September 25. 2016

Market Review

U.S. stocks finished another week of gains. For the week, the Dow Jones Industrial Average gained 0.8 percent to end at 18,261.45. The S&P 500 added 1.2 percent over the five days to close at 2,164.69. The Nasdaq recorded also a weekly gain of 1.2 percent to finish at 5,305.75. All key S&P sectors ended in positive territory for the week, led by utilities. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 12.2.

Strategy Review

Over the past weeks, we highlighted the fact that the market followed a typical textbook like consolidation period and, therefore, the quality of the underlying tape structure would give us further guidance where the market is heading. Because in normal circumstances, a consolidation period is considered to be a healthy one as long as short-term to mid-term market breadth remains supportive or is at least forming some bullish divergences. In such a case, any short-term oriented trend break can be ignored as the market is just taking a (healthy) breather within an ongoing uptrend. Otherwise, such a consolidation period forces the market into a typical top building process, which is then of course just the harbinger of a more significant pullback/correction. To be more precise, a classical top building process can take a couple of weeks, whereas the first stronger pullback (3-5 percent) after an important high is just part of a larger distribution top. After such a pullback, the market usually strongly bounces back (above or slightly below) to its former high, although most of our mid-term and even sometimes our long-term oriented trend- as well as breadth indicators are already faltering/turning bearish. In fact, in our last week’s comment we started to get quite cautious as we had received a growing number of evidences within our indicator framework that the consolidation period slightly started to transform into a corrective top-building process. Moreover we said as long as our mid-term oriented indicators had not turned bearish still and remained, therefore, supportive, it was a bit too early to sell and too late to buy. As a consequence, we advised our members to place a stop-loss limit around 2,020 until we see some solid improvements within our indicator framework.

Short-Term Technical Condition

Unfortunately, this is not the case right now if we focus on our short-term oriented trend indicators. From a pure price point of view, the current short-term oriented trend turned quite neutral as the S&P 500 managed to close within both envelope lines of the Trend Trader Index. Nevertheless, we can see that both envelope lines of this reliable indicator are still drifting lower, indicating that ? from a pure structural point of view – the underlying trend structure of the market remains bearish. Basically, the same is true if we focus on the Modified MACD and the Advance-/Decline 20 Day Momentum Indicator. Although both indicators are signaling some form of improvements within the overall trend structure of the market, their signals are a way too weak to take them too seriously at the moment. This is due to the fact that any stronger down-day could easily lead to a bearish crossover within both indicators and, therefore, they are far away from confirming the latest move by the market. As a matter of fact, the recent gains from last week can be still classified as a bounce rather than the start of a new sustainable short-term oriented up-trend.

Basically, the same is true if we analyze short-term market breadth. Given the fact that the market finished the week with decent gains, the improvements in the readings of our short-term oriented tape indicators have been also developing moderately so far. As a matter of fact, most of them are still showing a huge bearish divergence if we consider the current levels from the S&P 500! This applies in particular to the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as both indicators remain bearish or just flashed an outright weak bullish crossover signal last week. This is telling us that the underlying tape momentum of the market remains quite weak-kneed and, therefore, the recent bounce still looks quite fragile. The case is slightly different if we focus on the percentage of stockss which are trading above their short-term oriented simple moving averages (20/50). Both tape indicators rebounded quite strongly last week, but nevertheless their absolute levels should be much higher given the fact that the S&P 500 is trading near record highs. Another weak tape signal is coming from the NYSE New Highs ? New Lows Indicator. Despite the fact that the total amount of new highs increased for the week, their absolute number is a way too low given the fact that the market is trading only a few percentage below its record high! As a consequence, the High-/Low Index Daily gained some bullish ground on low levels but is far away from confirming the current level from the S&P 500.

From a pure contrarian point of view, the overall technical picture of the market is also getting increasingly bearish on a very short-time frame. That is mainly due to the fact that the gauge from the OEX Options Call-/Put Ratio Oscillator Weekly flashed a bearish signal last week. This indicates that the recent bounce on Friday caused a lot of optimism among the crowd as the amount of calls increased significantly last week. Moreover, we can see that the WSC Capitulation Index remains quite bearish, whereas the Smart Money Flow Index has definitely not confirmed the latest gains from the Dow Jones Industrial Average. As a matter of fact only the WallStreetCourier Index is giving some support at the moment and, therefore, we would not be surprised to see increased volatility next week.

