May 15. 2016

Market Review

U.S. stocks finished another week in negative territory. For the week, the Dow Jones Industrial Average slid 1.2 percent to 17,535.32. The S&P 500 finished at 2,046.49 and posted a weekly drop of 0.5 percent. Both, the Dow Jones and the S&P 500 posted their first three-week losing streak since January. The Nasdaq dropped 0.4 percent from the week-ago close to 4,717.68. Most key S&P sectors finished in the red for the week, led by financials. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, rose to trade near 15.

Strategy Review

In our last week’s comment, we highlighted the fact that the market followed a typical textbook like consolidation period and, therefore, the quality of the underlying tape structure would give us further guidance where the market is heading. Because in normal circumstances, a consolidation period is considered to be a healthy one as long as short-term to mid-term market breadth remains supportive or is at least forming some bullish divergences. In such a case, any short-term oriented trend break can be ignored as the market is just taking a (healthy) breather within an ongoing uptrend. Otherwise, such a consolidation period forces the market into a typical top building process, which is then of course just the harbinger of a more significant pullback/correction.

Above all, we said that such a summer top would be in line with our cyclical roadmap (Presidential Cycle). To be more precise, after a weak start into 2016, the cycle suggested a move towards new record highs in early Q2 before the market is running into a major top within summer. As those historical patterns should only be seen as a rough guideline instead of a precise trading plan, we mentioned the fact that the quality of the underlying market tape during the consolidation period would give us further guidance which scenario is going to happen. Moreover, we said that if the market followed a typical top-building process, we expected to see at least another final rally attempt towards or even above new record high. If such a move is accompanied with deteriorating breadth signals (especially on a mid-term time horizon), we have the ultimate piece of evidence that an important market top is in place. Another interesting point is that we saw a quite encouraging break-out attempt as the S&P 500 rallied towards 2,084 until Tuesday, before losing steam for the rest of the week. As already mentioned last week, such a pattern typically occurs during a top building process and, therefore, we have received even more evidence for our summer top scenario (at least from a pure pattern point of view). But as mentioned above, our indicator framework remains key area of focus.

Short-Term Technical Condition

Although the recent consolidation period has put the S&P 500 only slightly above the lower boundary of the current trading range, the short-term oriented trend structure of the market continued to deteriorate significantly last week. This is mainly due to the fact that the gauges of our entire short-term trend indicators (Trend Trader Index and the Modified MACD) continued to gain more bearish ground or remain outright weak (Advance-/Decline 20 Day Momentum). In addition, we can see that both envelope lines of that reliable indicator have slightly started to build a bearish rounding top. Therefore, we have received even more confirmation that the current weakness is definitely part of a bigger top building process (into summer) rather than being a short-lived (and healthy) consolidation period. Another concerning fact is that the Modified MACD continued to decrease and shows a widening bearish gap, indicating that more down-testing is likely! The same is true, if we focus on the Advance-/Decline 20 Day Momentum Indicator. Despite the fact that this indicator still remains bullish from a pure signal point of view, its gauge is trading at outright low levels and has not formed a bullish divergence recently.

Unfortunately, short-term oriented market breadth had to take a hard hit during the last couple of trading sessions as apart from the High-/Low Index Daily, our entire short-term breadth indicators turned bearish or deteriorated significantly last week. Especially, our Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily continued to show a widening bearish gap, indicating that the underlying tape momentum of the market is outright negative at the moment. Another concerning fact is that the percentage of stockss which are trading above their short-term oriented moving averages (20/50) dropped below their 50 percent bullish threshold, plus we saw a larger increase in the number of stockss which are hitting a fresh yearly low. So despite the fact that we saw a rally towards 2,084 at the beginning of the week, our entire short-term oriented tape indicators have not shown any signs of improvements recently. This indicates that the current consolidation period is definitely not constructive in its nature anymore as the market internals are far away from being healthy at the moment.

