May 17th 2020

Market Review

U.S. stocks finished Friday with slight gains but the major indexes capped the week with losses. For the week, the Dow Jones Industrial Average slid 2.7% to 23,685.42. The S&P 500 finished at 2,863.70 and posted a weekly drop of 2.2%, notching its worst week since March. The Nasdaq dropped to 9,014.56 and finished the week 1.1% lower. Most key S&P sectors ended in negative territory for the week, led by energy. The health care sector was the only gainer. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 32.6.

Strategy Review

In our last week’s comment, we highlighted the fact that the market internals looked extremely healthy and, therefore, there were no major dealbreaker visible back then. As a result, we expected that the S&P 500 would have enough power to break above the upper border of its trading-range, even though  it would need a couple of attempts to do so. In fact, on Tuesday the S&P 500 had rallied towards the upper boundary of its current trading range, before the rally was faded again. After testing the lower boundary on Thursday, the S&P 500 rallied again to close in the middle part of its trading range on Friday. As already stated several times – from a pure technical point of view – a trading range/consolidation period is always a fork in the road. Because during such a time period, we either see (1) improving readings within our indicator board (increase in new yearly highs, higher percentage of stocks trading above their SMA 20/50 …) which would be then the basis for a strong bullish break-out, (2) or the tape (market breadth) condition worsens, which is then the vanguard for a significant trend-reversal/sell-off (e.g. 2020, late 2019, early/mid 2018, early 2016, mid 2015 or 2011 …). Worth mentioning is the fact that such a process could normally take a couple of days or even weeks, whereas the tilt between corrective and supportive consolidation could get sometimes quite narrow. So if we consider only the recent price action of the market, one could argue that the latest behavior of the market was not really unusual at all (as the S&P 500 just closed in the middle part of its trading range). However, the situation looks completely different if we analyze the underlying tape condition of the market (as it deteriorated significantly for the week). This is definitely a game changer, since the consolidation period has transformed from a healthy into a quite corrective set-up. This can be seen very well if we focus on our technical market indicators.

Short-Term Technical Condition

From a pure price point of view, the short-term oriented trend of the market can be described as quite neutral as the S&P 500 closed between the two envelope lines of the Trend Trader Index. Moreover, we can see that both envelope lines are still drifting higher, indicating that we saw higher highs and higher lows within the past 20 days. So all in all, the pure short-term oriented price information still looks quite constructive in its nature. Nevertheless, the situation looks completely different if we analyze the underlying momentum of that short-term oriented price trend. There we can see that the Modified MACD is about to flash a bearish crossover signal soon, whereas the Advance-/Decline 20 Day Momentum Indicator dropped to into the bearish territory last week. Worth mentioning is the fact, that these are the first negative short-term oriented trend signals since the rebound started in late March. Hence, we received the first indication that the current rally may run out of steam. As already mentioned a couple of times, it is not unusual to see some bearish short-term oriented trend signals during a longer lasting consolidation period. As a matter of fact, we have to analyze if such a trend break is caused by a few heavy weighted stocks in the index, or if it is the result of broad based selling pressure. In such a situation, a trend-break could easily transform into a stronger pullback, as there is no safety net around to cushion such a move. Consequently, our short- to mid-term oriented tape indicators remains key area of focus.

Unfortunately, short-term oriented market breadth had to take a hard hit during the last couple of trading sessions as most of our tape indicators weakened significantly or even turned bearish. This is a quite surprising outcome, if we consider the fact that the market just closed in the middle part of its trading range. However, the most threatening tape signal is coming from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily, as both indicators flashed a strong bearish crossover signal last week. This indicates that the underlying tape momentum of the market has clearly turned negative on a short-term time perspective. This fact can be also observed if we have a closer look at the percentage of stocks which are trading above their short-term oriented simple moving averages (20/50). Both gauges decreased for the week and even passed the bearish threshold (20). As a matter of fact, both indicators have formed a quite bearish divergence (if we consider the current level of the S&P 500). This is another threatening signal at the moment, as it tells us that the latest decline of the S&P 500 was driven by the whole market and not only by a few-heavy weighted stocks in the index. The readings from the NYSE New Highs minus New Lows Indicator also turned slightly bearish as the number of new lows has shown some strengths recently, whereas the number of new highs has not improved at all. Therefore, the High-/Low-Index Daily also turned bearish last week. Consequently, it looks like that the ongoing consolidation period has now an outright corrective tilt.

