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October 17h 2021

Market Review

U.S. stocks closed out a very volatile week with strong gains. For the week, the Dow Jones Industrial Average rose 1.6% to end at 35,294.76. The S&P 500 gained 2% from last Friday’s close to end at 4,471,37. The Nasdaq jumped 3.4% for the week to end at 14,897.34. Nearly all key S&P sectors ended in positive territory for the week, led by the materials sector. Comm. services was the only decliner. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 16.3.

Strategy Review

Since mid-September, we have received a growing number of evidences that the market was in the middle of a corrective top-building process. To be more precise, our indicator framework showed that only due to the strong performance of a few mega-caps, the S&P 500 had reached a new all-time high, although the remaining stocks were already faltering. We warned our members that such a situation was extremely dangerous since a trend-reversal within these few stocks could trigger a stronger pullback since there was literally no safety net around which would be able to cushion such a move. Moreover we said that even if we did not see a stronger pullback immediately, the upside potential of the market should also remain capped (as the market would not have enough breadth/power to rally substantially higher). As a matter of fact, we said it was a good time to step onto the sideline as the opportunity cost (risk-/reward ratio) of not being invested was extremely low.

In fact, the rally quickly ended after the S&P 500 had lost 5.7% from its high in September through its low on the 4th of October. Afterwards we said the market followed a textbook-like top-building and sell-off pattern (1. low quality market top > 2. initial sell-off > 3. oversold bounce > 4. second sell-off towards or even below the previous low > 5. stronger bounce > 6. bottom or further selling pressure depending on the underlying quality of the move). Moreover, we mentioned that a typical sell-off cycle was quite tricky, since the way down would be always accompanied by stronger and sometimes longer-lasting counter-trend rallies. Thus, analyzing the quality (downside- and upside participation) of each correction leg as well as the following bounce would help to identify whether the market got back to stage 3 or if it had already entered stage 6 (which marks of course the end of such a cycle).

In early October our indicator framework showed stronger signs of stabilization on a short-term time horizon, whereas the mid-term oriented condition of the market still looked quite damaged back then.  Thus, we said that such a stabilization process would still remain quite fragile/corrective in its nature as long as we would not see stronger improvements within our indicator framework. Indeed, in early October the market stabilized and even showed stronger performance into expiration. Consequently, the big question is if the current correction cycle has come to an end or if further selling pressure can be expected.

Short-Term Technical Condition

The short-term oriented trend of the market clearly turned bullish as the S&P 500 closed 63 points above the bullish envelope line from the Trend Trader Index. So, from a purely price point of view, the short-term uptrend of the market remains intact as long as the S&P 500 does not drop below 4.355 (bearish threshold from the Trend Trader Index). This bullish short-term oriented price trend is also supported by the Modified MACD, which flashed a quite strong bullish crossover signal on Friday. On top of that we can see that the gauge from the Advance-/Decline 20 Day Momentum Indicator also jumped back into the bullish territory. Despite the fact that our entire short-term trend indicators are back on track, we can still see some bearish divergences around. Both envelope lines of the Trend Trader Index are still decreasing, whereas the gauge of the Advance-/Decline 20 Day Momentum Indicator could be also a bit stronger. Although the short-term trend picture of the market looks quite positive, the short-term market breadth will give further insights about the quality of the latest gains.

The underlying market breadth status of the market clearly strengthened last week. First of all, both the Modified McClellan Volume Oscillator Daily and the Modified McClellan Oscillator Daily flashed a strong bullish crossover signal, indicating that the momentum of advancing issues and advancing volume turned positive last week. More importantly, we saw a healthy increase in the number of stocks which are hitting a fresh yearly high (especially on Friday), together with an outright low number of stocks which were pushed to a new yearly low. Consequently, the High-/Low-Index Daily widened its bullish gap. Thus, the quality of the latest gains was quite high since they were the result from a strong demand all across the board (rather than being only driven by a few mega caps). This can also be observed if we focus on the percentage of stocks which are trading above their short-term oriented moving averages (20/50). Both gauges succeeded to get back to bullish levels and especially SMA 20 jumped to the highest level for weeks (65%). Therefore, they have clearly confirmed the latest gains of the S&P 500. A fact, which can also be observed if we focus on short-term up-volume.

On the contrarian side, we can see that most of our option based indicators remain neutral (AII CBOE Put-/Call Ratio, AII Bulls/Bears Survey, WSC Dumb Money Indicator, AII CBOE Call-/Put Ratio Oscillator and the Equity Options Call-/Put Ratio Oscillator). On the other hand, we can see that the WSC Capitulation Index is also still showing a risk-off market environment, whereas the Smart Money Flow Index is still indicating increased volatility ahead. A fact, which is also confirmed by the Presidential Cycle, since the time frame after October tends to be quite challenging. Although this is a quite negative signal, the market breadth has a higher priority in our process.

