January 6th 2019

Market Review

U.S. stocks closed the first week of the year with solid gains. The Dow Jones Industrial Average added 1.6 percent over the holiday-shortened week to end at 23,433.16. The S&P 500 recorded a weekly 1.9 percent gain to close at 2,531.94. The Nasdaq advanced 2.3 percent from last Friday’s close to finish at 6,738.86. Among the key S&P sectors, energy was the greatest gainer for the week, while utilities was the only negative sector for the week. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, dropped to 21.4.

Short-Term Technical Condition

From a pure price point of view the short-term oriented trend condition of the market turned quite neutral, as the S&P 500 closed in the middle of both envelope lines of the Trend Trader Index. Nevertheless, we should not forget that both lines of the Trend Trader Index are still decreasing and, therefore, the recent gains can be still categorized as bounce rather than the start of a new and sustainable up-trend at the moment. But apart from this fact, we can see many positive developments within our remaining short-term oriented trend indicators. The gauge from the Advance-/Decline 20 Day Momentum Indicator clearly confirmed last week’s rally as it showed a strong recovery/spike last week. Another quite encouraging signal is coming from the Modified MACD, as we saw a solid surge in the short-term oriented trend line, which finally led to a small bullish crossover signal within this reliable indicator. Consequently, any upcoming weakness would most likely just produce a bullish divergence in its readings, as extremely heavy losses would be necessary to bring this short-term oriented gauge back to its former low! As a matter of fact, we can be pretty sure that that the bounce will continue for a while as it could easily turn out to be quite strong in its nature.

This setting is also confirmed by our short-term oriented breadth indicators as they showed some stronger signs of recovery last week. The most encouraging signal is coming from the High-/Low-Index Daily, as its bearish gauge dropped significantly last week. The main reason for this quite supportive signal is the fact that we have recently seen a very strong reduction in the number of new lows, in combination with a minor increase of new highs. Worth mentioning is the fact that this was the first increase, since mid-December. Even on Thursday, there was hardly any increase in the number of new lows, although the S&P 500 plunged 2.47 percent on that day! As a matter of fact, it was not a big surprise at all that markets strongly rallied on Friday. Anyhow, this is an outright encouraging tape signal telling us that the market internals strengthened on an extremely broad basis. To be more precise, the sell-off on Thursday was mainly driven by a few heavy-weighted stocks in the index (e.g. Apple), although the broad market was holding up quite well. Such strong tape signals are absolutely essential for our aggressive traders, as they give a clear indication when to reduce or to increase any outstanding positions. Anyhow, as long as this pattern continues, the overall tone should be supportive. This can be also observed if we focus on the percentage of stocks which are trading above their short-term oriented moving averages (20/50). Both gauges recovered significantly last week and especially the 20 days’ time frame gauge jumped to the highest level for months. This is another indication, that the market hit an important intermediate low last week. The same applies for the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily. Both indicators recovered significantly last week and the first one even succeeded to flash a bullish crossover signal. This is telling us that the short-term oriented momentum of advancing issues and advancing volume finally turned positive. This is telling us that the latest recovery was mainly driven by a strong demand, rather than being just a short-squeeze. Consequently, we strongly believe that the latest bounce marked the beginning of a longer-lasting bear-market rally. The main reason why we still talk about a bear-market rally is due to the fact that the absolute readings of our indicator framework are still a bit too weak-kneed at the moment. However, as long as we do not see a stronger spike in new lows (or other typical short-term oriented tape deterioration signals), the bounce will not be at risk of fading out – at least for now.

On the contrarian side, we can see that the market is quite overbought (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) and, therefore, it could be possible to see some rocky sessions on a very short-time frame. However, the most important contrarian signal is still coming from the option market. As already mentioned last week, with such bearish readings within the Daily Put/Call Ratio All CBOE Options it is quite likely to see higher or at least stable prices until 18th of January (when the option expiring date is due). Moreover, such bearish readings often indicate an important (intermediate) low (as long as we see additionally a stronger recovery within short-term market breadth). Another reason, why we think that the latest bounce has the potential to mark an important intermediate low is due to the fact that market sentiment is outright bearish at the moment. So if the latest rally will continue a lot of money managers will be forced to get back into the market. This purchasing power could, therefore, additionally act as strong driver for higher prices into early Q1. Another interesting fact was, that our Smart Money Flow Index did not confirm the sell-off on Thursday, indicating a lot of smart buying on that day. The only negative signal is coming from the WSC Capitulation Index, which is still indicating a risk-off market scenario.

