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October 4th 2020

Market Review

U.S. stocks wrapped a volatile week whereas all three major U.S. averages finally finished the week higher. The Dow Jones Industrial Average recorded a weekly increase of 1.9% to finish at 27,682.81. The S&P 500 added 1.5% for the week to finish at 3,248.44, ending four-week losing streaks. The Nasdaq also advanced 1.5% from the week-ago close to 11,075.02. Most key S&P sectors ended in positive territory for the week, the energy sector was the only decliner. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 27.3.

Short-Term Technical Condition

Despite the fact that the market finished the week on a higher note, the improvements in the readings of our short-term oriented trend indicators have been developing moderately so far. This becomes quite obvious if we focus on the Trend Trader Index. There we can see that the pure price driven short-term oriented trend of the market turned neutral as the S&P 500 managed to close within both envelope lines of this reliable indicator. Although this can be interpreted as quite supportive fact, we should not forget that this signal was mainly triggered by the strong decreasing envelope lines rather than being the result of a structural trend change. Hence, as long as we do not see a change in the direction of both envelope lines the underlying trend structure of the market remains quite bearish biased. The same is true if we focus on the Modified MACD and the Advance-/Decline 20 Day Momentum Indicator. Despite the fact that both indicators showed some form of improvements last week, they have not turned bullish so far (and have, therefore, not confirmed the latest bullish price action of the S&P 500). So from a strict trend point of view, the latest recovery can be still classified as volatile bounce rather than the beginning of a new sustainable uptrend – at least from the current point of view. Nevertheless, we should not forget that increased volatility is quite common when the short-term oriented trend-structure of the market remains bearish (decreasing envelope lines of the Trend Trader Index). In such an environment it is quite common to see stronger price movements in both directions, which could often lead to fast changing signals within our remaining trend indicators. Consequently, we additionally need to analyze short-term market breadth as it will give us further conviction if a stronger move in one direction is just the result of increased volatility or the potential start of a major trend-reversal.

Analyzing short-term market breadth reveals  a quite intermingled picture at the moment. Despite the fact that the short-term oriented gauges from the Modified McClellan Oscillator Daily as well as the Modified McClellan Volume Oscillator Daily showed stronger signs of stabilization last week, both indicators still remain bearish from a pure signal point of view. Hence, they have not confirmed the latest price action of the S&P 500. This indicates that the overall tape momentum remains quite weak-kneed and, therefore, it might be a bit too early to bet on a major trend-reversal for the moment. This can be also seen if we focus on the percentage of stocks which are trading above their short-term oriented moving averages (20/50). Despite the fact that the SMA 20 succeeded to flash a small bullish signal last week, their overall level should be much stronger if we consider the current level of the S&P 500. Especially, the SMA 50 is still trading at outright weak levels indicating that the majority of all U.S. stocks remain in a short-term oriented (price driven) down-trend. Hence, the latest strength can be still classified as (oversold) bounce rather then being the result of broad based demand all across the board. This picture is also confirmed by the NYSE New HighsNew Lows Indicator as the total number of stocks hitting a fresh 52 weeks low even increased during the week (whereas the number of new highs has not shown any stronger signs of improvements yet). As a result, the High-/Low-Index Daily remains quite weak-kneed although it still remains slightly bullish from a pure signal point of view. Thus, it looks like the recent strength was mainly driven by a handful of mega-caps in the index rather than being the result of a healthy demand all across the board. A fact, which can be also observed if we focus on the Upside-/Downside Volume Index Daily, since its bullish gauge is a way too low to justify a stronger short-term oriented uptrend at the moment.

From a pure contrarian point of view, we have not seen major signs of capitulation so far (indicating that the latest bounce might run out of steam quite quickly). The Smart Money Flow Index has not confirmed the latest strength in the Dow Jones Industrial Average, indicating further troubles down the road.  This picture is widely confirmed from a pure seasonal point of view (Presidential Cycle and Decennial Cycle) since the market often faces further selling pressure after a stronger bounce in late September/early October. Another red flag is based on the fact that the latest bounce led to increased optimism within the option market (since the Equity Options Call-/Put Ratio Oscillator and the  All CBOE Options Call-/Put Ratio Oscillator turned neutral again, whereas the z-score from the All CBOE Options Put-/Call Ratio is approaching its bearish threshold again). This shows – that on a very short-time frame – a lot of good news is already priced in (leaving enough room for negative surprises). On the other hand we can see that the WSC Capitulation Index dropped by half of its rise indicating some form of stabilization, whereas the AII Bulls & Bears survey still shows enough pessimism on a mid-term time horizon. Nevertheless, on a very short-time perspective there is still enough room left for negative surprises.

