July 1st 2018

Market Review

U.S. stocks ended the week with losses. The Dow Jones Industrial Average dropped 1.2 percent from the week-ago close to 24,271.41. The S&P 500 recorded a 1.3 percent loss over the week and finished at 2,718.37. The Nasdaq Composite booked a weekly fall of 2.4 percent to end at 7,510.30. For the month, the Dow Jones Industrial Average slipped 0.6 percent while the S&P 500 rose 0.5 percent and the Nasdaq gained 0.9 percent. For the second quarter, all three ended in the green, with the Dow Jones Industrial Average up 0.7 percent, the S&P 500 up 2.9 percent, and the Nasdaq climbing 6.3 percent. For the first half of the year, the Dow Jones Industrial Average is down 1.8 percent and the S&P 500 is up 1.7 percent. The Nasdaq is up 8.8 percent. Most key S&P sectors ended in negative territory for the week, led by technology. Utilities and energy were the only gainers. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 16.1.

Strategy Review

In our last week’s comment, we highlighted the fact that the market followed a typical textbook like consolidation period (aka volatile side-ways trading) as the underlying market breadth structure (especially on a mid-term time horizon) remained quite supportive. As already mentioned a couple of times, the short-term oriented trend of the market is only giving a limited picture about the current condition of the market as it includes a lot of noise. Therefore, it is not unusual that some/all of our short-term oriented trend indicators tend to deteriorate, when the price action of the momentum of the market is slowing down. In such a situation, short- to mid-term market breadth will give guidance if the current short-term oriented bearish trend will lead to further stronger losses or if it was only caused by too much market noise (or just from a few heavy weighted stocks in the index). Because under 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.

Short-Term Technical Condition

Not surprisingly, last week’s price action has led to an ongoing deterioration in the readings of our entire short-term oriented trend indicators (Trend Trader Index, Modified MACD and the Advance-/Decline 20 Day Momentum). Even worse is the fact that both envelope lines of the Trend Trader Index have slightly started to build a bearish rounding top. Therefore, we received even more confirmation that the current weakness is definitely part of a bigger distribution process (into deeper 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 dropped for the week and is trading at outright low levels.

Unfortunately, also our entire short-term oriented market breadth indicators had to take a hard hit during the last couple of trading sessions. Especially, the short-term gauges from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily continued to show major signs of exhaustion, indicating that the underlying momentum and volume of advancing stocks on NYSE literally collapsed. This picture is now also widely confirmed by the NYSE New HighsNew Lows Indicator, as we have seen some stronger spikes of new lows, whereas the number of new yearly highs continued to deteriorate last week! Consequently, the High-/Low-Index Daily flashed a bearish crossover signal. Thus, the chances for a healthy and sustainable rebound are extremely low at the moment. On top of that it also tells us that the latest decline was driven by the whole market and was not only caused by a few heavy weighted stocks within the S&P 500! As a matter of fact, it was also not a big surprise that the percentage of stocks which are trading above their short-term oriented moving averages (20/50) also dropped significantly – and even into deep bearish territory (20). So all in all, given the outright bearish short-term oriented breadth structure of the market, we do not believe that the market has enough power to remain on those levels or that any upcoming oversold gains (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) will be sustainable in their nature.

From a pure contrarian point of view, we can see that the latest decline caused a larger spike in the total amount of put options. As approximately 90 percent of all uncovered options are an also-ran, a stronger but not sustainable bounce until 15th of July (option expiring date) cannot be ruled out at the moment. However, apart from that fact our remaining contrarian indicators still look quite grim. Especially, the Smart Money Flow Index is far away from confirming the current levels from the Dow Jones Industrial Average. The last time we saw such strong divergences between this reliable indicator and the Dow was a couple of months before the “Trump Rally” had started. Compared to back then, the Smart Money Flow Index is now showing a huge bearish divergence. Given the outright weak tape structure, we would not be surprised if the market is running into a major market top in deeper summer. Moreover, we can see that the WSC Capitulation Index rose into bearish territory last week, indicating that the market has now entered a risk-off market environment!

Mid-Term Technical Condition

Another reason why we believe that the market is highly at risk for a stronger pullback is clearly the fact that the mid-term oriented condition of the market also deteriorated last week. The gauge from the Global Futures Trend Index dropped almost 20 percentage points for the week and closed at 46 percent! This is far below the important 60 percent threshold. As a consequence, the risk of a fast paced correction is extremely high (of course only in combination with weak or bearish readings in mid-term oriented market breadth) and it is definitely time to get a cautious stance. So even if we do not see a stronger pullback immediately, as long as the gauge of this indicator remains near or below 60 percent (in combination with weak mid-term market breadth), the upside potential of the market should be limited as well! Only from a pure price point of view, the mid-term oriented uptrend of the market still remains intact as the WSC Sector Momentum Indicator keeps trading at solid bullish levels so far. This indicates that most sectors within the S&P 500 are still in a mid-term oriented up-trend at the moment (as we have not seen a stronger pullback so far). This can be also seen if we focus on our Sector Heat Map as the momentum score of all sectors (except utilities, consumer staples and materials) keeps trading above the one from riskless money market (currently at 23.8 percent).

More importantly, mid-term market breadth has also shown some signs of exhaustion recently and, therefore, we even received further evidences that the market is highly at risk for major disappointments into deeper summer. The percentage of stocks 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 Volume 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. 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 these two indicators in combination with a mid-term oriented trend-break mostly led to a stronger correction in the past. Also the Modified McClellan Oscillator Weekly widened its bearish gap. Consequently, it is definitely time to get a more cautious at the moment.

Long-Term Technical Condition

Unchanged compared to the previous weeks remains the long-term oriented trend of the market. The WSC Global Momentum Indicator continued its bearish ride and dropped again to the lowest level for months. A clear sign that a lot of local equity markets around the world are trading below their long-term trend-lines and that the current bull-run is fading out. Also the Global Futures Long Term Trend Index continued its decrease and dropped again to the lowest level for months. But once again, a positive signal is coming from our WSC Global Relative Strength Index as the relative strength of all risky markets was holding up quite well last week. But currently, already 4 markets are trading below the one from U.S. Treasuries. The readings from our long-term oriented tape indicators (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stocks which are trading above their 200 day moving average) weakened last week.

Model Portfolios

As it was the last Friday of the month, we received a new allocation advice from the WSC All Weather Portfolio and the WSC Inflation Proof Retirement Portfolio. The allocation of the WSC Global Tactical ETF Portfolio and the WSC Sector Rotation Strategy remains unchanged.

Bottom Line

Given the fact that our tape indicators deteriorated significantly all across the board, in combination with quite negative long-term top bulling market patterns, we received stronger evidences that the market will face stronger headwinds into deeper summer. 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 some short-term 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 pretty capped at the moment. On the other hand, we also think that the chances for a fast paced correction are also increasing on a very fast pace (as the gauge from the Global Futures Trend Index trades below 60 percent in combination with outright weak mid-term oriented market breadth). As a matter of fact, we think it is definitely time to get a more cautious at the moment. For that reason, we would advise our conservative members to place a stop loss limit around 2,687. 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 2,687 and should increase their exposure if we see further down testing below 2,676.

Stay tuned!