December 13. 2015

Market Review

The S&P 500 dropped 3.8 percent for the week to finish at 2,012.37. The Nasdaq lost 4.1 percent for the week to end at 4,933.47. Among the key S&P sectors, utilities were the best weekly performer, while energy dragged. The CBOE Volatility Index, or VIX, a measure of investor uncertainty, jumped to 24.

Short-Term Technical Condition

In our last week’s comment we highlighted the fact that we expected to see either a short-term consolidation/pullback or the market should be at least capped on the upside. Moreover, we mentioned that our strategic bullish outlook remained unchanged as long as the market keeps trading above 2,000 and/or as long as our market breadth indicators (especially on a mid-term time horizon) remain supportive. As a matter of fact, the recent pullback was not a big surprise at all, as the market dropped towards the lower boundary of its current trading range. Nevertheless, the big question is if the market will regain strength or if further weaknesses can be expected?

If we focus on our short-term oriented trend indicators, we can see that S&P 500 closed 70 points below the bullish threshold from the Trend Trader Index. So from a pure price point of view, the short-term oriented bearish trend of the market remains intact as long as the S&P 500 does not close above 2,080 (upper envelope line from the Trend Trader Index). This negative price driven trend is also confirmed by the Modified MACD, which gained even more bearish ground last week, indicating that further down-testing is likely. Above all, we can see that the gauge from the Advance-/Decline 20 Day Momentum Indicator has not formed a positive divergence yet, which would be the first indication for a major trend reversal. On top of that we can see that from a pure structural point of view, the short-term oriented trend of the market has also turned bearish yet as both envelope lines of the Trend Trader Index have started to decrease as well. As already mentioned last week, it is not unusual to see a lot of changing signals within short-term oriented trend indicators when the market remains in a consolidation mode. Therefore, short- to mid-term market breadth is a key area of focus to evaluate if the current pullback should be considered as normal move within the current trading range or if a bearish break-out can be expected.

Unfortunately, short-term oriented market breadth had to take a hard hit during the last couple of trading sessions as most of our tape indicators deteriorated significantly last week. Especially, the short-term gauges from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily showed major signs of exhaustion (already at the beginning of the week), indicating that the underlying tape momentum of the market is extremely bearish biased at the moment. With such weak readings, it would be a bit too early to bet on a stronger trend-reversal for the time being. This picture is widely confirmed by the NYSE New HighsNew Lows Indicator, as we have seen a quite strong increase in the amount of new lows, whereas the amount of new yearly highs remains outright depressed! As a matter of fact, the High-/Low-Index Daily strengthened its bearish signal and, therefore, the chances for a healthy rebound are extremely low at the moment. Moreover, its reading is telling us that the whole market is quite damaged as not only heavy weighted stocks have pulled the S&P 500 lower. Consequently, it was not a big surprise at all, that also the percentage of stockss which are trading above their short-term oriented moving averages (20/50) dropped also below their 50 percent bullish threshold last week. So in the end, most of the selling pressure was coming from the broad market rather than from a few large- and mega caps and, therefore, the recent price action must be interpreted as quite serious warning signal.

From a pure contrarian point of view, the situation looks quite mixed at the moment. Market participants are purchasing put options on very fast pace as the z-score from the Daily Put/Call Ratio All CBOE Options and the Global Futures Put/Volume Ratio grew into bullish territory. That means, that the recent amount of put options rose one and two standard deviation, respectively, above its historical mean, which can be interpreted as quite supportive signal for contrarians. The same is true if we focus on the Global Futures Bottom Indicator, which flashed a buy signal last week, whereas the readings from the Smart Money Flow Index still remain supportive. On the other hand we can see that the WSC Capitulation Index strengthened its bearish signal from last week and is, therefore, still indicating a risk-off market environment. On top of that we can see that market sentiment deteriorated significantly last week and, therefore, a lot of purchasing power has been pulled out of the market recently, which can be seen as another red flag on the horizon!

