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December 9th 2018

Market Review

U.S. stocks finished the shortened week with deep losses. The Dow Jones Industrial Average slumped 4.5 percent over the week to 24,388.95. The S&P 500 retreated 4.6 percent for the week to finish at 2,633.08. The Nasdaq tumbled 4.9 percent for the week to finish at 6,969.25. It was the biggest weekly percentage decline for all three benchmarks since March, while also marking the worst start to a December since 2008. The slump pushed the S&P 500 and Dow Jones Industrial Average back into negative territory for 2018, while the Nasdaq is clinging to a 1 percent year-to-date gain. Most key S&P sectors ended in negative territory for the week, led by financials. Materials were the only advancers. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, closed near 23.2.

Strategy Review

In our last week’s market comment, we highlighted the fact that the market had successfully entered the fifth step of our projected path (low quality market top -> correction -> bounce -> re-test -> year-end rally = bull-trap -> bear market).  Consequently, we expected that the latest rally should definitely turn out to be corrective in its nature rather than being the start of a new and sustainable uptrend (as the overall technical condition of the market had looked outright grim). As such a corrective counter-trend rally could just last several days or even weeks (and as things could change quickly during the week), we said that our members should keep a close eye on our short-term oriented indicators since they would tell us when to finally pull the trigger from a strategic point of view. In fact, two out of our three short-term oriented trend indicators turned already bearish on Tuesday and additionally, short-term oriented market breadth showed also stronger signs of exhaustion on that day. Not surprisingly, what followed was a stronger sell-off that pushed major indexes slightly above to their first correction low in early October. Consequently, the market has now entered the final stage within our projected path. Worth mentioning is the fact, that the latest stage of such a cycle tends to be a quite tricky one, as the way down is often accompanied by stronger but corrective counter-trend rallies and is, therefore, not a one way street. As a matter of fact, our short-term oriented indicator framework is now key area of focus.

Short-Term Technical Condition

As already mentioned above, the short-term oriented trend of the market turned bearish on Tuesday and continued to deepen during the rest of the week. At the end of the week, the S&P 500 closed 57 points below the bearish threshold from the Trend Trader Index. Consequently, the short-term oriented price trend of the market remains bearish as long as the S&P 500 does not close above 2,734 (upper threshold from the Trend Trader Index). Also from a pure structural point of view, the short-term oriented price trend of the market was broken, as both envelope lines of the Trend Trader Index started to decrease on a fast pace. The situation looks similar if we analyze the underlying momentum of this short-term oriented price trend. The Advance-/Decline 20 Day Momentum Indicator also turned bearish on Tuesday and continued to plunge further into bearish territory last week. Only the Modified MACD still remains bullish from a pure formal point of view and has, therefore, not fully confirmed the magnitude of the latest decline. Basically, the same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator as its gauge was holding up quite well compared to mid-October (when the S&P 500 was trading at similar levels). So despite the fact that the market remains quite short-biased at the moment, another stronger but corrective bounce looks quite possible.

This view is also widely confirmed by our entire short-term oriented market breadth indicators. Despite the fact that the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily are about to flash a bearish crossover signal soon, they were holding up quite well, if we consider the magnitude of the latest decline. Moreover, the absolute levels from both indicators are much higher compared to the latest two re-tests we saw in mid-October and late November. This indicates that the underlying momentum and volume of advancing stocks on NYSE remains outright weak-kneed but were holding up quite well in relative terms. This picture is also confirmed by the NYSE New HighsNew Lows Indicator. On Thursday it showed the strongest peak for months in the number of new lows and has, therefore, confirmed the price action of the market. The case was different on Friday. The S&P 500 plunged for another 2 percent, but the number of new lows was much lower compared to the day before and compared to mid-October. Consequently, the High-/Low-Index Daily rocketed to outright bearish levels but did not reach similar levels like in mid-October or late-November. So despite the fact that the latest decline was driven by the whole market, the magnitude of the latest sell-off was not fully confirmed by the broad market! As a matter of fact, it was also not a big surprise that the percentage of stocks which are trading above their short-term oriented moving averages (20/50) did not reach a new low, although they slumped for the week. So given the outright bearish readings within our short-term oriented tape indicators, together with quite positive divergences (in relative terms), we think the chances are quite high to see another stronger but corrective counter-trend rally within the next couple of days.

