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January 31. 2016

Market Review

All three major U.S. averages finished the week with gains. For the week the Dow Jones Industrial Average advanced 2.3 percent to end at 16,466.30. The blue-chip index is down 5.5 percent for January, its worst start to a year since 2009. The index had its worst month since August. The S&P 500 added 1.8 percent for the week to finish at 1,940.24. The broad index is still down 5.1 percent for January, also its worst since 2009. The index had also its worst month since August. The Nasdaq advanced 0.5 percent from the week-ago close to 4,613.95. The Nasdaq plunged 7.9 percent in January, its worst month since May 2010. Most key S&P sectors finished higher, led by energy. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, held just above 20.

Strategy Review

In last week’s comment we highlighted the fact that a typical bottom tended to occur as a process rather than as a V-shaped recovery. Normally, if the market hits an important low, we usually see a strong counter trend rally, which normally lasts about 5 to 10 or even 20 trading sessions. Worth mentioning is the fact that in that time period, financial media tend to overestimate positive news flow/market opinions causing greed among market participants. After that, the market tends to show renewed strong weaknesses, which could then lead to a retest or even a break of its previous low. If this weakness comes along with more positive divergences within our market breadth indicators, we can be quite sure that the market hits rock bottom (as most market participants got burned); otherwise renewed waterfall declines can be expected.

On top of that, we also mentioned that we received a lot of evidences that 1,815 represented such an important (but intermediate) low as we had seen the typical technical pattern for such an event (spike in our fear-/option based contrarian indicators, overshooting bearish readings within our tape indicators as well as a general washout in market sentiment). As we never catch a falling knife, we also said that the case for such an intermediate low remained intact as long as the market does not drop below 1,867, whereas a move above 1,920 would give us the final confirmation for that intermediate low. As a consequence, we advised our aggressive traders to close their profitable short positions in such a case as an overshoot towards 1,950 and worst case even towards 1,987 could be expected. In fact, after the S&P 500 had refused to drop below 1,867 last week, the broad benchmark rallied almost 2.5 percent for the week, to close at 1,940. So in other words, the S&P 500 is following a textbook-like bottom building process at the moment. Nevertheless, we should not forget that 1 out of 10 bottoms have not been V-shaped in the past. Thus the developments within our short- to mid-term oriented breadth indicators are definitely key area of focus right now as they will give us further guidance in those volatile markets!

Short-Term Technical Condition

According to our short-term oriented trend indicators, the market remains quite quite short-biased at the moment. Despite the fact that the Trend Trader Index flashed a neutral trend-scenario on Friday, we can see that both envelope lines from that reliable indicator are still drifting lower on a very fast pace. This is telling us that within the past 20 days we saw lower highs and lower lows, which is another typical pattern if the market remains short-biased. Thus, the neutral signal within our Trend Trader Index was mostly driven by declining envelope lines rather than a stronger move by the market. This can be also observed if we focus on the Advance-/Decline 20 Day Momentum, which remains quite bearish and has, therefore, refused to confirm the latest bounce at the end of the week. The case is slightly different if we focus on the Modified MACD as the indicator flashed a very weak but bullish crossover signal on Friday. Despite the fact that this can be interpreted as some form of positive divergence, the signal is still a way too weak to be taken too seriously at the moment! During a volatile bouncing process it is not unusual to see a lot of changing signals within short-term oriented trend indicators. As a consequence, our tape indicators will give us more guidance if the recent bounce will turn out to be corrective or more sustainable in its nature.

Despite the fact that the market finished the week with solid gains, the readings within our short-term trend indicators have been developing moderately so far. Apart from the fact that the readings from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily turned slightly bullish last week, the overall short-term oriented tape structure of the market still looks quite shallow at the moment. This is mainly due to the fact that the recent recovery is still mostly driven by heavy weighted stocks (large-caps) within in the S&P 500, whereas the broad market still remains quite weak-kneed. This becomes quite obvious if we focus on the NYSE New Highs-/New Lows Indicator, as only the total amount of new lows has decreased significantly over the past week, whereas the total amount of new highs remains quite depressed. Worth mentioning is the fact that we saw at least new highs on Friday, but their number was a way too small to be taken too seriously at the moment. As a matter of fact, the High-/Low Index Daily has not turned bullish so far and we have only seen a strong reduction in new lows rather than a strong increase in new highs. Consequently, the market internals still look to weak to bet on a sustainable uptrend at the moment. Basically, the same is true if we have a closer look at the percentage of stockss which are trading above their short-term oriented moving averages (20/50). Despite the fact that we saw an encouraging bullish surge on a 20 days? time frame, both gauges are too weak to support a sustainable rally at the moment!