Mid-Term Technical Condition

This view is now also widely confirmed by the current mid-term trend oriented condition of the market as the readings from the Global Futures Trend Index deteriorated significantly for the week. As a matter of fact, the gauge from this reliable indicator is just trading 500 basis points above its extremely bearish 20 percent threshold, indicting further troubles ahead! Despite the fact that the gauge from the Global Futures Trend Index indicated a bearish biased consolidation over the past couple of weeks, the overall trend structure still looked supportive back then as we have seen at least some upside momentum within that indicator. Since last week, this picture changed dramatically as the gauge is far away from being supportive and, therefore, the recent decline might be just the starting point for further troubles (even if we do not see further selling pressure immediately). As already mentioned a couple of times, 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 risk will be definitely not over as long as its gauge remains below its outright bearish 60 percent threshold (in combination with weak mid-term tape signals)! Only from a pure price point of view, the mid-term oriented trend of the market still remains intact as the WSC Sector Momentum still remains quite bullish at the moment. This indicates that most sectors within the S&P 500 remain in a mid-term oriented up-trend and are, therefore, outperforming riskless money market. This can be also seen if we have a closer look at our Sector Heat Map, as the majority of sectors still have a higher momentum score than riskless money market. In such a scenario, most sectors tend to perform positive on an absolute basis. Although this can be still seen as quite constructive signal, we are quite concerned about the weak readings within our Global Futures Trend Index. To evaluate which signal is more accurate at the moment, mid-term oriented market breadth will give us more guidance.

Right now, mid-term market breadth does not look rosy at all, which is another indication for major troubles ahead. Especially, the percentage of stockss which are trading above their mid-term oriented moving averages (100/150) have clearly confirmed the recent sell-off, whereas the Modified McClellan Oscillator Weekly flashed a bearish crossover signal last week. This indicates that the overall momentum of the market internals is outright damaged at the moment, although the market is just on the lower range of its current trading range Above all, we can see that the Advance-/Decline Index Weekly as well as the Upside-/Downside Volume Index Weekly also deteriorated significantly last week and have, therefore, turned bearish or about to do so Consequently a lot of purchasing power was pulled out of the market recently. In such a situation the risk of a fast paced correction remains outright high! So all in all, given the overall weak mid-term oriented trend-structure, in combination with quite bearish biased mid-term oriented market breadth, the correction risk remains outright high at the moment. For that reason, we would like to remind our conservative members to keep their stop loss limit around 2,000 (as already suggested last week). This stop loss limit should be in place until our short- to mid-term oriented indicator framework turns positive again!

Long-Term Technical Condition

The long-term technical condition of the market remains unchanged. The Global Futures Long Term Trend Index is still indicating a vulnerable technical environment for US equities, whereas the relative strength score of all risky markets keeps trading well below the one from US Treasuries. Above all, we can see that still only 8 percent of all local market indexes around the world remain within a long-term oriented up-trend at the moment This is telling us that the overall market environment remains highly selective in which broader diversified investors are strongly underperforming. More importantly, long-term market breadth also deteriorated significantly last week and, therefore, we think the overall outlook remains difficult. Last week, there was a significant spike in long-term new lows, whereas the percentage of stockss which are trading above their long-term oriented moving averages (200) grew deeper into bearish territory. Above all we can see that the Modified McClellan Volume Oscillator Weekly has lost some steam recently.

Bottom Line

The recent pullback has clearly left its mark on our core-indicators. If we ignore the usual positive seasonal tendencies in the last couple of days in December, we think the current condition of the market looks outright corrective at the moment. So even if we do not see further selling pressure immediately, we think the current risk-/reward ratio is extremely depressed for the time being. As a matter of fact, we would advise our conservative members to place a stop-loss limit around 2,000 as we would like to see a move below that important threshold before we issue a strategic sell signal. Aggressive traders should sell into strength, if the S&P 500 drops below 2,000 and should increase their exposure if we see further down testing below 1,980. Stay tuned!