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October 12. 2014

Market Review

In line with our recent call, U.S. stocks ended the week with deep losses and with the main benchmarks recording their deepest weekly declines in more than two years. For the week the Dow Jones Industrial Average dropped 2.7 percent to 16,544.10. The blue-chip index turned negative for the year. The S&P 500 lost 3.1 percent over the week to end at 1,906.13. The benchmark index suffered its biggest weekly drop since May 2012. The Nasdaq declined 2.3 percent from the week ago close to finish at 4,276.24. The tech-heavy benchmark suffered also its worst weekly decline since May 2012. Most key S&P sectors ended in negative territory for the week, led by energy. Utilities and consumer staples were the only gainers. The Chicago Board Options Exchange Volatility Index (VIX) jumped above 20 for the first time since February, surging 46 percent for the week.

Short-Term Technical Condition

After the strong sell off, the short-term oriented down-trend of the market remains well in force and gained even more bearish ground last week! From a pure price point of view, we can see that the S&P 500 closed 81 points below the bullish threshold from the Trend Trader Index, whereas both envelope lines of this reliable indicator kept drifting lower for the week, indicating an outright bearish trend-structure at the moment. The same is true if we focus on the Modified MACD, as its gauge gained even more negative momentum last week and has not shown any signs of positive divergences so far. Above all, the gauge from the Advance-/Decline 20 Day Momentum Indicator remains well below its bullish threshold, although it refused to confirm the latest low on Friday. This indicates some form of a positive divergence, although this signal is still a way too weak to be taken too seriously at the moment.

Additionally, short-term market breadth has not shown any signs of bullish divergences/crossover signals yet and, therefore, it looks like that any upcoming oversold bounce should not lead to a major trend reversal at this point in time. The percentage of stockss which are trading above their short-term oriented moving averages (20/50) are trading far below their 50 percent bullish threshold, indicating that the underlying trend structure of the market remains outright weak. Moreover, the gauge from the 50 days? time frame even dropped to a new low and was, therefore, strongly confirming the sell-off on Friday! To be more precise, slightly more than 85 percent of all NYSE listed stocks are now trading below their 20 and 50 day moving averages and are, therefore, clearly in a short-term oriented down-trend at the moment. Another concerning fact is that the Modified McClellan Oscillator Daily remains in an outright bearish free fall, whereas both trend lines have not shown any signs of positive strength yet. This indicates that the underlying breadth momentum of the market is outright bearish and is, therefore, confirming the current short-term oriented bearish trend of the market. In addition, the number of stockss hitting a fresh yearly low soared to 443 on Friday, the highest level since 2013! This number is quite concerning, especially if we compare the current levels from the S&P 500 with its latest correction low in mid-August 2014, where only 110 stocks dropped to a new 52-weeks low. This can be also seen if we focus on the High-/Low Index Daily, as its bearish gauge is about 7 percent higher compared to mid-August! Therefore, it looks like that the current correction could turn out to be much stronger in its nature compared to the latest ones we saw.

From a pure contrarian point of view, the overall technical picture of the market is a bit intermingled at the moment. This is mainly due to the fact that the market flashed a 9-to-1 down-day on Friday, indicating a selling climax. After such an event, the market tends to rebound for a couple of days before further losses can be expected. In addition, the market is becoming increasingly oversold (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) and given the fact that the Market Timer Index remains bullish, in combination with a fresh buy signal from the Global Futures Bottom Indicator, an oversold bounce is likely. Moreover, the S&P 500 was not able to close below its strong support level of 1,905/1,900, which can be seen as quite positive signal. On the other hand, we can see that our reliable Smart Money Flow Index is still showing a quite bearish divergence to the Dow, as its gauge dropped significantly below its former August low (although the Dow did not so far). Moreover, the VIX Index did not form any signs of bullish divergences so far, plus the amount of bulls on Wall Street have not dropped below 30 percent yet, and, therefore, it might be too early to call for a sustainable bottom right now.
Furthermore, we have not received any typical signs for a bottom building process yet. This is mainly due to the fact that 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 about 5 to 10 trading sessions. After that, the market tends to retest or even break its previous low. If this retest/break does come along with positive divergences within our market breadth indicators, and in combination with lower levels from the VIX, the market tends to hit rock bottom. Right now we are quite far away from such a situation.