The situation from a pure contrarian point of view is getting increasingly supportive. This is mainly due to the fact that we can see a lot of fear among the crowd (Daily Put/Call Ratio All CBOE Options, Global Futures Put/Volume Ratio, WallStreetCourier Index and the WallStreetCourier Index Oscillator). Consequently, the chances for another oversold rebound at the beginning of the week are increasing. Such a rebound could potentially force some market participants to cover their short positions, which would then result in again in a stronger counter trend move towards 2,100 (especially if we consider the amount of bears). On the other hand, we can see that the WSC Capitulation Index remains in cautious territory, whereas the mid- to long-term oriented NYSE Member Debt Margin Indicator is still forming a huge negative divergence to the current readings of the S&P 500, plus our reliable Smart Money Flow Index has also started to form a rounding top. So from a pure contrarian point of view, a short-term bounce towards the upper range of the recent consolidation period looks quite likely. Therefore, further top building into May could be possible, before major troubles might be due.

Mid-Term Technical Condition

Another reason, why it is possible to see a final but corrective break-out attempt or at least further top building is the fact that our mid-term oriented trend indicators still remain supportive. The gauge from our reliable Global Futures Trend Index remains on the upper end of its bullish consolidation period and, therefore, the market has still some chance to for an overshoot (mainly driven by large-caps). Nevertheless, its gauge has started to lose momentum recently and has, therefore, confirmed the down-side move from the S&P 500. In such a scenario, the upside potential of the market should remain capped (even if we see another break-out attempt). Consequently, if the gauge from the Global Futures Trend Index breaks below 60 percent (in combination with weak/bearish market breadth), we will have the ultimate confirmation for our summer top scenario! However, from a pure price point of view, the mid-term oriented uptrend of the market remains intact as the WSC Sector Momentum Indicator remains quite bullish and, therefore, most underlying sectors within the S&P 500 have not broken below their mid-term oriented uptrend yet. This can be also seen if we have a closer look at our Sector Heat Map, as the momentum score of riskless money market remains at zero percent, whereas defensive sectors such as utilities and consumer staples remain the strongest sectors for the time being. Interestingly, the defensive leadership among sectors might be another indication that increased volatility might be ahead.

More importantly, mid-term market breadth has shown also some signs of exhaustion recently and, therefore, we even received further evidences for our cyclical roadmap! Especially, the percentage of stockss which are trading above their mid-term oriented simple moving average (100/150) continued their bearish ride, although they have not closed below their 50 percent threshold yet. The same is true if we have a look at the Upside-/Downside Index Weekly and the Advance-/Decline Index Weekly. Both indicators still remain bullish from a pure signal point of view, but dropped significantly for the week. Right now, their readings still remain quite supportive but if this trend continues it might be just a question of time until we receive a bearish crossover signal within those indicators. As a consequence, 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 (which would be in-line with our cyclical roadmap). Only the Modified McClellan Oscillator has not shown any signs of weaknesses yet and, therefore, it could be possible that the top building process might continue for a while until a stronger correction might be due.

Long-Term Technical Condition

Unchanged compared to the last two weeks, the WSC Global Momentum Indicator shows that 78 percent of all global markets remain within a long-term oriented uptrend. Additionally, we can see that the gauge from the Global Futures Long Term Trend Index increased significantly last week, although it is still trading in the bearish area from a pure signal point of view. This long-term bullish up-trend is still widely confirmed by long-term market breadth. Last week, the improvements within the bullish readings of the High-/Low Index Weekly and the Modified McClellan Volume Oscillator Weekly continued to increase. Only the percentage of stockss which are trading above their (200) day moving average decreased for the week and are touching the bearish threshold. So if we consider those quite supportive long-term readings, we think any upcoming correction should not be resulting in a financial melt-down.

Bottom Line

Given the fact that our tape indicators deteriorated significantly all across the board, in combination with quite typical top bulling market patterns, we received further evidences for our summer top scenario. Consequently, the recent (healthy) consolidation period transformed into a corrective top building process. As we have not seen further bearish crossover signals within our mid-term oriented indicators yet, in combination with quite bullish readings on the contrarian side, another (corrective) rally attempt could not be ruled out at the moment. Nevertheless, we think upside potential of the market looks quite capped at the moment. On the other hand, we also think that the chances for a fast paced correction are also increasing on very fast pace. Given the fact that the gauge from the Global Futures Trend Index could easily drop below its bullish 60 percent threshold overnight, together with the fact that most of our mid-term tape indicators are only updated on a weekly basis, we think it is time for our conservative members to place a stop loss limit around 1,995. This stop loss limit should be in place until our mid-term indicator framework turns positive again! Aggressive traders should sell into strength, if the S&P 500 drops below 2,020 and should increase their exposure if we see further down testing below 1,995. Stay tuned!