Mid-Term Technical Condition

Anyhow, another major reason why our cautious view has softened recently is based on the fact that our entire mid-term oriented indicators also improved last week. This becomes obvious if we examine the gauge from the Global Futures Trend Index as it managed to get back into the bullish consolidation area and above the 60% threshold. This is a very important trend signal, as it shows that the ongoing corrective consolidation period transformed back into a more supportive set-up. Thus, the threatening correction risk has clearly diminished last week. Also, our WSC Sector Momentum Indicator has not shown any weakness and keeps trading at solid bullish levels. This is an indication that the mid-term oriented price driven trend of the market improved compared to the previous weeks and that more sectors of the S&P 500 got back on track. Also, our Sector Heat Map reveals that the majority of sectors within the S&P 500 has a higher momentum score than riskless money market. In addition, the score of the riskless money market dropped by 2 percentage points last week (to 6.5 %).

Mid-term oriented market breadth reveals again an intermingled setting. On the one side, the picture generally improved compared to the previous week. This becomes obvious if we focus on our advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line), as all of them gained bullish ground last week or even jumped to the highest level for weeks (Advance-/Decline Volume Line). Hence, they are clearly confirming the latest high of the S&P 500. Also, the percentage of stocks which are trading above their mid-term oriented simple moving averages (100/150) increased for the week (still the SMA 100 is trading slightly below the bullish threshold and the SMA 150 only shy above). On the other side, some indicators still remain unchanged compared to the previous weeks. Our Modified McClellan Oscillator Weekly has been dropping for weeks and not succeeded to form a rounding bottom yet. And also the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly have not succeeded to turn bullish yet. So, all in all, these signals are telling us that the market still remains somehow vulnerable on a mid-term time frame. However, as long as the short-term tape condition continues to strengthen this negative signals should not be a major reason of concern. Nevertheless, it is important to keep an close eye on the development of those indicators in the next couple of days, the situation tends to change quite quickly at the moment.

Long-Term Technical Condition

The long-term oriented trend of the market also showed signs of improvements last week. First, our Global Futures Long Term Trend Index stopped its decline and stabilized at high levels, indicating that the long-term oriented trend of U.S. equities is regaining momentum. In addition, our WSC Global Momentum Indicator succeeded to pass the bullish threshold as it jumped 23 percentage points, indicating that currently 65% of all local equity markets around the world (which are covered by our Global ETF Momentum Heat Map) are trading above their long-term oriented trend lines. Moreover, also our WSC Global Relative Strength Index slightly increased compared to the previous week (although it also reveals that the relative strength of many risky markets is trading below the one from U.S. Treasuries). If we examine our long-term oriented tape indicators, we can see that the High-/Low Index Weekly remained unchanged, while the Modified McClellan Volume Oscillator Weekly and the SMA 200 improved.

Model Portfolios

Last week, there were no changes within the WSC All Weather Model Portfolio, the WSC Inflation Proof Retirement Portfolio and the WSC Dynamic Variance Portfolio. Since the momentum score of consumer discretionary rose above average and above the momentum score of the S&P 500, we received a buy signal for that sector within our WSC Sector Rotation Strategy.

Bottom Line

Although we expected to see a bounce into expiration, the quality of that move turned out to be surprisingly strong. A fact which can also be observed if we focus on gauge of the Big Picture Indicator, which nearly jumped back into its bullish quadrant. Thus, the risk of another correction leg (below the latest low of the S&P 500) has clearly diminished – at least from the current point of view. On the other hand side, there are still some weak signals around (especially on a mid-term time horizon). That is the reason why the WSC Mid-Term Composite just managed to flash a tiny bullish signal. Therefore, there is still also a small chance that the current recovery will be faded again at some point in time. Currently, this is pure speculation but we will monitor our short-term oriented indicators closely within the next couple of days/weeks. Nevertheless, given the current development of our signals it is time to upgrade our strategic view from cautious to bullish since the downside risk looks quite capped at the moment. Worth mentioning is the fact that we are not afraid of issuing a strategic sell signal immediately (if the quality starts to diminish again since capital preservation remains the most important driver for success). But currently, the risk-/reward ratio looks attractive again – at least for the time being. For that reason, we think it would make sense for conservative members to raise exposure again (by buying into weaknesses rather to chase the market too aggressively on the upside).

Stay tuned!