December 21. 2014

Market Review

U.S. stocks ended a turbulent week with the biggest weekly gain since October. The Dow Jones Industrial Average jumped 3 percent from the week-ago finish to 17,804.80. The Standard & Poor?s 500 surged 3.4 percent from the prior Friday’s close to 2,070.65, slightly below its all-time high. The broad index recorded its biggest weekly gain in nearly two years. The Nasdaq advanced 2.4 percent from last Friday’s close to 4,765.80. All key S&P sectors finished the week in positive territory, led by energy. The CBOE Volatility Index, or VIX, fell 22 percent in the week to 16.49, the most since October.

Short-Term Technical Condition

Right in line with our recent call, U.S. stocks strongly rebounded towards Christmas! As a matter of fact, the market is moving in line with our cyclical roadmap (Charts of Interest and Cycles), where we had expected to see a pullback in the first two weeks of December, before seasonal tailwinds brought further gains. Not surprisingly, the short-term uptrend of the market started to strengthen last week. This is mainly due to the fact that the S&P 500 managed to close 32 points above the bearish threshold from the Trend Trader Index. Therefore, from a pure price point of view, the market remains in a short-term oriented uptrend as long as the S&P 500 does not drop below 2,038. Nevertheless, both envelope lines of the Trend Trader Index are still drifting lower, which indicates that the current trend structure of the market still remains slightly bearish from a pure structural point of view. The same is true if we focus on the Modified MACD and the Advance-/Decline 20 Day Momentum. Both gauges improved fairly last week and, therefore, they flashed a small bullish signal last week (Advance-/Decline 20 Day Momentum) or about to do so (Modified MACD), if we see further strong gains ahead. Nevertheless, we can still see a lot of bearish divergences in their readings, as the Advance-/Decline 20 Day Momentum Indicator as well as the short-term oriented gauge from the Modified MACD should be much higher, if we consider the current level from the S&P 500. Nevertheless, if we consider the magnitude of the recent recovery, it is not quite unusual that our short-term oriented trend indicators are showing some form of bearish divergences.

As a matter of fact, short- to mid-term oriented market breadth is key area of focus as it will give us guidance if the recent surge was just an oversold bounce or the start of a new sustainable uptrend. Apart from the fact that the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily still remain quite bearish from a pure signal point of view, overall short-term market breadth showed some encouraging signs of improvements last week. This is mainly due to the fact that we have seen a huge reduction in the number of stockss which are hitting a fresh yearly low, together with a strong increase of stocks which have been pushed to a new yearly high. Therefore, the High-/Low Index Daily flashed a small bullish crossover signal last week. Nevertheless, we should not forget that the bullish gauge of the High-/Low Index Daily should be much higher (at least 6-8 percent), if we consider the current level from the S&P 500. For the time being, this bearish divergence can be ignored as the percentage of stockss which are trading above their short-term oriented moving averages (20/50), as they have been pushed back to quite encouraging bullish levels. This is telling us that the recent rally was supported by a broad basis and, therefore, it looks like that the overall trend momentum of the market is regaining strength. This can be also seen if we focus on the ratio between S&P 500 and the Russell 2000, which indicates that small caps have started to regain their footing.

The situation on the contrarian remains almost unchanged compared to last week. The readings from most of our dumb money as well as option based indicators remain outright bullish (All CBOE Options Put/Call Ratio, OEX Options Call-/Put Ratio Oscillator, Uptick-/Downtick Ratio Daily and the Global Futures Trading Index), as the small fry was buying massively put options last week. As a matter of fact, dumb money got terrible burned, as the market strongly rebounded last week. In addition, we saw a 9-to-1 up-day, which is another indication for a trend-reversal. From a pure seasonal point of view, we expect further gains into the years end although the pace is likely to slow down as the market is quite overbought (Upside-/Downside Volume Ratio Daily). Nevertheless, the Smart Money Flow Index is still showing a huge bearish divergence to the Dow. In our opinion, this is another long-term indication that the recent rally is just part a multi-week and corrective rebound pattern/top building process, which could finally led to a strong and significant correction in early Q1 2015.

Mid-Term Technical Condition

The technical picture on a mid-term time frame remains almost unchanged compared to last week. From a pure price point of view, the WSC Sector Momentum Indicator is still signaling that most sectors within the S&P 500 have not broken below their mid-term oriented uptrend yet. This can be also seen if we have a closer look at our Sector Heat Map. Despite the fact that the relative strength score of riskless money market is trading above 10 percent, it remains below most other industries and, therefore, the overall mid-term oriented up-trend remains intact so far. Nevertheless, the upside potential of the market should remain capped on a mid-term time horizon as long as the Global Future Trend Index keeps trading within its bearish trading range. Therefore, we received even more confirmation that the recent decline is definitely part of a larger distribution pattern, which could unfold in Q1 2015.

However, right now it is a bit too early to get concerned about this fact as mid-term oriented market breadth is still holding up quite well. Especially, the percentage of stockss which are trading above their mid-term oriented moving averages (100/150) have been pushed back into bullish territory again, indicating that the broad market is regaining momentum. Above all, the amount of mid-term oriented advancing issues as well as mid-term oriented up-volume continued to gain more bullish ground on high levels! As a matter of fact, we think the market is not at risk for a major correction at the moment and, therefore, we even can ignore the bearish readings from the Modified McClellan Oscillator Weekly at the moment. Although the current technical environment looks quite supportive for the time being, we cannot ignore the fact that most of our indicators are trading well below their recent highs and are, therefore, showing a huge long-term bearish divergence to the market. In our opinion, this is another indication that the market remains in a multi-week top building process. So, either those bearish divergences will be sorted out within the next couple of weeks or we might see a significant correction in early Q1 2015 (preferred scenario).

Long-Term Technical Condition

From a pure technical point of view, the long-term oriented up-trend of the market remains intact as the Global Futures Long Term Trend Index has not turned bearish yet. Nevertheless, we can see that the global bull market remains quite selective as only 32 percent of all local equity markets around still remain within a long-term oriented up-trend. From a pure asset allocation point of view, US equities remain the place to be as they are still leading all other risky markets in terms of relative strength. Apart from the fact that the Modified McClellan Volume Oscillator Weekly still remains quite bearish, long-term market breadth showed some small signs of improvements last week. Especially, the High-/Low Index Weekly continued to gain more bullish ground on low levels, whereas the percentage of stockss which are trading above their long-term oriented moving average (200) were pushed back into bullish territory last week. Nevertheless, both indicators are showing a huge long-term bearish divergence to the market which is another piece of evidence for our multi-week rebound scenario!

Bottom Line

The short-term situation remains unchanged compared to last week. Given the overall seasonal tendencies, together with increased bullish signals within our short-term trend- as well as tape indicators, further gains into the year-end are likely. As a matter of fact, aggressive traders should remain bullish as long as our short-term oriented indicator framework remains constructive. Although we received more confirmation for our multi-week top-building process, more conservative members should hold their equity position as we think it still a bit too early to call for a major market top right now. Stay tuned!