November 18th 2018

Market Review

U.S. stocks finished the week with losses. The Dow Jones Industrial Average dropped 2.2 percent over the week to 25,413.22. The S&P 500 lost 1.6 percent for the week to finish at 2,736.27. The Nasdaq shed 2.2 percent for the week to end at 7,247.87. Among the key S&P sectors, health care was the best weekly performer, while energy dragged. Most key S&P sectors ended in negative territory for the week, led by discretionary. The materials sector was the only gainer. The CBOE Volatility Index, or VIX, a measure of investor uncertainty, traded near 18.1.

Short-Term Technical Condition

If we focus on our short-term oriented trend indicators, we can see that their readings developed quite moderately last week. From a pure price point of view, the current short-term oriented trend turned quite neutral as the S&P 500 closed within both envelope lines of the Trend Trader Index. Moreover, we can see that both envelope lines of this reliable indicator started to drift lower last week, indicating that – from a pure structural point of view – the underlying trend structure of the market got bearish again. Basically, the same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator as its gauge slightly dropped below its bullish threshold on Friday. Only the Modified MACD still remains quite bullish, although its short-term oriented trend gauge has lost some steam recently. This is telling us that there is still some positive momentum left, although the market finished the week with stronger losses. Another interesting fact is that the Advance-/Decline 20 Day Momentum Indicator and the Modified MACD are showing stronger signs of positive divergences right now, as their gauges should be much weaker if we compare them with previous levels of the S&P 500 from the 22nd of October. Consequently, any upcoming re-test of the previous low would most likely just produce further bullish divergences in their readings, as extremely heavy losses would be necessary to bring this short-term oriented gauge back to its former low! Although this can be interpreted as a quite positive signal, we should not forget that the current stabilization phase still remains quite weak-kneed at the moment. Moreover, we should not forget that it is not quite unusual to see a lot of changing signals within our short-term oriented trend indicators during a volatile stabilization process. Therefore, short- to mid-term market breadth is a key area of focus to evaluate if the current bottom building process will be just temporary of sustainable in its nature.

If we examine our short-term oriented breadth indicators, we can see that their readings slightly weakened for the week and are, therefore, a bit intermingled at the moment. Nevertheless, their overall readings could have been definitely worse, if we consider the fact that the market finished the week with deep losses. This becomes pretty obvious if we focus on the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily which have not flashed a bearish crossover signal so far. This indicates that the underlying tape momentum still remains quite constructive. Moreover, it is telling us that the latest decline was mostly driven by the tech-rout rather than by the broad market. 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), as both indicators formed a quite bullish divergence compared to previous levels from the S&P 500 at the end of October. Another positive divergence is coming from the NYSE New HighsNew Lows Indicator, as there were only 182 new lows on Friday. The last time the S&P 500 dropped to similar levels (end-October), we saw more than 400 new lows. As a matter of fact, the High-/Low Index Daily has also formed a quite bullish divergence recently, although it remains quite bearish from a pure signal point of view. Despite the fact that most of our short-term oriented tape indicators have started to show some stronger signs of positive divergence recently, we should not forget that – from a pure signal point of view – most of them still remain quite bearish. As a matter of fact, the market looks quite capped in both directions and, therefore, further bottom building into deeper November looks quite likely.

From a pure contrarian point of view, we can see that most of our option based indicators still remain quite supportive at the moment (Daily Put-/Call Ratio All CBOE Options, Global Futures Put-/Volume Ratio, Global Futures Put-/Volume Ratio Oscillator, All CBOE Options Call-/Put Ratio Daily and the Equity Options Call-/Put Ratio Oscillator Weekly). This is another indication that the market remains in a bottom building process at the moment. On top of that, we can see that the WSC Capitulation Index continued to drop significantly for the week, indicating that we might have seen the worst already – at least on a short-term time perspective. Moreover – from a pure cyclical point of view – the market is often supported by seasonal tailwinds (Christmas Rally) in the end of the fourth quarter. On the other hand side, we can see that the Smart Money Flow Index has not shown any major bullish moves so far, indicating further troubles on a mid-term time horizon. This signal confirms our view, that the recent sell-off is just part of a bigger top-building process which should unfold in early next year.

