October 14th 2018

Market Review

U.S. stocks finished the week in negative territory, leaving the major benchmarks with the steepest weekly slump since March. The Dow Jones Industrial Average slumped 4.2 percent over the week to 25,339.99. The Dow Jones Industrial Average booked its third straight weekly loss. The S&P 500 dropped 4.1 percent for the week to finish at 2,767.13. The S&P 500 also logged in a three-week losing streak, its longest since June 2016. The Nasdaq slipped 3.7 percent for the week to end at 7,496.89. All key S&P sectors finished in the red for the week, dragged by materials. The CBOE Volatility Index, or VIX, a measure of investor uncertainty, jumped 50 percent to 21.31.

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 2,850 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 longer lasting consolidation period (which was not our preferred scenario). Anyhow, the stop-loss limit was triggered on Tuesday and stocks continued to drop significantly for the week, marking their largest weekly drop since March. Nevertheless, 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, January 2016 or just in February this year. Therefore, short-term indicator framework will be key area of focus right now.

Short-Term Technical Condition

As highlighted in our latest call, the magnitudes of the latest declines turned out to be quite strong. The short-term down-trend of the market remains well in force and even gained more bearish ground last week, as the S&P 500 closed 110 (!) points below the bearish threshold from the Trend Trader Index. Consequently, the short-term oriented price trend of the market remains bearish as long as the S&P 500 does not close above 2,904 (upper threshold from the Trend Trader Index). Also from a pure structural point of view, the short-term oriented price trend of the market was broken, as both envelope lines of the Trend Trader Index started to decrease (on a fast pace). The situation looks similar if we analyze the underlying momentum of this short-term oriented price trend. This becomes quite obvious if we focus on the Modified MACD and the Advance-/Decline 20 Day Momentum Indicator as their gauges plunged deeply into bearish territory last week! On top of that, both indicators clearly confirmed the sell-off from last week. So from a pure price point of view, the stronger counter-trend move on Friday can be categorized as oversold bounce, rather than the start of a new sustainable uptrend.

This view is also widely confirmed by our entire short-term oriented market breadth indicators. 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 and plummeted significantly into bearish territory and to the lowest level months. This indicates that the underlying momentum and volume of advancing stocks on NYSE literally collapsed. Moreover, both indicators did not shown any signs of recovery on Friday, which is another indicator for further selling pressure ahead. This picture is also confirmed by the NYSE New HighsNew Lows Indicator, which showed the strongest peak for months in the number of new lows, whereas the number of new yearly highs was nearly zero! Consequently, the High-/Low-Index Daily rocketed to the highest bearish level for months. 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 large-caps 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) slumped also to the lowest level for months. To be more precise, right now there are only 5/12 percent of all NYSE listed stocks which are trading above their 20/50 days moving average! So in the end, most of the selling pressure was coming from the broad market rather than from a few large-caps and, therefore, it is a way too early to bet on a sustainable trend-reversal (at least for the time being).

From a pure contrarian point of view, the market is extremely oversold and, therefore, further stronger (but not sustainable) bouncing into early next week cannot be ruled out at the moment. Another indication for that fact is that we saw just one 9-to-1 day so far, which often marks a short-term bottom (before another retest from the previous low can be expected). Apart from these facts, the picture on the contrarian side looks quite grim. The Smart Money Flow Index clearly confirmed the sell-off from last week and even indicates that the current correction could easily turn out to be much stronger in its nature. Another concerning fact is that we hardly saw any stronger hedging activity within the option market and the overall market sentiment still remains somehow supportive (if we consider the recent decline). Two facts, which hardly occur if the market hits rock bottom. Another indication for a more sustainable bottom would be a significant drop of the WSC Capitulation Index. So all in all, it looks like that the worst is not over yet.

Mid-Term Technical Condition

This picture is widely confirmed by our mid-term oriented trend indicators as they continued to deteriorate last week (and have, therefore, not shown any signs of bullish divergences so far). The gauge from the Global Futures Trend Index plummeted finally into the bearish area and is trading at only 13 percent – the lowest level since January 2016. Consequently, the Global Futures Trend Index has clearly confirmed the latest sell-off from the S&P 500. 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. Also from a pure price point of view, the mid-term oriented uptrend of the market deteriorated, as the WSC Sector Momentum Indicator dropped significantly (after months of constant increases). But still most sectors (48 percent) within the S&P 500 are outperforming riskless money market on a relative basis. Our Sector Heat Map reveals that the momentum score of riskless money market jumped to 22 percent (from 0 percent last week) and that in the last week 3 sectors dropped below the one from riskless money market. Consequently, there is still a bit room left before we could expect to see a final wash-out.

Another threatening fact is that our entire mid-term oriented breadth indicators continued to deteriorate last week. Especially, our Modified McClellan Oscillator Weekly widened its bearish gap significantly and also the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) dropped to their lowest level for years. This indicates that the underlying trend momentum of the market is outright bearish, as most of all NYSE listed stocks are definitely not in an uptrend anymore. Another concerning signal is coming from the Advance-/Decline Index Weekly and from the Upside-/Downside Volume Index Weekly (as both indicators are quite bearish at the moment). This indicates that a lot of purchasing power was pulled out of the market last week. In addition, our entire advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line in Percent, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line) dropped once again significantly last week and, therefore, we expect to see further pain ahead.

Long-Term Technical Condition

On a very long-time frame, the technical picture of the market also weakened. The WSC Global Momentum Indicator dropped 3 percentage points to 15 percent. This is telling us that just 15 percent of all local equity markets around the world (which are covered by our Global ETF Momentum Heat Map) are still trading above their long-term oriented trend lines. This is a clear signal that the current correction could easily turn out to be much stronger in its nature. In addition, also our Global Futures Long Term Trend Index – which was increasing for 11 weeks – finally started to drop last week. This signals that the long-term oriented trend of U.S. equities also started to stall on elevated levels. Our WSC Global Relative Strength Index shows that the relative strength of nearly all risky markets is trading well below the one from U.S. Treasuries (which is another indication for a risk-off market environment). Also our long-term oriented tape indicators (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly, percentage of stocks which are trading above their 200 day moving average) had to take a hard hit last week. This is another piece of evidence that the market looks vulnerable for further (and stronger) disappointments on a mid-term time horizon.

Model Portfolios

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

Bottom Line

In line with our recent call, the market is now in the middle of a correction. As we have not seen even any typical signs for an important low within our indicator framework yet, we are definitely expecting to see further/stronger selling pressure ahead. As a matter of fact, conservative investors should stay on the sideline as the current risk-/reward ratio still remains outright low at the moment. However, do not get nervous if we see several positive days on a very short-time frame, as the oversold bounce from Friday might continue into early next week (before we are expecting to see another retest/break of the latest low at 2,710). If such a retest/break comes with positive divergences within our indicator framework, it is time for aggressive traders to stop selling into strength.

Stay tuned!