November 1st 2020

Market Review

All three major U.S. averages finished the week with steep losses. The Dow Jones Industrial Average lost 6.5% over the week to close at 26,501.60. The S&P 500 lost 5.6% for the week to finish at 3,269.96. The Nasdaq fell 5.0 percent over that time period to end at 10,911.59. All key S&P sectors ended lower for the week, led by the discretionary sector. The Chicago Board Options Exchange Volatility Index, the gauge of S&P 500 options prices known as the VIX, jumped to 37.6.

Strategy Review

It was a tough week as U.S. equities faced their biggest weekly decline since March. Despite the fact that we expected some form of increased sentiment driven washout days and/or volatility to dampen short-term optimism, the magnitude of the recent decline turned out to be surprisingly strong. Normally, these sentiment driven washout events are important catalyst as they relieve overbought conditions and dampen short-term optimism, which is then often the basis for further growth. However, the recent decline was definitely far above average in terms of price and time, plus we additionally saw a stronger deterioration within our entire indicator framework during the whole week. Consequently, the big question is if the recent sell-off was just an exaggerated version of such a sentiment event or if it was just the beginning of a stronger correction?

Short-Term Technical Condition

Not surprisingly, the short-term oriented price trend of the market clearly turned bearish last week. The the S&P 500 closed 97 points below the bearish threshold from the Trend Trader Index, after dropping below its bearish threshold already on Monday. In addition both envelope lines from this indicator started to form a rounding top and started to decrease. This shows that – from a pure price point of view – the chances for a V-shaped recovery remains quite limited since the underlying price trend looks quite bearish at the moment. Additionally, this negative price trend is also supported by the fact that the Modified MACD widened its bearish gap during the whole week. Basically, the same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator, which dropped into the negative territory and has, thus, clearly confirmed the latest price action of the S&P 500. Although these signals look quite grim at the first sight, we can also identify some positive divergences in the Modified MACD and the Advance-/Decline 20 Day Momentum Indicator. Both indicators where holing up quite well if we compare their current readings with those at the end of September, when the S&P 500 fell towards similar levels. Moreover, it is not quite unusual to see bearish signals within  our short-term oriented trend indicators during stronger washout-events. As a matter of fact, short- to mid-term market breadth is a key area of focus to evaluate the odds that the recent sell-off was just a limited sentiment event or if it has the power to transform into a more significant correction.

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 and dropped fully into the bearish territory (especially the 20 SMA). This shows a stronger deterioration within the broad market, since most stocks are now per definition already in a short-term oriented price driven down-trend. Additionally, the short-term oriented momentum of this broad based down-trend also turned strongly negative. 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 20 stocks reaching a new yearly high and only 64 stocks reaching a new yearly low on Friday. This is quite a small number if we consider that the broad index lost more than 5% for the week. Normally, we would expect to see numbers around 100 to 150. Hence, the High-/Low-Index Daily was holding up quite well under these circumstances, although it flashed a small bearish crossover signal. In addition, we could also see some bullish divergences since the negative readings in the Upside-/Downside Volume Index Daily, SMA 20/50 and the Modified McClellan Volume Oscillator Daily are definitely stronger than those we have seen at the end of September when the S&P 500 was trading at similar levels. So all in all, we have received minor ingredients for a bottom building process. Nevertheless, these signals are still a bit too weak-kneed to be taken too seriously at the moment. Therefore, further confirmation is needed since the market internals still look quite bearish from a pure signal point of view. As long as this is the case, the chances for a sustainable trend-reversal remain low.

On the contrarian side, we can see that the market is quite oversold (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) and, therefore, some form of short-term bounce/stabilization is highly likely. Moreover, we can see that the recent decline dampened short-term optimism considerably since most of our option based indictors (Daily Put-/Call Ratio All CBOE Options Indicator, WSC Put-/Volume Ratio, WSC Dumb Money Indicator) have finally turned neutral. We even saw some minor bullish signals here as well (Equity Options Call-/Put Ratio Oscillator and the AII CBOE Call-/Put Ratio Oscillator) which is not a big surprise given the magnitude of the recent decline. These are definitely the first typical ingredients for a bottom building process. Another positive ingredient is coming from the seasonal side (Presidential Cycle) as the market often faces stronger tailwinds in November after a quite negative time period from September to October. Interestingly, we have not seen a strong spike in the number of bears yet. Therefore, it could be possible to see some support here as well. However, on the other side we can also see that the WSC Capitulation is still rising, indicating that the recent selling cycle is not over yet. Basically the same is true if we focus on the Smart Money Flow Index which shows that the big guys are betting on further major troubles down the road. From a pure contrarian point of view, the ingredients for some kind of stabilization are definitely increasing as we saw first signs of fear in the market. Nevertheless, we are still a bit early in that stage since some signals could be definitely stronger in their nature.

