February 11th 2018

Market Review

U.S. stocks finished another week in negative territory, recording the worst weekly losses in about two years. The Dow Jones Industrial Average finished with a 5.2 percent weekly loss at 24,190.90, marking its largest weekly drop since January 2016. The S&P 500 slumped 5.2 percent for the week to 2,619.55, also marking its largest weekly drop since early January 2016. The Nasdaq Composite booked a 5.1 percent weekly loss and finished at 6,874.47, representing its worst week since early February of 2016. All key S&P sectors finished in the red for the week, led by energy. The CBOE Volatility Index, widely considered the best gauge of fear in the market, finished near 29.1.

Strategy Review

Despite the fact that the market was just trading a few percentages below its all-time high two weeks ago, we received a growing number of evidences that the market was highly at risk for a stronger correction. Mainly, because our indicator framework showed us that the underlying tape structure was faltering on a very fast pace, although the broad market was still holding up quite well back then. We warned our members that in such a situation, therefore, any upcoming gains would not be sustainable in their nature. As a result, we advised our conservative members to place a stop-loss limit around 2,690 as it was just a question of time until sharp waterfall declines could be expected. The main reason why we did not issue a strategic sell signal immediately was due to the fact that there was still a small chance to see a typical bull trap (a corrective/non-sustainable large-cap driven bounce towards the previous high). In such a case, we would have increased the stop-loss limit towards a higher level. In fact, the stop-loss limit was triggered on Monday and after a short rebound on Tuesday stocks continued to drop significantly for the week, marking their largest weekly drop since early January 2016. Anyhow, after we have successfully predicted/side-stepped the latest carnage, the big question is if it is time for a bargain hunt or will the market face further declines?

Normally, a typical bottom tends to occur as a process rather than as a V-shaped recovery. If the market hits an important bottom, we usually see a strong counter trend rally, which normally lasts for a couple of trading sessions. After that, the market tends to show renewed 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 (especially within the Nyse New HighsNew Lows Indicator, a lower VIX and further tape strengthening signals), we can be quite sure that the market hits rock bottom. We saw such a typical bottom building processes in August 2015 or January 2016. Therefore, short- to mid-term market breadth will be key area of focus right now.

Short-Term Technical Condition

If we focus on our short-term oriented trend indicators, we can see that the short-term down-trend of the market remains well in force and even gained more bearish ground last week. From a pure price point of view, we can see that the S&P 500 closed 137 points below the bearish threshold from the Trend Trader Index. So from a pure price point of view, the S&P 500 is extremely far away from getting back into a short-term oriented uptrend. The same is true if we focus on the Modified MACD, which remains in a bearish free fall and reached the lowest level for months. Additionally, its gauge shows a widening bearish gap and has, therefore, refused to confirm the recent bounce on Friday. The case is slightly different if we focus on the Advance-/Decline 20 Day Momentum Indicator. Despite the fact that this indicator plummeted to the lowest level for months, it has shown a small bullish divergence recently. This was mainly due to the fact that the magnitude of its decline after the bounce on Tuesday could have been worse, indicating that the intraday low on Friday 2,532 represents an outright important support level.

To evaluate if this critical support level will represent in important low, short-term market breadth is absolutely key area of focus right now. Despite the fact that our entire short-term tape indicators remain outright bearish from a pure signal point of view, we can at least identify some small bullish divergences in their readings. Despite the fact that the S&P 500 dropped to 2,532 on an intraday basis on Friday, the percentage of stocks which are trading above their short-term oriented moving averages (20/50) were holding up relatively well compared to the levels they reached on Monday and Tuesday (where the first down-leg hit the market). Another interesting fact is that on the end of the week, the Upside-/Downside Volume Index Daily was much lower than the days before, indicating some form of final wash-out. This coincides with the fact that the number of new lows spiked on Tuesday, although the market was trading much lower at the rest of the week. This is a quite positive signal as it indicates that the broad market is somehow stabilizing, albeit on outright low readings. As a matter of fact, the High-/Low-Index Daily has shown some form of bullish divergence recently, although the indicator itself remains outright bearish from a pure signal point of view. So despite the fact that we can already see some typical ingredients for an important bottom, the overall momentum of the market (McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily) still remains quite damaged at the moment. Moreover, the positive divergences are still a bit too weak-kneed and therefore, the development of those divergences in the next couple of trading sessions will give us the final confirmation.