This scenario looks also quite possible from a pure contrarian point of view. The market is quite oversold (Advance-/Decline Ratio Daily) and we additionally saw a 9-to-1 day on Friday. This indicates a strong wash-out day, which often acts as basis for another rally attempt. Another positive factor is coming from a pure cyclical point of view. According to our monthly cycles (average performance from the Dow Jones Industrial Average since 1896), the market often hits its monthly low around the 10th of December. Afterwards, the market tends to be quite bullish biased until the end of December. Another supporting fact is that the WSC Capitulation Index did not confirm the latest sell-off and, therefore, another but corrective rally attempt looks quite likely.

Mid-Term Technical Condition

The main reason, why we believe that any upcoming bounce should just turn out to be corrective in its nature is due to the fact that the mid-term oriented condition of the market also weakened significantly last week. The gauge from the Global Futures Trend Index is trading clearly in the bearish area at only 14 percent and has, as a consequence, clearly confirmed the latest sell-off from the S&P 500 (from a strategic point of view). Moreover, we can say that the current correction cycle will be definitely not over as long as its gauge remains far below its outright bearish 60 percent threshold. Also from a pure price point of view, the mid-term oriented uptrend of the market deteriorated, as the WSC Sector Momentum Indicator continued to drop and touched the threshold to the bearish area. According to our Sector Heat Map, right now only outright defensive sectors (which should outperform during a bear market) are outperforming riskless money market on a relative basis. This picture fits quite well to the the pure cyclical point of view and confirms our base scenario that the market has now entered the fifth and final stage of our projected path.

Another confirmative signal for our bear market call is the fact that our entire mid-term oriented breadth indicators continued to deteriorate last week. Especially, our Modified McClellan Oscillator Weekly gained more bearish ground and also the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) dropped to their lowest level for weeks (100) or even years (150). This indicates that the underlying trend momentum of the market is outright bearish, as most of all NYSE listed stocks are definitely not in an uptrend anymore. Another concerning signal is coming from the Advance-/Decline Index Weekly and from the Upside-/Downside Volume Index Weekly as both indicators reached their highest bearish levels for years. This indicates that a lot of purchasing power was pulled out of the market last week. In addition, our entire advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line in Percent, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line) dropped last week and, therefore, we expect to see further pain on a mid-term time horizon.

Long-Term Technical Condition

On a very long-time frame, the technical picture of the market also continued to weaken (which is in-line with our strategic outlook). Dropping to 5 percent, our WSC Global Momentum Indicator reached its lowest reading for years. This is telling us that nearly zero 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 lines. This is a clear signal that the global bull market has come to an end! In addition, also our Global Futures Long Term Trend Index also gained more bearish ground. Our WSC Global Relative Strength Index, in contrast, showed some small improvements, but still the relative strength of nearly all risky markets is trading well below the one from U.S. Treasuries. This is another indication for a risk-off market environment. Also our long-term oriented tape indicators (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly, percentage of stocks which are trading above their 200 day moving average) had to take a hard hit last week and reached their worst levels for months. This is another piece of evidence that the market looks vulnerable for further (and stronger) disappointments on a mid- to long-term time horizon.

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 All Weather Portfolio, the Inflation Proof Retirement Portfolio and the WSC Global Tactical ETF Model. As the underlying risk management indicator (WSC Sector Momentum Indicator) of the WSC Sector Rotation Strategy turned bearish, the portfolio is switching into its predefined bear-market allocation. This view is widely in line with our current outlook.

Bottom Line

The market has now successfully entered the final stage of our predicted path and, therefore, any upcoming bounce/rally should turn out to be a bear-market rally instead of being the start of a new and sustainable uptrend. This case scenario will be unchanged as long as we do not see a significant recovery within our mid-term oriented indicator framework. Consequently, we remain bearish from a pure strategic point of view. However, on a very short-time frame, another stronger but corrective rally attempt looks quite likely, as the latest decline was not fully confirmed by our short-term oriented indicator framework. As a matter of fact, we would advise our conservative members (who did not have the time to close their position last week) not to get out of the market immediately on Monday morning. The best approach is to place a stop-loss order at 2,595 (just in case if we do not see the expected technical bounce). If we see a stronger bounce, we would advise them to sell their positions step by step into the rally as the market looks quite capped on the upside. Conservative members who sold last week should remain on the side-line, although we might see another stronger bounce towards the year-end.

Stay tuned!