February 21. 2016

Market Review

U.S. stocks finished the week with solid gains. For the week, the Dow Jones Industrial Average gained 2.6 percent to close at 16,391.99. The S&P 500 ended at 1,917.78 and booked a weekly gain of 2.8 percent. Both, the Dow and the S&P 500, managed to log their best weekly gains since November. The Nasdaq rocketed 3.9 percent over the week to finish at 4,504.43; the largest weekly gain since mid July. All key S&P sectors ended in positive territory, led by technology. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, held near 20.5.

Strategy Review

In our last week’s comment, we highlighted the fact that our indicator framework was telling us that we had seen the worst already. Consequently, we believed that the market had hit an important low as the second down-leg towards the latest correction low at 1,813 was accompanied by quite positive divergences within our short-term oriented indicator framework. A fact we expected to see as the market followed a typical textbook like bottom-building process (low -> bounce -> retest of low plus positive divergences -> bottom or -> retest of low plus negative divergences -> no bottom). Moreover, we said that from a pure seasonal point of view (Presidential Cycle), it could be possible that such a low would only act as basis for another stronger rally (even towards new highs) into April. After that, we could see another significant correction leg into Q2 2016, which should represent a major bottom in risky assets. Although the market is following those historical patterns quite closely, we should not forget that those historical patterns should just be seen as a rough guideline instead of a precise trading plan. As a matter of fact, our indicator framework will give us further guidance where the market is heading. So if our cyclical roadmap is correct, any upcoming rally should be accompanied by a growing number of bearish divergences within our indicator framework to confirm such a scenario. Basically, the same is true on a very short-term basis. Last week, we said that we needed to see some bullish divergences in our indicator framework to make absolutely sure that we are not catching a falling knife. So all in all, the bullish divergences/signals within our indicator framework will tell us if it is time to get back into the market this week.

Short-Term Technical Condition

Not surprisingly, the short-term uptrend of the market strengthened significantly last week after most of our short-term oriented indicators turned bullish last week. To be more precise, the S&P 500 closed 43 points above the bearish threshold from the Trend Trader Index, indicating that the market is per definition in a bull-mode as long as the broad equity benchmark does not close below 1,847. Furthermore, we can see that both envelope lines of this reliable indicator have also started to bottom out as well, which can be seen as another encouraging trend-signal that we might have seen the worst already. The same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator, which did not show a strong bullish divergence two weeks ago and has finally turned outright bullish on Monday. Consequently, it was not a big surprise at all that the market finished the week with solid gains. Anyhow, the most important short-term trend signal is coming from the Modified MACD, which also flashed a quite strong bullish crossover signal last week. Given the fact that we have seen a quite strong surge in the short-term oriented gauge of this reliable indicator, we strongly believe that the market is now trading in a powerful uptrend, as quite heavy losses would be necessary to bring this indicator back into its bearish mode on a short-term time horizon.

Moreover, it was good to see that short-term oriented market breadth showed some strong signs of improvements compared to last week, although not all of our tape indicators have turned bullish yet. The most encouraging tape signal is coming from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as both indicators turned outright bullish at the beginning of the week. This indicates that the broad market is regaining momentum on a very fast pace. This can be also seen if we focus on the percentage of stockss which are trading above their short-term oriented moving averages (20/50). Both indicators have clearly confirmed the recent break-out attempt by the S&P 500 as both gauges have reached the highest level since December 2015. As matter of fact, both indicators (20/50) formed somehow a quite bullish divergence, although we have not seen a bullish signal on the 50 days? time frame yet. Basically, the same is true if we take a look at the NYSE New HighsNew Lows Indicator. There we can see that there was a tremendous reduction in the total amount of new lows, indicating that the market internals are strengthening. As a matter of fact, the bearish gauge from the High-/Low Index Daily also decreased significantly and is, therefore, also confirming the recent gains from last week. Nevertheless, we can also see that the total amount of new highs remains quite depressed and, therefore, the indicator has not turned bullish so far. So all in all, the recent rally is widely confirmed by quite positive readings within our short-term market breadth indicators. As a matter of fact, we think that the recent gains will definitely turn out to be more sustainable in their nature. Thus we received further confirmation (at least on a very short time frame) that we have seen the worst already!