Mid-Term Technical Condition

This view is also strongly confirmed by the current mid-term oriented condition of the market. Especially, the gauge from the Global Futures Trend Index remains below its extremely bearish 20 percent threshold and has not shown any signs of strength yet. As already mentioned in our previous market comments, as long as we do not see any 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 below its outright bearish 20 percent threshold! Moreover, from a pure price point of view, we can also see that the mid-term oriented uptrend of the market has slightly started to deteriorate as the WSC Sector Momentum Indicator lost some momentum recently. This is mainly due to the fact that the relative strength score from Energy dropped below the readings from riskless money market within our Sector Heat Map, indicating a mid-term oriented trend-break within that sector.

More importantly, mid-term oriented market breadth continued to gain more bearish ground last week and has, therefore, not shown any signs of bullish divergences yet. Especially, the Modified McClellan Oscillator Weekly dropped to a new low last week and is, therefore, signaling that the overall mid-term oriented tape momentum remains outright weak. This can be also observed if we focus on the percentage of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150). Both indicators have been pushed to their lowest levels for months, whereas the S&P 500 is still trading near its latest correction low in mid-August. As a matter of fact both indicators are, therefore, still showing a huge bearish divergence to the current levels from the S&P 500. In addition, the Advance-/Decline Index Weekly as well as the Upside-/Downside Volume Index Weekly remain quite bearish. Normally, as long as both, advancing issues as well as up-volume are trading below their bearish counterparts, the underlying tape structure of the market remains outright weak. In such a scenario, the market is extremely vulnerable and, therefore, the current risk/reward ratio remains extremely low at the moment.

Long-Term Technical Condition

As per last week’s report, the long-term condition of the market continued to show major signs of exhaustion, which is in line with our short- to mid-term oriented bearish outlook. Apart from the fact that the Global Futures Long Term Trend Index is still indicating a technical bull market for the S&P 500, most global market indexes are facing stronger corrections at the moment. Therefore, the WSC Global Momentum Indicator continued to gain more bearish ground last week, plus the relative strength from most risky markets is trading below the relative strength from U.S. Treasuries. This is another indication for a mature bull market. This can be also seen if we focus on long-term market breadth. Last week, the Modified McClellan Volume Oscillator Weekly dropped to a new low, indicating that the underlying tape momentum of the market is outright bearish at the moment. Moreover, the majority of all NYSE listed stocks remains well below their long-term oriented trend-lines, whereas the High-/Low Index Weekly is about to flash a bearish crossover signal soon. So all in all, we have received even more confirmation that the current bull market is running out of steam! If we have a closer look at our Model Portfolios, we can see that there have been no changes in the allocation advice from any model portfolio (WSC Inflation Proof Retirement Portfolio, WSC All Weather Portfolio, WSC Sector Rotation Strategy and the WSC Global Tactical ETF Portfolio) last week.

Bottom Line

The overall outlook remains almost unchanged compared to last week. In line with our recent outlook, the market is in the middle of a correction and, therefore, conservative members should keep staying on the sideline as the current risk-/reward ratio is too low at the moment. Furthermore, we have not seen any major positive signals/divergences within our short- to mid-term indicator framework to call for an important bottom at the moment. Nevertheless, we will monitor our indicators closely within the next couple of days, as a break of 1,900/1,890 would call for a final overshoot towards 1,850/1,820 which is our worst case scenario. On the other hand, a break above 1,925 would pave the way towards 1,948 /1,978, before a new retest can be expected. Stay tuned!