Mid-Term Technical Condition

This coincides with the fact that the mid-term oriented trend-condition of the market still looks quite vulnerable at the moment. This is mainly due to the fact that the gauge from the Global Futures Trend Index keeps trading below its 60% bullish threshold! As already mentioned a couple of times – from a formal point of view – the correction risk will not be off the table as long as its gauge keeps trading below that important threshold! Thus, it might be a bit too early for strategic bargain hunters to get back into the market. Given the fact that we have not seen a stronger correction so far, the pure mid-term oriented price driven uptrend (measured by the WSC Sector Momentum Indicator) remains intact so far. This can be also observed if we examine our Sector Heat Map, as the momentum score of all sectors (except energy) remains above the one from riskless money market.

Another concerning fact is that mid-term oriented market breadth has not shown any signs of major improvements yet. Apart from the fact that the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) shows that the mid-term oriented price driven up-trend remains quite broad based, the underlying trend momentum still looks quite weak-kneed at the moment. Especially, the Upside-/Downside Volume Index Weekly and the Advance-/Decline Index Weekly are telling us that the momentum of advancing issues and advancing volume is a way too weak to justify the current level of the S&P 500 or even significant higher prices. Worth mentioning is the fact that every stronger pullback in the past was led by bearish readings within both indicators (together with a Global Futures Trend Index score below 60%). As a matter of fact, we think the risk-/reward ratio for being strategically invested remains depressed. In addition, most of our advance-decline indicators have not formed any kind of bullish divergences yet (Advance-/Decline Line Weekly, Advance-/Decline Line Daily, Advance-/Decline Volume Line). So from a current mid-term breadth point of view, the upside-potential of the market looks quite capped, whereas the down-side risk remains high.

Long-Term Technical Condition

So far, the long-term oriented trend of the market remains positive. Our WSC Global Momentum Indicator showed some minor improvements last week and indicates that still 54 percent of all local equity markets around the world (which are covered by our Global ETF Momentum Heat Map) are trading above their long-term oriented trend lines. Also our Global Futures Long Term Trend Index increased once again for the week, signaling that the long-term oriented trend of U.S. equities remains intact. In addition, the relative strength of all risky markets where still holding up quite well compared to treasuries. Also long-term market breadth (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and especially the SMA 200) showed some small improvements last week (although their overall levels look quite weak-kneed as well).

Model Portfolios

Last week, there were no changes within the WSC All Weather Model Portfolio, the WSC Inflation Proof Retirement Portfolio, the WSC Dynamic Variance Portfolio and the WSC Sector Rotation Strategy.

Bottom Line

The situation remains almost unchanged compared to last week and, therefore, it is a way too early to change our strategic bearish outlook. To be more precise – from a pure seasonal point of view  –  further bouncing into early next week cannot be ruled out. However, given the fact that the latest bounce had literally zero positive impact on our indicator board (especially within a mid-term time perspective), the recent recovery can be still described as corrective rather than being healthy in its nature. A fact can be also seen if we focus on our WSC Big Picture Indicator which started to show a bearish consolidation market scenario a couple of days ago. Consequently, the market is highly at risk for further disappointments. Thus, we see absolutely no reason to change our strategic bearish outlook for the time being. So even if we do not see stronger selling pressure immediately, with such weak readings across the board the upside potential of the market looks extremely capped as well. As a matter of fact, the risk-/reward ratio still looks too low to justify a bargain hunt at the moment. Hence, our bearish view will remain in place as long as we do not see a significant recovery within our short- to mid-term oriented indicator framework. So in the end, we would recommend our conservative members to stay on the sideline, whereas aggressive traders should focus on the short-side as long as our short-term oriented indicator framework continues to worsen/remain bearish. Nevertheless, we would recommend to use close stops as the risk of nasty bounces remain high.

Stay tuned!