January 31st 2021
U.S. stocks wrapped a volatile week and due to a weak Friday, all three major U.S. averages finished the week finally in negative territory. The Dow Jones Industrial Average shed 3.2% over the week to 29,982.62. The S&P 500 booked a weekly loss of 3.3 to finish at 3,714.24. The Nasdaq lost 3.5% over that time period to end at 13,070.69. All key S&P sectors ended in negative territory for the week, led by energy. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, jumped to 33.1.
It was a tough week as all three major averages dropped more than 3%, posting their worst week since October. Despite the fact that we expected some form of increased sentiment driven washout days to dampen short-term optimism, the magnitude of the recent decline turned out to be surprisingly strong. Normally, sentiment driven washout days are important catalyst as they relieve overbought conditions and dampen short-term optimism, which is then often the basis for further growth. Apart from the fact that the recent decline was somehow above average, our entire short-term oriented indicator framework took a hard hit on Wednesday and continued to deteriorate the days after. Consequently, the stronger down-day on Friday was more a tape issue rather than being the result of a sentiment event. Consequently, the big question is if the recent selling-pressure was just the result of the recent Hedge Fund squeeze (and, therefore, a one day event) or if it was just the beginning of a longer-lasting trend-reversal?
Short-Term Technical Condition
The short-term oriented trend of the market obviously turned bearish last week. On Friday the S&P 500 closed 97 points below the bearish threshold from the Trend Trader Index, after dropping below its bearish threshold already on Wednesday. This negative short-term oriented price trend was also supported by a bearish crossover signal from the Modified MACD on that day, indicating further selling pressure ahead. Since then, the bearish gap of the Modified MACD continued to widen, which is another indication that the recent trend-break might be more sustainable in its nature. Another negative signal is coming from the Advance-/Decline 20 Day Momentum Indicator, as it dropped significantly for the week. As a result this reliable indicator has formed quite a bearish divergence to the current levels of the S&P 500 (although the indicator itself has not turned bearish yet). Consequently, further selling pressure cannot be ruled out from a pure trend point of view. Although this signal looks quite grim on the first sight, we can also see that – from a pure structural point of view – the short-term oriented uptrend has not been completely broken yet since both envelope lines of the Trend Trader Index are still holding up quite so far. As a matter of fact, short- to mid-term market breadth will give us further guidance if the recent weakness has the potential to transform into a more significant pullback or if it was just the realization of increased volatility.
Unfortunately, also our entire short-term oriented market breadth indicators had to take a hard hit during the last couple of trading sessions. Thus, it looks like that the market is getting increasingly vulnerable for further disappointments. More specifically, the percentage of stocks which are trading above their short-term oriented simple moving averages (20/50) decreased significantly in the last week. The gauge from the 20 SMA even dropped to the bearish territory and the 50 SMA is about to do so soon. Especially, the magnitude of the weekly decline for both indicators turned out to be quite strong. Consequently, the recent short-term oriented down-trend is quite broad-based in its nature since it is backed by a broad basis. Additionally, the short-term oriented momentum of this broad based down-trend also turned strongly negative last week. This can be seen if we focus on the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as both indicators flashed a bearish crossover signal on Monday, respectively Wednesday. Another negative signal is coming from the Upside-/Downside Volume Index Daily, showing that the selling pressure was not only focused on a few heavy weighted stocks in the index. On the other hand, we can see that most of this selling pressure was mainly driven by profit taking so far (which can be interpreted as still a quite positive signal). This becomes obvious if we focus on the NYSE New Highs/New Lows Indicator, as we still saw 54 stocks reaching a new yearly high and only 5 stocks reaching a new yearly low on Friday. As long as new lows are not outpacing new highs, the underlying tone should remain somehow constructive. Nevertheless, the number of new highs is quite low if we consider the fact that the S&P 500 is just trading 3% below its all-time high. As a matter of fact, the High-/Low-Index Daily also starting to show a quite bearish divergence since it dropped faster than the S&P 500 so far. Consequently, the risk of further (stronger) selling pressure is increasing on a very fast pace. On the other hand, even if we do not see some stronger selling pressure immediately, the upside potential of the market also looks quite capped (if we consider all these bearish divergences around).
On the contrarian side, we can see that the decline on Friday has finally started to dampened short-term optimism since we saw a stronger spice in put options (All CBOE Put-/Call Ratio Daily) and a stronger decrease in the number of bulls on Wall Street, indicating some form of stabilization on a very short-time frame. Moreover, the Equity Options Call-/Put Ratio Oscillator and the WSC Put-/Volume Ratio Oscillator finally turned neutral last week. Although this can be interpreted as a quite positive development, we can see that there is still some room left before sentiment might hit fearful levels. This is based on the fact that the z-score of the All CBOE Put-/Call Ratio Daily still remains outright bearish, whereas the WSC Put-/Volume Ratio and the WSC Dumb Money Indicator have not shown any major moves yet. Additionally, we can see that the gauge from the Smart Money Flow Index dropped significantly last week. Given the fact that Hedge Funds got grilled last week, this might not be a big surprise at all. Nevertheless, it is a mid-term oriented warning signal, which is also confirmed by the fact that the gauge from the WSC Capitulation Index spiked into bearish territory last week. So although we saw some small signs of capitulation last week overall market sentiment still remains quite stretched form a current point of view. Another negative signal is coming from a seasonal point of view (Presidential Cycle). There we can see that the market often faces a stronger pullback into mid-February, before facing some tailwinds in early March. Give the recent developments, such a scenario cannot be neglected at the moment. On the other hand, the decennial cycle is showing some strengths in that time period and, therefore, a longer-lasting consolidation period could also be a possible outcome (at least from a pure contrarian point of view).