Mid-Term Technical Condition

Probably, the most concerning fact at the moment is that the mid-term oriented condition of the market also deteriorated significantly during the last week. This is mainly because the gauge from the Global Futures Trend Index dropped almost 24 percentage points for the week and closed at 57%. This is already in the bearish consolidation area and below the very important threshold of 60%. In such a case, the technical condition of the market is quite fragile as the risk of further disappointments is definitely increased: of course only in combination with weak or bearish readings in mid-term oriented market breadth. As this is already the case, it is definitely time to get a bit a cautious stance – even if we see some form of stabilization ahead. Because from a pure technical point of view, the market remains now short-biased as long as the gauge of this indicator remains below 60%, or more importantly, is not showing any signs of bottoming out. So even if we see some form of bounce ahead, a sustainable recovery is only possible if this indictor is getting back on track. On the other hand side, we can see that the price driven mid-term oriented price-driven uptrend has not been broken yet since the WSC Sector Momentum Indicator still remains quite bullish for the time being. This is a quite supportive fact for the time being. This can be also seen if we focus on our Sector Heat Map as the momentum score of riskless money market just rose 3 percentage points for the week.

Another reason to be alert is due to the fact that mid-term oriented market breadth also deteriorated significantly last week. As a matter of fact, the latest decline was more than just a sentiment driven washout event. Especially, our Modified McClellan Oscillator Weekly rolled over into bearish territory last week and also the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) dropped and closed slightly below their bullish threshold (100). This indicates that the underlying trend momentum of the market can be now described as quite weak-kneed. Nevertheless, it was also good to see that the SMA 150 was holding up quite well, plus both indicators have definitely formed some kind of bullish divergence (if we compare their current readings with those they had in end of September). However, the most concerning signal is coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly as both indicators slightly turned bearish last week. This indicates that a lot of purchasing power was pulled out of the market last week and, therefore, the market internals have now a bearish tilt. As long this is the case, we do not believe that the market has enough power to trigger a fast paced trend-reversal. Consequently, the upside potential looks quite capped at the moment.

Long-Term Technical Condition

On a very long-time frame, the technical picture of the market remains bullish at the moment and, therefore, we do not think that the current sell-off does lead to a new bear market for the time being. The WSC Global Momentum is still trading in bullish territory and indicates that 54 percent of 35 local equity markets all around the world (which are covered from our Global ETF Momentum Heat Map) are still in a long-term oriented up-trend at the moment. Moreover, it was good to see that the readings from the Global Futures Long Term Trend Index also showed some solid levels last week. This can be also monitored if we focus on the Global Relative Strength Index, as the relative strength of all risky markets keeps trading far above the one from U.S. Treasuries. Nevertheless, we can also see some exhaustion in long-term market breadth, as the readings from our entire long-term oriented tape indicators (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stocks which are trading above their 200 day moving average) weakened last week. This might be another piece of evidence that the market looks vulnerable on a short- to mid-term time horizon.

Model Portfolios

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.

Bottom Line

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 consider the quite weak but still somehow supportive signals, the latest decline can be still categorized as an extreme washout-event although it also has caused a lot of technical damage. 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. Nevertheless, its gauge is also not far away from hitting its bearish section. Thus, the recent sell-off has still the potential to transform into a more significant correction, especially when we see further deterioration within our indicator framework. This could happen literally in days, although for now the situation still looks somehow supportive. Consequently, before we issue a strategic sell-signal we would like to see some negative price action first. Therefore, we would advise our members to place a stop-loss limit at 3,190 (intra-day level). This stop loss limit should be in place until our indicator framework turns positive again. Aggressive traders should be flexible in such a volatile market environment by monitoring our short-term oriented indicators quite closely in the next couple of days (for the overall direction). Moreover, it would make sense to play extreme moves contrarian as we expect volatility to remain high.

Stay tuned!