The situation looks a bit different if we focus on our contrarian indicators. There we can see that the majority of market participants (AII Bulls & Bears survey) remains extremely cautious at the moment. This is telling us that a lot of bad news is already price in. Hence, from a theoretical point of view, the market should have enough room left to climb the wall of worry. So this signal is definitely not fitting in the puzzle right now. On the other hand, we can see that the gauge from the Smart Money Flow Index keeps deteriorating since early April, whereas the WSC Capitulation Index is still indicting further troubles down the road.

Mid-Term Technical Condition

Another major reason, why we turned quite cautious is based on the fact that the mid-term oriented trend condition of the market also weakened significantly last week. This is mainly due to the fact that the gauge from the Global Futures Trend Index surprisingly dropped to 54% and, hence, below its important bullish 60% threshold. So from a pure formal point of view, the technical condition of the market can be described as outright corrective at the moment. In such a market environment, any upcoming gains tend to be limited in price and time (of course only with negative short- to mid-term oriented tape signals). This view remains in place as long as this gauge keeps trading below 60% and does additionally not show any signs of positive momentum. If we focus on the WSC Sector Momentum Indicator, we can see that the mid-term oriented price driven trend of the market slightly improved compared to last week (although it is still slightly bearish from a pure signal point of view). This signals that some sectors of the S&P 500 are slightly getting back on track, although the overall trend remains bearish. This can be also seen if we focus on our Sector Heat Map, as the momentum score of riskless money market remains unchanged.

Another reason why we are getting quite cautious right now is due to the fact that mid-term market breadth has also started to show some signs of exhaustion recently. First of all, the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) decreased once again for the week. Also the Upside-/Downside Volume Index Weekly and the Advance-/Decline Index Weekly weakened last week. As a matter of fact, their absolute bullish levels can be described as quite weak-kneed at the moment since they have not improved at all compared to last week. On top of that the Modified McClellan Oscillator Weekly also declined, which is another indication that the underlying tape momentum of the market is slowing down on a fast pace at the moment. Also the Advance-/Decline Line Daily and the Advance-/Decline Volume Line decreased last week. The only positive signal is coming from our Advance-/Decline Line Weekly which was holding up quite well last week. So from a pure mid-term oriented tape perspective, it looks like the market does not have enough power to show some strong bullish moves, whereas the downside potential of the market started to increase significantly! As a matter of fact, it looks like the market is heading into a make or break set-up within soon.

Long-Term Technical Condition

The long-term oriented trend of the market shows the same picture as in the previous weeks. The WSC Global Momentum Indicator is still trading at the lowest level possible (0%) and not shown any bullish moves so far. This is an indication that there are absolutely no local equity markets around the world (which are covered by our Global ETF Momentum Heat Map) which have managed to get back above their long-term oriented trend lines so far. Also our Global Futures Long Term Trend Index, which has been decreasing for weeks now, continued to drop. This fact is telling us that the long-term oriented trend of U.S. equities is quite damaged at the moment. While our WSC Global Relative Strength Index remained nearly unchanged compared to the previous week, it also reveals that the relative strength of all risky markets is trading far below the one from U.S. Treasuries. If we examine our long-term oriented tape indicators we can see that the Modified McClellan Volume Oscillator Weekly weakened while the SMA 200 and the High-/Low Index Weekly remained nearly unchanged.

Model Portfolios

Last week, there were no changes within the WSC All Weather Model Portfolio, the WSC Inflation Proof Retirement Portfolio, the WSC Dynamic Variance Portfolio and the WSC Sector Rotation Strategy.

Bottom Line

Despite the fact that the latest slow-down was somehow in-line with our expectations, the deterioration within our tape indicators turned out to be a quite strong surprise. Especially, the weaker readings within our short-term oriented tape indicators in combination with a weaker Global Futures Trend Index are indicating some form of a stronger exhaustion (although the market just trades in the middle of its trading range). As a matter of fact, there is a very high chance that the current consolidation period will turn out to be corrective in its nature. That does not necessarily means that we see a stronger correction immediately, but the downside risks are definitely increasing on a fast pace. On the other hand, there are still some small positive signals on the contrarian side, which do not fit into the puzzle right now. In fact, a final large cap driven overshoot can also not be ruled out, before further troubles might be due. Nevertheless, we think it is time to get a more cautious view. This corrective base case scenario remains in place as long as we do not see any improvements within our indictor framework. But before we issue a final strategic sell signal, we would like to see some negative price actions first. Hence, we think it would make sense for conservative investors to adjust their stop-loss limit at 2,780 (intra-day) basis, whereas aggressive traders should focus on the short-side again if we see a break in our short-term oriented trend indicators

Stay tuned!