Mid-Term Technical Condition
Although the situation looks quite difficult on a short-term time perspective, the mid-term oriented up-trend of the market has not been affected yet. Although our Global Futures Trend Index slightly decreased for the week it is still trading in its outright bullish area (95 percent) and, hence, is far away from being bearish. As always mentioned, as long as the gauge from this indicator does not show negative momentum (and remains above 60%) the risk to see a correction (declines below -10%) should be limited. Therefore, it will be crucial to monitor the gauge of this indicator closely within the next couple of days as it will give us further guidance if the recent short-term weaknesses will have the potential to transform into a more significant move (if we see a fast deteriorating gauge of this indicator). Anyhow, currently most sectors within the S&P 500 still remain in a strong mid-term oriented price driven uptrend as the WSC Sector Momentum Indicator is still trading at quite encouraging bullish levels. As a matter of fact, the underlying price trend of the S&P 500 looks quite solid at the moment (which is not a big surprise if we consider the fact that the market is still trading near record highs). This can be also observed if we examine our Sector Heat Map, as the momentum score of all sectors remains above the one from riskless money market (currently at 0%).
However, another reason to be a bit alerted is due to the fact that mid-term oriented market breadth also started to deteriorate last week (although the market only lost 3 percent for the week). This is another piece of evidence that the latest decline was definitely more than just a sentiment driven washout event. While the Advance-/Decline Line Weekly was holding up very well and the SMA (100/150) and the Advance-/Decline Line Daily slightly declined for the week, the Advance-/Decline Volume Line, in contrast, plummeted to the lowest level for weeks. These are quite hefty moves if we consider the fact that the market is still trading slightly below its all-time high. Moreover, we can see that the short-term oriented gauge of the Modified McClellan Oscillator Weekly also started to weaken on high bullish levels, showing that the underlying mid-term oriented tape momentum started to fade away. Further concerning signals are coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly. Despite the fact that both indicators remain quite bullish from a pure signal point of view, they deteriorated significantly for the week. If this trend continues it might be also just a question of time until we see a bearish crossover signal in these two indicators. In the past, bearish readings within both indicators (together with a Global Futures Trend Index score below 60%) were mostly a reliable predictor for stronger losses down the road. Right now, we are not there yet, but we will have to keep a close eye on this development.
Long-Term Technical Condition
The long-term oriented trend of the market remains nearly unchanged compared to the previous weeks. Despite the washout on Friday, our WSC Global Momentum Indicator has not shown any weaknesses and remains at the highest level possible. Hence, it signals that 100% 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. As pointed out several times, this is a quite supportive technical signal, as it shows that the current bull market remains quite globally in scope. Another encouraging signal is coming from our Global Futures Long Term Trend Index which succeeded to stay at the highest level for years. This indicates that the S&P 500 remains in a strong technical bull market – at least for the time being. Furthermore, our WSC Global Relative Strength Index still shows increased risk-appetite among investors. Focusing on our long-term market breadth indicators reveals that the SMA 200 slightly decreased, while the Modified McClellan Volume Oscillator Weekly and the High-/Low Index Weekly even succeeded to improve.
As it was the last Friday of the month, we received a new allocation advice from the WSC All Weather Portfolio, the WSC Inflation Proof Retirement Portfolio and the WSC Dynamic Variance Portfolio. The allocation of the WSC Sector Rotation Strategy remains unchanged.
Despite the fact that we expected to see some nasty sentiment driven pullbacks, the recent decline as well as the deterioration within our indicator framework turned out to be surprisingly strong. However, if we compare the current levels of the S&P 500 (which is still trading slightly below record highs) in combination with the quite weak/bearish biased tape condition and the still elevated sentiment, the risk for a stronger re-pricing is increasing on a fast pace. As a result, the risk-/reward ratio is getting a quite negative tilt (at least on a short-term time perspective). That does not necessarily mean that we see increased further pressure immediately, but on the other hand – with such weak readings all across the board – the upside potential of the market also looks quite capped. At least on a short-term time perspective. Currently, it is still a bit too early to say if we see a stronger pullback or a longer-lasting consolidation period instead. A fact which can be also observed if we focus on our Big Picture Indicator (path view), since its gauge is still showing a weak bullish market biased environment. However, since the situation could change literally within days and given the fact that some input parameters of the Big Picture Indicator only change on a weekly basis, we are getting somehow cautious already (although our mid-term oriented indicator framework still looks quite bullish). Therefore, the best approach for experienced short-term traders is to monitor our daily indicator framework quite closely, whereas we would advise that our conservative member should take profits and/or should place a stop loss limit at 3,650 (intra-day level). This stop loss limit should act as safety net if things change quickly during the week and should be in place until our indicator framework turns positive again. In other words, we would prefer to sacrifice 2 to 3% upside potential to receive an all-clear signal again instead of running the risk of participating a fast-paced correction.