From a pure contrarian point of view, the recent bounce has started to have its designated impact on short-term sentiment, which is another typical pattern during a volatile bottom building/re-testing process. The short positions from the small-fry/dumb money accelerated, as the Odd-Lot Short Positions spiked on Friday (as they thought this bounce might be a good entry point), whereas the ISE Call-/Put Ratio Oscillator dropped from bullish into bearish territory. As those market participants tend to be dead wrong in most cases, a continuation of the recent bounce (at least into next week) looks extremely likely. The same is true if we focus on the All CBOE Put-/Call Ratio Daily, WallStreetCourier Index Oscillator and the WallStreetCourier Index. There we can see that the market has not completely worked off the predominant bearish sentiment within the option market yet and, therefore, further strength (on a short-term time frame) cannot be ruled out at the moment. Only the WSC Capitulation Index has not turned bullish yet as the market remains (obviously) in a risk-off mode.

Mid-Term Technical Condition

More importantly, the mid-term oriented trend-condition of the market is also far away from showing any signs of bullish divergences at the moment and, therefore, a re-test of the recent low at 1,815 still looks quite likely at the moment. This becomes quite obvious if we focus on the Global Futures Trend Index, which kept trading at outright bearish levels and is, therefore, definitely not confirming the latest recovery from the S&P 500! As already mentioned in our previous market comments, as long as we do not see any stronger upside-momentum in the gauge of this reliable indicator or at least some bullish divergences, any upcoming bounce should be limited in price and time. Moreover, we can say that the current correction cycle will be definitely not over as long as its gauge remains far below its outright bearish 60 percent threshold. Above all we can see that the WSC Sector Momentum Indicator continued to strengthen its bearish signal! This is telling us that the momentum score of most sectors within the S&P 500 are still underperforming the momentum score of riskless money market within our Sector Heat Map. In such a scenario, most sectors tend to perform negative on an absolute basis!

More importantly, the current bearish mid-term oriented trend is still strongly confirmed by mid-term oriented market breadth. This is mainly due to the fact that our entire mid-term oriented tape indicators remain outright bearish and have, therefore, not shown any signs of bullish divergences yet. Especially, the short-term oriented gauge from the Modified McClellan Oscillator Weekly dropped to a new low, signaling that the overall mid-term oriented tape momentum of the market remains outright bearish at the moment. This can be also observed if we focus on the percentages of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150). Both indicators are telling us that there was no recovery within the broad market so far as most NYSE listed stocks remain in a strong mid-term oriented down-trend at the moment. Consequently, the strong recovery on Friday was mostly driven by short-covering and was, therefore, not supported by a broad basis. Thus, it was not a big surprise at all that the NYSE Short Interest Ratio dropped significantly for the week. Another concerning tape signal is coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly, as their bearish signals remain quite persistence for the week. As a matter of fact both indicators are almost trading at bear-market levels. In such a scenario, the market remains extremely vulnerable for further disappointments and, thus, we think the current risk-/reward ratio is too low to bet on a sustainable trend-reversal at the moment.

Long-Term Technical Condition

On a long-term horizon, the situation remains almost unchanged compared to last week. The Global Futures Long Term Trend Index kept trading far below its bullish threshold, indicating that the U.S. equities remain in an extremely risk-off environment at the moment. This can be also seen if we focus on the WSC Global Momentum Indicator as only 10 percent of all local market indexes around the world managed to close above their long-term oriented trend-lines. In a global context, we, therefore, received further confirmation that global equity markets are at risk for further disappointments. Consequently, it is not a big surprise at all that the relative strength of all risky markets kept trading far below the one from U.S. Treasuries. On top of that, we can see that this negative long-term trend is widely confirmed by long-term market breadth. As per last week’s report, the Modified McClellan Volume Oscillator Weekly continued to gain more bearish ground, whereas the percentage of stockss which are trading above their long-term simple moving averages and the High-/Low Index Weekly are far away from being supportive at the moment

Bottom Line

In line with our recent call, the S&P 500 has now entered a typical stabilization/bottom-building phase. Consequently, from a pure pattern point of view, the recent move from the S&P 500 can be still categorized as bounce rather than the start of a new sustainable uptrend. For the time being, this view is strongly confirmed by our indicator framework, as we have not seen any major positive signals/divergences within their readings yet. As a consequence, conservative members should keep staying on the sideline and be patient as the current risk-/reward ratio still remains too low! From a pure trading perspective, a break of the S&P 500 above 1,950 would give way towards 1,965 and worst case towards 1,987. On the other hand, a break below 1,900 would call for further down-testing towards 1,881, whereas a break of 1,845 would give way towards the latest correction low. So in this context we would advise our aggressive traders to use extremely close stops. Stay tuned!