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June 01. 2014

Market Review

Right in line with our recent call, U.S. stocks rallied for the week, lifting the benchmark indexes to new record highs. The Dow Jones Industrial Average rose 0.8 percent in the holiday-shortened week to end at 16,717.17, topping its May 13 record. The blue-chip index notched a monthly gain of 0.8 percent. The S&P 500 gained 1.2 percent over the week to 1,923.57, also a record. The benchmark index for American equities advanced 2.1 percent in May, with both the Dow and the S&P tallying a fourth monthly gain. The Nasdaq soared 3.1 percent to 4,242.62. The tech-heavy index ended with a 3.1 percent gain in May. The monthly gain was the index?s first in three months. Among the key S&P sectors, utilities and consumer staples were the best weekly performer. The Chicago Board Options Exchange Volatility Index, a gauge of options prices known as VIX, ended at 11.40.

Short-Term Technical Condition

The short-term uptrend of the market continued to gain more bullish ground last week. This is mainly due to the fact that the S&P 500 closed 42 points above the bearish threshold from the Trend Trader Index, which indicates that the underlying bullish trend of the market remains intact as long as the broad equity benchmark does not drop below 1,881. Furthermore, we can see that both envelope lines of this reliable indicator have slightly started to drift higher. This is telling us that within the past 20 days we saw higher highs and higher lows, which is another typical pattern for a strong short-term oriented uptrend. The same is true if we focus on the readings from the Modified MACD, as they have not shown any signs of a threatening bearish crossover signal yet. Above all, the gauge from the Advance-/Decline 20 Day Momentum Indicator finished the week at quite encouraging levels, although it should be much higher given the fact that the S&P 500 reached a new all-time high last week.

More importantly, short-term oriented market breadth showed also some signs of improvements and is, therefore, confirming the current short-term oriented uptrend of the market. Especially, the Modified McClellan Oscillator Daily showed an increasing bullish gap last week, indicating that the market internals are strengthening (at least on low basis). Furthermore, we have seen a small 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 bullish gauge from the High-/Low Index Daily reached the highest level since early April. 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 gained more bullish ground last week (20), or have slightly been pushed back into bullish territory (50), the S&P 500 was not really supported by a broad basis. This is mainly due to the fact that both gauges should be trading at least at 75 percent, given the fact that the S&P 500 reached a new all-time high last week. 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 is signaling an all-clear mode for now, as its gauge kept trading at quite low levels. Apart from that fact, we can see that the option market turned from contrarian into neutral territory last week, indicating that the optimism among the crowd is increasing. Another threatening fact is that the Smart Money Flow Index is still showing a huge long-term bearish divergence to the Dow, which is another indication for our cyclical roadmap (Charts of Interest and cycles), where we are expecting to see a decline between 10 and 20 percent later this year. On a very short-time frame, the market is quite overbought (Upside-/Downside Volume Ratio Daily and the Advance-/Decline Ratio Daily) and in combination with quite greedy readings within our dumb money indicators (ISE Call-/Put Ratio and the Large Block Index Oscillator), a stronger pullback/washout day looks quite likely. Nevertheless, we think that such a move would be only part of a larger top-building process as the current technical environment is still suggesting an overshoot towards 1,950/1,970 into mid-June.

Mid-Term Technical Condition

The main reason, why we believe to see further strengths at least into mid-June is the fact that the gauge from the Global Futures Trend Index gained 500 basis points to 83 percent last week. Therefore, it has reached the upper end of its bullish consolidation area, which can be seen as a quite bullish signal. Normally, as long as the gauge of this reliable indicator remains above its 60 percent threshold, equities do not appear to be at risk of entering a high double digit drop or even a new cyclical bear market (at least for the moment). For that reason, an overshoot towards 1,950/1,970 looks quite likely, although its gauge has not confirmed the recent break-out from the S&P 500, which is another indication for a mature rally. In addition, the WSC Sector Momentum Indicator is far away from being bearish, indicating that most sectors within the S&P 500 are per definition in a strong mid-term oriented uptrend. As per last week’s report, industrials, materials and energy are/remain the strongest sectors right now, whereas utilities are 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.

More importantly, mid-term oriented market breadth remains constructive, although we can still see a lot of long-term bearish divergences in their readings. Especially, the percentage of stockss which are trading above their mid-term oriented moving averages (100/150) turned (100) or remain (150) bullish, but their gauges are far away from supporting the current level from the S&P 500. This is another indication, that only large cap stocks are pulling major indexes higher! Nevertheless, it was good to see that the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly gained bullish ground on high levels, whereas the Modified McClellan Oscillator Weekly showed an increasing bullish gap last week. For that reason, the bearish divergences within the percentage of stocks which are trading above their mid-term oriented moving averages can be ignored, at least for the time being. Nevertheless, as long as we do not see a healthy rotation into small-caps in combination with a strengthening mid-term oriented market breadth structure, we remain cautious and, therefore, we will monitor our indicator framework quite closely over the next couple of weeks.

Long-Term Technical Condition

The long-term uptrend of the market has not been broken yet and, therefore, our long-term bullish outlook has not been changed so far. The Global Futures Long Term Trend Index is indicating a technical bull market. Nevertheless, the relative strengths score from US equities have dropped below the bullish 50 percent from the WSC Global Relative Strengths Indicator, which is another indication that US equities could run into an important top within the next couple of weeks. Anyhow, right now it is too early to get concerned about those facts as the WSC Global Momentum Indicator still remains quite strong, indicating that most risky markets remain in a long-term uptrend. More importantly, long-term oriented market breadth still looks quite constructive, as the percentage of stockss which are trading above their 200 day simple moving average remain bullish (at least from a pure signal point of view). Moreover we can see that the Modified McClellan Volume Oscillator Weekly has not turned bearish yet, whereas the amounts of stocks which are hitting a fresh 52 weeks high are trading well above their bearish counterparts, indicating still a positive market breadth environment for the time being. Nevertheless, the High-/Low Index Weekly, the percentage of stockss which are trading above their 200 day simple moving average as well as the Modified McClellan Volume Oscillator Weekly are already forming a long-term bearish divergence to the market. Right now it is too early to get concerned about those readings. But given the fact that we are still expecting to see a cyclical bear market later this year (Charts of Interest), we would not be surprised if those bearish divergence will continue to mounting up within the next couple of weeks! All in all, the technical picture of the market slightly improved compared to last week, but most of the bearish divergences have still not been sorted out so far! In our opinion, the market is highly likely to overshoot towards 1,950/1970 into mid June, as market sentiment and the option market still remaintoo depressed for a typical market top. Another important pattern we are waiting for (apart from bearish readings within our mid-term indicator framework) is a typical path of a top-building process. Normally, if the market is topping out, we see a lot of non-confirmation/bearish readings within our short- to mid-term oriented indicators although the market is trading at record levels. Afterwards, we normally see stronger declines (3-4 percent), lasting a couple of days which are then followed by another rally attempt which pushes the market to a new high or it fails to break above. As long as we do not see any of the mentioned facts or such a distribution pattern, we think it is too early to call for an important market top for now!

Bottom Line

The bottom line: the current technical set-up is telling us that further strength into mid-June is likely, although on a very short-time frame increased volatility might be likely. Nevertheless, we still have a lot of evidences that the current rally has reached a mature stage. But as long as our indicator framework remains bullish (at least from a pure signal point of view) and as long as we do not see a typical top-building process pattern, we think it is too early to call for a major market top right now. Therefore, we stick to our initial price target of 1,950/1,970 into mid-June for now, but we will monitor our indicators quite closely over the next couple of weeks. Stay tuned!