December 22. 2013

Market Review

U.S. stocks rallied for the week, with the Dow and S&P 500 scoring record closes. After losing ground in the prior two weeks, the Dow Jones Industrial Average gained 3 percent this week to finish at 16,221.14. That was its best week since mid-September and in terms of point gain, it was the best since early January. The S&P 500 soared 2.4 percent, to close at 1,818.31 and also snapped a two-week losing streak. The Nasdaq gained 2.6 percent from the week ago close to finish at 4,104.74. All key S&P sectors ended in positive territory for the week, led by industrials. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, slid below 14.

Short-Term Technical Condition

Last week we highlighted the fact that it is highly likely that the market will follow its typical seasonal pattern, which should push the S&P 500 towards 1,820/1,840 by the end of the year. Moreover, we mentioned that such a move is just part of a larger top-building process into January, if we do not see significant improvements within our indicator framework. Despite the fact that the market has shown quite gains last week, the improvements in the readings of our short-term oriented trend indicators have been developing moderately. Apart from the Trend Trader Index, which has switched from bearish into bullish territory last week, we have not seen any bullish crossover in our reliable Modified MACD so far, indicating that the market still remains vulnerable on a very short-term time frame. This can be also seen if we focus on the Advance-/Decline 20 Day Momentum, which still remains slightly bullish from a pure signal point of view, but its gauge should be much higher given the fact that the S&P 500 has reached a new all-time high last week.

Nevertheless, short-term market breadth has shown some small signs of improvements, as our Modified McClellan Oscillator Daily has flashed a small bullish crossover signal last week, indicating that the market internals are strengthening, at least on very low levels. Furthermore, we have seen a reduction in the number of stockss which are hitting a fresh yearly low, together with an increase of stocks which have been pushed to a new yearly high and, therefore, the High-/Low Index Daily has flashed a bullish crossover signal last week. Nevertheless, the amount of new highs should be much higher (at least 10 percent), if we consider the current level from the S&P 500. The same is true if we have closer look at the percentage of stockss which are trading above their short-term oriented moving averages (20/50). Despite the fact, that both indicators have been pushed back into bullish territory (above 50 percent), their gauges remain should be much higher, indicating that the recent break-out by the S&P 500 was not supported by a broad basis. In such a scenario heavy weighted stocks are pulling the index higher, whereas less weighted stocks (the majority in number terms) are still trading below their short-term oriented trend lines.

If we have a closer look at our contrarian indicators, we can see that the WSC Capitulation Index has decreased significantly, although it has not dropped by half of its rise yet, indicating some form of short-term capitulation. Nevertheless, we are expecting the 9-week crash cycle next week and, therefore, it is quite possible to see another washout day. This would coincide with the fact that the Smart Money Flow Index has not confirmed the recent bounce from the Dow Jones Industrial Average. Another reason of concern is the fact that the option market, overall market sentiment as well as the dumb is a way too bullish in our point of view.

Mid-Term Technical Condition

Despite the fact that we have some improvements in the Global Futures Trend Index, its gauge still remains within its bearish trading range area and is, therefore, not confirming the current levels from the S&P 500! As already mentioned last week, as long as the gauge does not close above 60 percent, the risk of sharp pullbacks remain outright high as any upcoming gains have more a corrective bounce character rather than a sustainable breakout. However, from a pure price point of view, the market still remains in a mid-term oriented up-trend as the WSC Sector Momentum Indicator has not shown any signs of weaknesses so far. The indicator is telling us that most sectors within the S&P 500 remain in a strong uptrend and are outperforming riskless money market. As per last weeks’ report, healthcare, consumer discretionary and industrials are/remain the strongest sectors right now, whereas utilities is highly likely to continue to underperform the market, since its relative strength score is trading far below from the relative strengths score of the S&P 500.

If we focus on our mid-term oriented breadth indicators, we can see that the rally from last week has led to some improvements in their readings. The Modified McClellan Oscillator Weekly has shown a decreasing bearish gap plus the percentage of stockss which are trading above their mid-term oriented moving averages (100/150) have regained some strength recently. Right now 66 percent of all NYSE listed stocks are trading above their 100 day simple moving average and 71 percent of them are above their 150 day simple moving average. Although those ratios are clearly bullish, we think they should also be much higher if we compare them with the current readings from the S&P 500. The same is true if we focus on the Upside-/Downside Index Weekly and within the Advance-/Decline Index Weekly. Both indicators have shown some encouraging strengths last week, but their readings are still too low and are, therefore, forming a bearish divergence to the S&P 500. If we consider all those bearish divergences around, we think the market has reached a fork in the road. Either, those bearish divergences are mounting up, and, therefore, we see a sell-off into a significant correction within the next couple of weeks, or the market will be able to wipe out all those trend-breaking divergences and we will see further rallying into Q1. Right now, the current technical set-up looks quite weak-kneed but the underlying trend remains bullish. Therefore, we think it is too early to take the chips from the table as we still need to see further confirmations within our indicator framework.

Long-Term Technical Condition

The long-term uptrend of the market (WSC Global Momentum, Global Futures Long Term Trend Index and the WSC Global Relative Strengths) remains well in-force and, therefore, our long-term bullish outlook has not been changed so far. The WSC Global Momentum Indicator is trading at 65 percent, indicating that most local equity indices around the world markets (all denominated in USD) are still in a long-term oriented uptrend, plus the Global Futures Long Term Trend Index is still indicating a technical bull market. If we have a closer look at our Global Relative Strengths Indicator, we can see that the European equities remain the most attractive markets from an asset allocation point of view, whereas the U.S. is catching up fast. More importantly, long-term market breadth is still confirming the long-term uptrend of the market as the percentage of stocks which are trading above their 200 day simple moving average remains stable at 75 percent and the High-/Low Index Weekly remains quite bullish, although the amount of new lows has started to increase recently. Only the Modified McClellan Volume Oscillator Weekly is still lagging behind, but given the strengths within our other long-term oriented indicators, those readings can be ignored for the time being.

Bottom Line

The bottom line: on a very short time frame the market is quite overbought and with some non-confirmation within our contrarian indicators it can be possible to see increased volatility next week, although the underlying short-term oriented trend of the market remains bullish. For that reason, we would advise our aggressive traders to keep a close eye on the Trend Trader Index. Conservative investors should remain invested in equities as we think it is still a bit too early to take the chips from the table. Nevertheless, they should adjust their safety stop-loss limit around 1,740 just in case the market does not follow a typical path of a top-building process. Stay tuned!