Mid-Term Technical Condition

The main reason, why we believe the market just has hit an intermediate and not a final low is due to the fact that the technical condition of the market still looks very vulnerable at the moment. Although our Global Futures Trend Index increased by nearly 10 percentage points last week and, therefore, confirmed the latest gains of the S&P 500, the gauge is still too far away from passing its important 60 percent bullish threshold! As already mentioned a couple of times – from a formal point of view – the current correction cycle will be not be over as long as its gauge keeps trading below that important threshold! In consequence, the latest recovery can be still classified as bounce rather than a new sustainable uptrend. Also the WSC Sector Momentum Indicator has not succeeded to improve recently and even dropped to its lowest level for years! This fact reveals that the momentum score of most sectors within the S&P 500 are underperforming the momentum score of riskless money market. This circumstance is also proofed by our Sector Heat Map as the momentum score of riskless money market continued to increase (by 10.3 percentage points during the week) and jumped to 93.5 percent. Already nine sectors are now trading below the one from riskless money market! As already pointed out in our previous outlooks, this is just another indication for our preferred scenario that the recovery will just turn out to be a bear-market rally instead of being the start of a new bull-market!

Mid-term market breadth, in contrast, showed quite strong signs of recovery and, therefore, we received further confirmation for our short-term bear-market rally scenario. Our entire advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line in Percent, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line) increased significantly last week, indicating that the bounce might continue for a while. Moreover, mid-term oriented advancing issues and mid-term oriented up-volume continued to gain more bullish ground. Also the percentage of stocks which are trading above their mid-term oriented moving averages (100/150) showed some improvements, although on very low levels compared to the increase of the broad index. This indicates that the market remains supportive on a short-term time frame, but too weak on an absolute basis. However, we can see that the Modified McClellan Oscillator Weekly continued to decrease, indicating that overall tape momentum remains quite poor at the moment. Consequently, if any upcoming rally will not be able to get our mid-term oriented tape indicators back on track, we can be pretty sure to see another significant correction cycle later this year!

Long-Term Technical Condition

The long-term outlook of the market still shows a quite grim technical picture at the moment. Although our WSC Global MomentumIndicator increased last week, it is still trading at a very low level. This indicates that only 20 percent 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. Also our Global Futures Long Term Trend Index continued to decrease and dropped to the lowest level for years. In addition, our WSC Global Relative Strength Index did not show any improvements last week and the relative strength of all risky markets is trading below the one from U.S. Treasuries. This is a clear indication that the market still remains in a technical bear-market at the moment. Focusing on our long-term oriented tape indicators reveals that the Modified McClellan Volume Oscillator Weekly also weakened, while percentage of stocks which are trading above their 200 day moving average and High-/Low Index Weekly slightly improved.

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 Sector Rotation Strategy, the WSC Inflation Proof Retirement Portfolio and the WSC All Weather Model Portfolio. The WSC Global Tactical ETF Portfolio is switching from cash into treasuries.

Bottom Line

From a pure strategic point of view, the market remains in a technical bear-market. This is mainly due to the fact that our entire mid- to long-term oriented indicators remain quite bearish for the time being. However, on a short-term time perspective, the picture looks quite different. Despite the fact that we expected some kind of stronger bounce, the recovery within our short-term oriented indicators turned out to be quite strong last week. As a matter of fact, we strongly believe that there is a good chance that the latest bounce will turn out to be the start of a stronger and longer-lasting bear-market rally into early Q1. The main reason why we mentioned bear-market rally is due to the fact that the latest correction cycle has definitely left its mark on our mid- to long-term oriented indicator framework. Normally, it is not quite unusual to see some stronger and longer-lasting recovery periods within a technical bear market, which are then just followed by further waterfall declines. In such a situation, our mid-term oriented indicator framework is key area of focus (e.g. Global Futures Trend Index). So in other words, if the upcoming counter trend rally is not accompanied by strong improvements within our mid-term oriented market breadth indicators (within the next couple of weeks), another correction leg in mid Q1 can be expected (preferred scenario for now). Anyhow, with extreme brightening readings within our indicator framework, the risk-/reward ratio of playing the upcoming bear-market rally looks quite attractive from the current point of view. Consequently, after our conservative members successfully side-stepped the recent turmoil, we think it is time to get back into the market (by buying into weaknesses rather than chasing the market too aggressively on the upside) as the risk-/reward ratio for such a bet looks quite attractive at the moment. If capital preservation is an absolutely key motivation, we would advise you to wait another week for further confirmation. Aggressive traders should focus on buying into weaknesses rather than selling into strength. Moreover, we think it makes sense for our conservative members to place a stop-loss limit (closing price) around 2,455 which should act as final safety net (during the week).

Stay tuned!!!