The situation on the contrarian side remains quite supportive. Although last week’s rally worked off a lot of bearish readings within our indicators (WallStreetCourier Index, Bottom Indicator, Global Futures Put/Volume Ratio and the OEX Call-/Put Ratio Oscillator Weekly) we can see that the fear among the crowd remains persistent (market sentiment). In our opinion, those extreme bearish readings in market sentiment could act as huge catalyst. Especially, if the recent rebound turns out to be sustainable in its nature, a lot of investors are forced to get back into the market quickly, which would fuel the rally even more. Moreover, we can see that our reliable Smart Money Flow Index has formed a huge bullish divergence compared to the Dow, which can be seen as another quite bullish sign for contrarians.

Mid-Term Technical Condition

Despite the fact that the conditions on a short-term time frame are brightening, the technical mid-term condition of the market still remains weak/vulnerable for the time being. This is mainly due to the fact that the gauge from the Global Futures Trend Index has not managed to pass its bullish 60 percent threshold yet. As already mentioned a couple of times, from a pure formal point of view, this indicates that the recent correction cycle is definitely not over yet. Therefore, it was good to see that the gauge from the Global Futures Trend Index has at least shown some positive momentum recently, although it has not confirmed the latest levels from the S&P 500 so far. Although this can be still seen as quite red flag, there might be a good chance that those divergences are sorted out soon, especially if we consider the quite strong readings on a very short time frame. However, from a pure price point of view we can also see that the mid-term oriented down-trend remains well intact as the WSC Sector Momentum Indicator has not turned bullish so far. This is telling us that the momentum score of most sectors within the S&P 500 are still underperforming the momentum score of riskless money market within our Sector Heat Map. In such a scenario, most sectors tend to perform negative on an absolute basis as they remain in a mid-term oriented down-trend.

More importantly, mid-term oriented market breadth showed some small signs of recovery and, therefore, we received further confirmation for our bottom scenario. Especially, the Modified McClellan Oscillator Weekly showed a decreasing bearish gap, plus the percentage of stockss which are trading above their mid-term oriented moving averages (100/150) also showed quite encouraging signs of recovery last week (although both indicators still remain bearish from a pure signal point of view). Moreover, it was quite good to see that mid-term oriented up-volume strengthened significantly last week, indicating that more volume was flowing in advancing stocks than in declining ones. Basically, the same is true if we focus on the Advance-/Decline Index Weekly! Nevertheless, the absolute levels of those important tape indicators still remain quite depressed, which is not a surprise at all if we consider the fact that the market might just have hit a final low recently.

Long-Term Technical Condition

On a long-term horizon, the situation remains almost unchanged compared to last week. The Global Futures Long Term Trend Index kept trading far below its bullish threshold, indicating that the U.S. equities still remain in an extremely risk-off environment at the moment. Consequently, it is not a big surprise at all that the relative strength of all risky markets kept trading below the one from U.S. Treasuries, although that gap has started to narrow recently. The same is true if we focus on the WSC Global Momentum Indicator, which tells us that only 20 percent of all local market indexes around the world managed to close above their long-term oriented trend-lines. Nevertheless, we can see that the gauge surged another 7 percent last week. This indicates that most local equity markets around the world have started to bottom out as well, which can be seen as quite supportive signal for our bottom scenario. More importantly, long-term market breadth also showed some small signs of recovery, although most of our indicators remain quite bearish from a pure signal point of view. Especially, the Modified McClellan Volume Oscillator Weekly showed some small signs of stabilization, although its readings remain quite bearish. The same is true if we focus on long-term new lows as well as the percentage of stockss which are trading above their long-term simple moving averages. So all in all, the long-term condition of the market remains weak, which might be another indication for our cyclical roadmap.

Bottom Line

In our last week’s comment we highlighted the fact that there was a good chance that the market had hit its final low as we had seen typical technical patterns for a major bottom. Moreover we mentioned that we additionally needed to see at least some bullish indication within our indicator framework (especially market breadth) to receive the ultimate bottom confirmation. So consequently, with brightening readings within our indicator framework, we think that we have seen the worst already. That does not mean that the market will take off immediately, but given the quite supportive readings within our short-term oriented indicator framework, we think the chances for another significant down-leg towards the latest low remain limited (at least of the time being). As a matter of fact, after our conservative members successfully side-stepped the recent turmoil, we think it is time to get back into the market as the risk-/reward ratio for such a bet looks absolutely attractive at the moment. Consequently, aggressive traders should focus buy into weaknesses rather than selling strength. Nevertheless, given the fact that the Global Futures Trend Index has not turned bullish so far, we keep a very close eye on the development of our short-term oriented indicators next week. From a pure trading perspective, a break of the S&P 500 above 1,925 would give way towards 1,950/1,965 and in an optimal case towards 1,980. On the other hand, a break below 1,900 would call for further down-testing towards 1,880 and worst case 1,845. Stay tuned!