfolio Composite is also changing most of its positions.

Bottom Line

On a short-term time frame, the fresh uptrend is definitely backed by a broader basis. Thus, the quality of the latest recovery looks quite high. A fact which can also be observed if we focus on the Big Picture Indicator (Path View) which jumped back into its “Stabilization Market Regime” on Thursday. Afterwards, the trend quality even continued to increase after the strong rally of the S&P 500 on Friday. As mentioned in the description of the Big Picture Indicator, in such a regime, it is quite difficult to differentiate if the recovery process is sustainable or just part of a stronger bear-market rally. Currently, it looks like the recovery has legs and as long as we see further strengthening in our short-term-oriented indicator framework, the situation should remain supportive. Thus, the risk of further stronger down-testing has diminished – at least from the current point of view. On the other hand side, there are still some weak signals around (especially on a mid-term time horizon). That is the reason why the WSC Mid-Term Composite has not managed to flash bullish signal so far. Consequently, there is still also a chance that the current recovery will fade out again at some point in time. Currently, this is pure speculation but we will monitor our short-term-oriented indicators closely within the next couple of days/weeks. Nevertheless, given the current development of our signals it is time to upgrade our strategic view from cautious to bullish since the downside potential looks quite capped at the moment. Worth mentioning is the fact that we are not afraid of issuing a strategic sell signal immediately (if the quality starts to diminish again since capital preservation remains the most important driver for success). But currently, the risk-/reward ratio looks attractive again – at least for the time being. For that reason, we think it would make sense for conservative members to raise exposure again (by buying into weaknesses rather to chase the market too aggressively on the upside).

Stay tuned!