However, another strong buy signal is coming from the contrarian side. There we can see that the recent sell-off has started to have its designated impact on short-term sentiment, which is another typical pattern during a volatile bottom building process. The CBOE Volatility Index spiked on Monday, but the gauge refused to jump higher on Friday, although the market reached a new intra-day low on that day. Another important fact is that the AII Bull-/Bear Spread as well as the z-score from the Daily Put-/Call Ratio All CBOE Options Indicator grew back into neutral territory (after being outright bearish for a couple of weeks), whereas the gauge from the Global Futures Bottom Indicator also indicates an important bottom at hand. On the other hand, we can see that the WSC Capitulation Index is obviously still indicating a risk-off scenario, although the fisher transformation from this indicator is about to form a rounding top.

Mid-Term Technical Condition

Not surprisingly, the mid-term oriented trend of the market also continued to deteriorate last week. This is due to the fact that the gauge from the Global Futures Trend Index plummeted 37 percentage points during the week to 22 percent – the lowest level since January 2016 and only 2 percentage points above the threshold to the bearish area. Consequently, the Global Futures Trend Index has not shown any signs of bullish divergences yet as it has clearly confirmed the latest sell-off from the S&P 500. It other words, if we do not see some kind of positive momentum/divergence from this indicator within the next couple of trading sessions, a retest towards the previous low at 2,532 cannot be 100% ruled out at the moment. 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. However, from a pure price point of view, the mid-term oriented uptrend of the market still remains intact as the WSC Sector Momentum Indicator still keeps trading in bullish territory. This indicates that most sectors within the S&P 500 are still outperforming riskless money market on a relative basis. This can be also seen if we focus on our Sector Heat Map as the momentum score of all sectors (except utilities like in the previous weeks) keeps trading above the one from riskless money market (currently at 15.6 percent). However, the current strength from the WSC Sector Momentum Indicator might be another piece of evidence that the current correction cycle is quite healthy/limited in its nature and will not trigger a new bear market.

The current mid-term oriented tape condition of the market also continued to deteriorate all across the board last week. Especially, the Modified McClellan Oscillator Weekly widened its bearish gap last week, which is another indication for an outright weak tape momentum at the moment. This can be also observed if we focus on the Advance-/Decline Index Weekly, which strengthened its bearish signal. On top of that we can also see that the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) dropped to the lowest level for months, indicating an outright damaged tape condition at the moment. Nevertheless, we can also observe some small form of bullish divergences in their readings (100/150) as their gauges were holding up relatively well compared to the levels they reached on Monday and Tuesday. Another encouraging fact is that the Upside-/Downside Volume Index Weekly is still trading at quite bullish levels and has, therefore, formed a huge bullish divergence to the current levels from the S&P 500. This is quite unusual, as both, the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly tend to turn bearish in times of a stronger correction. In our option, this is another piece of evidence that the correction will turn out to be quite limited in its nature.

Long-Term Technical Condition

This view is also confirmed if we focus on our long-term oriented trend indicators. There we can see that the long-term oriented uptrend of the market remains unchanged compared to last week, and therefore, we do not think that a stronger correction should lead to a new bear market at the moment. Mainly, because our WSC Global Momentum is trading at solid bullish levels and indicates that 85 percent of 35 local equity markets all around the world (which are covered from our Global ETF Momentum Heat Map) are still in a long-term oriented up-trend at the moment. Also the readings from the Global Futures Long Term Trend Index are trading at the highest levels for years. This can be also observed if we focus on the Global Relative Strength Index, as the relative strength of all risky markets keeps trading far above the one from U.S. Treasuries. However, we can also observe some exhaustion in long-term market breadth, as the readings from our entire 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) again weakened last week. As already pointed out last week, this is not a big surprise at all, if we consider the recent circumstances.

Model Portfolios

If we have a closer look at our Model Portfolios (WSC Inflation Proof Retirement Portfolio, the Global Tactical ETF Portfolio, the WSC Sector Rotation Strategy and the WSC All Weather Portfolio) we can see that there were no changes in the allocation last week.

Bottom Line

Although our entire short-term oriented indicators remain quite bearish from a pure signal point of view, we received a lot of evidences that 2,532 marked an important intermediate low. Therefore, we think it would make sense that aggressive traders should cover their short-positions if the S&P 500 breaks above 2,635. Furthermore, they should focus on the long side again (with tight stops), as long as we do see a reduction in the amount of new lows and/or an increase in new highs. On the other hand, if the S&P 500 breaks below 2,578, further down testing towards 2,532 and 2,520/2,515 can be expected (even though this is not our preferred scenario). Although we think that we might have seen the worst already, conservative members should still stay at the sideline as we would like to see at least some bullish signals within our indicator board first (before we issue a strategic bullish signal again).

Stay tuned!!!