Mid-Term Technical Condition

Last week, we were quite worried about the strong deteriorating readings within our Global Futures Trend Index since a drop below its 60 percent threshold would have told us that the risk of a fast paced correction was extremely high (of course only in combination with weak or bearish readings in mid-term oriented market breadth). Therefore, it was good to see that the recent bounce from last week caused a very small recovery within that reliable indicator. Consequently, the gauge from the Global Futures Trend Index is now trading at 67 percent or the lower part of its bullish consolidation area and, therefore, the immanent correction risk has slightly diminished. Nevertheless, the risk is still here as its gauge could easily drop 7 percent within a few days. Above all, with 67 percent, the indicator is far away from confirming the current levels from the S&P 500. So even if we do not see a stronger pullback immediately, we should not forget that the upside potential of the market remains also quite capped if we do not see any further strong positive momentum within that indicator. Therefore, the future development will be quite crucial to monitor as a new high from the S&P 500 in combination with readings below or slightly above 60 percent within the Global Futures Trend Index would be a clear indication for a suckers rally. However, if we focus on the WSC Sector Momentum Indicator, we can see that ? from a pure price point of view ? the mid-term oriented up-trend of the market remains intact as most sectors within the S&P 500 have not broken below their mid-term oriented trend-lines yet. Nevertheless, if we have a closer look at our Sector Heat Map we can see that the momentum score of most sectors continued to deteriorate while the score of riskless money market remains quite elevated. This is also a quite concerning technical signal, as it indicates further signs of fatigue among the broad market.

Basically, the same is true if we focus on mid-term market. Despite the fact that the Modified McClellan Oscillator Weekly remains bullish, it looks like that the indicator is about to flash a bearish crossover signal within the next couple of weeks, indicating a deteriorating tape momentum. The same applies if we examine the readings from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly. Both indicators still remain bullish from a pure signal point of view, but they showed hardly or absolutely no signs of recovery last week. In the past, bearish readings within those indicators (in combination with a bearish Global Futures Trend Index) mostly led to a stronger correction. However, right now we are not there yet and given the quite bullish readings within the percentage of stockss which are trading above their mid-term oriented moving averages (100/150), we think that the top building process continues for a while.

Long-Term Technical Condition

On a very long-time frame, the technical picture of the market remains quite unchanged compared to last week. As a matter of fact we do not think that a correction should lead to a new bear market at the moment. This is mainly due to the fact that the WSC Global Momentum indicates that 80 percent of 35 local equity markets all around the world (which are covered from our WSC Global ETF Momentum Heat Map) are still in a long-term oriented up-trend at the moment. Moreover, it was good to see that the readings from the Global Futures Long Term Trend Index also showed some signs of improvements last week. This can be also monitored if we focus on the Global Relative Strength Index, as the relative strength of most risky markets remains positive. Moreover, this long-term oriented uptrend of the market is still widely confirmed by long-term market breadth. This is due to the fact that the readings from our entire long-term oriented tape indicators remain bullish (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stockss which are trading above their 200 day moving average). Nevertheless, we can also see some exhaustion in their readings which might be another piece of evidence that the market looks vulnerable at the moment.

Bottom Line

The technical situation remains almost unchanged compared to last week. Although the market only trades a few percentages below its all-time high, we remain cautious. This is due to the fact that most of our indicators remain quite weak-kneed/non-confirmative and, therefore, we received further evidences that the market has entered a corrective top-building process. However, as we have not seen further bearish crossover signals within our mid-term oriented indicators yet another rally attempt towards the latest record high still looks possible (to complete a text-book like top building process). Consequently, it might be a bit too early to pull the trigger immediately. Nevertheless, we would advise our conservative members to keep/place a stop-loss limit around 2,020 as the risk of a fast paced pullback can also not be ruled out in such a non-confirmative technical market environment. This stop loss limit should be in place until our mid-term indicator framework turns positive again! Aggressive traders should go short, if the S&P 500 drops below 2,020 and should increase their exposure if we see further down testing below 2,010/2,000. Stay tuned!