October 7th 2018

Market Review

The weak tape structure had its designated impact as U.S. stocks finished the week with losses. The Dow Jones Industrial Average fell 0.4 percent in five trading days to end at 26,447.05. The S&P 500 recorded a 1.0 percent loss over the week and closed at 2,885.57. The Nasdaq slumped 3.2 percent for the week to 7,788.45. The technology-laden index recorded its worst week since March. Among the key S&P sectors, energy was the best weekly performer, while technology dragged. The Chicago Board Options Exchange Volatility Index (VIX), the gauge of S&P 500 options known as the VIX, traded near 14.08.

Short-Term Technical Condition

Not surprisingly, the short-term oriented trend of the market clearly turned bearish last week. This is due to the fact that the S&P 500 closed 14 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 2,917 (upper threshold from the Trend Trader Index). Also from a pure structural point of view, the short-term oriented up-trend of the market started to deteriorate, as both envelope lines of the Trend Trader Index are about to form a rounding top. 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, which continued its bearish ride, signaling that further selling pressure can be expected. Basically, the same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator as its gauge plunged deeper into bearish territory last week! Additionally, we can see that our entire short-term oriented trend indicators formed a huge bearish divergence as the S&P 500 just fell 1 percent over the week. But as already mentioned a couple of times, the short-term oriented trend of the market is only a limited picture about the current technical condition of the market (as it is not unusual that some/all of our short-term oriented trend indicators tend to deteriorate after a strong wash-out day). 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 was only caused by a handful of a few heavy weighted stocks in the index. So if short- to mid-term market breadth remains strong, the impact of a short-term oriented trend-break should be quite limited.

If we focus on short-term market breadth, we can see that the broad market 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 and/or plummeted significantly. This indicates 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 saw an outright strong spike in the number of new lows, whereas the number of new yearly highs dropped significantly! 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! Consequently, 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 deeper into bearish territory. To be more precise, right now there are only 16/27 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. Consequently, the main reason why we have not seen a stronger pullback in the S&P 500 yet is due to the fact that a few heavy-weighted large-caps are still holding up quite well. So all in all, the S&P 500 looks like it is on the brink of a strong correction at the moment (although it just trades slightly below its all-time high)!

On the contrarian side, we can see that the market is slightly oversold and, therefore, a smaller (non-sustainable) rebound might be possible. Apart from that fact, the picture still looks quite grim. The WSC Capitulation Index is still indicating a risk-off market environment, whereas the Smart Money Flow Index is far away from confirming the current levels from the Dow Jones Industrial Average. Another concerning fact is that the option market remains quite complacent, although the current technical condition of the market looks quite damaged. This is in-line with the AII Bulls & Bears survey, as the amount of bulls on Wall Street increased last week. We doubt that this purchasing power will drive the market fundamentally higher from current levels.

Mid-Term Technical Condition

Another reason why we believe that the market is highly at risk for further disappointments is due to the fact that the mid-term oriented condition of the market continued to deteriorate last week. This is mainly because the gauge from the Global Futures Trend Index dropped almost 14 percentage points for the week and closed at 25 percent! This is at the lower end of the bearish consolidation area and very far below the important threshold of 60 percent. In such a case, the technical condition of the market is highly at risk for a stronger pullback; of course only in combination with weak or bearish readings in mid-term oriented market breadth. As this is already the case, 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! This means that any upcoming relieve rally might be just part of a larger distribution top. As we have not seen a stronger pullback so far, the pure price driven mid-term oriented uptrend of the market remains intact. This can be seen if we focus on the WSC Sector Momentum Indicator, which is trading at the highest level for months. This indicates that most sectors within the S&P 500 are still outperforming riskless money market on a relative basis. This can be also observed by looking at our Sector Heat Map as the momentum score of all sectors keeps trading above the one from riskless money market (currently at 0.0 percent).

Another bearish ingredient for our market top scenario is the fact that our entire mid-term oriented breadth indicators continued to deteriorate last week. Especially, our Modified McClellan Oscillator Weekly dropped significantly and widened its bearish gap. Also the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) continued to drop and are trading below their bullish threshold. This indicates that the underlying trend momentum of the market is clearly bearish, plus most of all NYSE listed stocks are definitely not in an uptrend anymore. 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 significantly last week. However, the most concerning signal is coming from the Advance-/Decline Index Weekly, as it clearly turned bearish last week. And it is also a question of time that our Upside-/Downside Volume Index Weekly turns bearish. These facts indicate that a lot of purchasing power was pulled out of the market last week and, therefore, the market internals have now a clear bearish tilt at the moment.

Long-Term Technical Condition

The long-term oriented trend of the market shows the same picture as in the previous weeks. After 9 weeks in a paralyzed status, the WSC Global Momentum Indicator dropped last week to 18 percent, indicating that just 18 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 global bull-market is outright fragile at the moment. On the other hand side, our Global Futures Long Term Trend Index has been increasing for 11 weeks, signaling that the long-term oriented trend of U.S. equities remains intact (compared to the rest of the world). Our WSC Global Relative Strength Index shows that the relative strength of all risky markets was holding up quite well last week, but all markets (except one) are trading below the one from U.S. Treasuries. This is a sign for a slow growth period. Looking at our long-term oriented tape indicators reveals that the Modified McClellan Volume Oscillator Weekly, the percentage of stocks which are trading above their 200 day moving average and especially the High-/Low Index Weekly weakened last week (which is another red flag on the 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

Our base call remains unchanged compared to last week. Although the S&P 500 is trading slightly below its new all-time high, we still remain outright cautious at the moment. Because our indicator framework shows that only due a few mega-caps the S&P 500 is holding up quite well (although the broad market is already faltering on a very fast pace). In general, such a large-cap driven rally is quite dangerous to play (hardly sustainable in its nature). Because if we see a trend-reversal in these mega-caps, there is literally no safety-net around to cushion such a move. In such a situation, the risk of a strong and sharp trend-reversal remains high. Given the outright bearish tape structure at the moment, we think there are two scenarios possible. Either, we see a longer-lasting consolidation period (where we see a healthy rotation back into small caps) or the market is heading into a stronger correction within the next weeks (preferred scenario). Consequently, it might be a bit too early to pull the trigger immediately (as we would like to see some negative price action first). As a matter of fact, we would advise our conservative members to keep/place their stop-loss limit around 2,850. This stop loss limit should be in place until our mid-term indicator framework turns positive again! Aggressive traders should go short, if the S&P 500 drops below 2,850 and should increase their exposure if we see further down testing below 2,790/2,750.

Stay tuned!