Mid-Term Technical Condition

On a mid-term time horizon, the technical trend condition of the market remains nearly unchanged compared to the previous week. The Global Futures Trend Index is still trading far below its 60 percent bullish threshold. This is telling us that the current correction cycle will be not be over as long as its gauge keeps trading below that important threshold! However, a quite positive signal is that the gauge from the Global Futures Trend Index has again shown some positive momentum recently, as it increased 6 percentage points from last week! This is another indication that the recent correction low from the S&P 500 at 2,603 represents a strong intermediate bottom. Consequently, as long as its gauge does not show stronger signs of negative momentum, we think the downside potential of the market should remain capped at these levels. Another supportive fact is that the pure mid-term oriented price trend of the S&P 500 still remains intact. This can be seen if we focus on the WSC Sector Momentum Indicator, which is still trading at solid levels and finished the week nearly unchanged. This is telling us that most sectors within the S&P 500 are still outperforming riskless money market on a relative intermediate basis. And also the momentum score of riskless money market within our Sector Heat Map dropped by 5 percentage points last week, which is another indication for our intermediate bottom building scenario.

The main reason, why we believe that the current recovery should just be part of a bigger top building process is due to the fact that the recent correction has definitely left some marks on our mid-term oriented breadth indicators. The Modified McClellan Oscillator Weekly remains outright bearish as it did not show any signs of bullish recovery last week. This is signaling that the overall mid-term oriented tape momentum of the market remains outright weak at the moment. This can be also observed if we focus on the percentage of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150) as both indicators are still trading far below their bullish 50 percent bullish threshold. Nevertheless, we can also observe some small bullish divergences in their readings as both gauges were trading slightly lower at the end of October, where the S&P 500 was trading at similar levels.  Basically, the same is true if we focus on our entire advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line in Percent, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line). Another small positive signal is coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly. Both bearish indicators showed some small improvements, although the market finished the week with stronger losses. Although this can be seen as quite positive signal, we should not forget that our entire mid-term oriented breadth indicators still remain quite bearish from a pure signal point of view. So if any upcoming recovery is not confirmed by an improving mid-term oriented tape structure, we got further confirmation for our intermediate bottom scenario.

Long-Term Technical Condition

The long-term oriented trend of the market remains unchanged compared to the previous week. The WSC Global Momentum Indicator dropped to the lowest level for years and signals that only 10 percent of all local equity markets around the world (which are covered by our Global ETF Momentum Heat Map) are trading below their long-term oriented trend lines. Also our Global Futures Long Term Trend Index continued its bearish ride (but is still holding up quite well and trading in solid bullish territory). This signals that the long-term oriented trend of U.S. equities is reversing from quite elevated levels. Our WSC Global Relative Strength Index dropped significantly last week and reveals that the relative strength of nearly all risky markets is trading below the one from U.S. Treasuries (which is another indication for a risk-off market environment). Also our long-term oriented tape indicators had to take a hard hit. The Modified McClellan Volume Oscillator Weekly reached its worst readings for months. And the High-/Low Index Weekly and the percentage of stocks which are trading above their 200 day moving average also strengthened their bearish signals. This is another piece of evidence that the market looks vulnerable for further (and stronger) disappointments on a mid-term time 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 Global Tactical ETF Portfolio, WSC All Weather Portfolio and the WSC Inflation Proof Retirement Portfolio. As the momentum score of consumer staples rose above average and above the one from the S&P 500 within our Sector Heat Map, we received a buy signal for that ETF within our WSC Sector Rotation Strategy.

Bottom Line

Our base call remains unchanged compared to last week as we think the market remains in the middle of a volatile and intermediate bottom building process. In our option, there is a good chance that the current bottom building process will act as for another recovery/rally into the year-end before further troubles might be due. The main reason why we mentioned intermediate and not final low is due to the fact that the latest correction cycle has definitely left its mark on some of our mid- to long-term oriented indicator framework. In such a situation it is not unusual that the first correction and the subsequent stronger and longer-lasting counter trend rally are just part of a larger and longer-lasting top building process. So in other words, if the current counter trend rally is not accompanied by strong improvements within our market breadth indicators (within the next couple of weeks), another correction leg in early next year is highly likely.

Despite the fact that we have seen some increased bullish divergences within our indicator framework, we should not forget that the current bottom building process but still looks a bit fragile in its nature. This is mainly due to the fact that the current tape condition of the market is a bit too strong to justify another move below the previous correction low and too weak to justify a stronger rally at the moment. Consequently, further volatile sideways trading cannot be ruled out at the moment. Although we strongly believe that we might have seen the worst already (at least for now), we think it would make sense for our conservative members to place a stop-loss limit again at 2,595. This stop-loss limit should act as safety net, just in case if our indicator framework strongly deteriorates during the week and will, therefore, not confirm our intermediate bottom scenario.

Stay tuned!