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August 20th 2017

Market Review

U.S. stocks finished another week with losses. The Dow Jones Industrial Average lost 0.8 percent over the week to 21,674.51. The S&P 500 booked a weekly loss of 0.7 percent to close at 2,425.55. Both the Dow and the S&P 500 finished Friday for a second week of losses, with the Dow suffering its largest two-week percentage decline since mid-September 2016. The Nasdaq declined 0.6 percent for the week to end at 6,216.53. Friday marked the fourth week of losses for the Nasdaq, its longest weekly losing streak since May 2016. Most key S&P sectors ended in negative territory for the week, led once again by energy. Utilities, consumer staples and materials were the only gainers. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 14.3.

Strategy Review

In our last week’s comment we highlighted the fact that we remained outright cautious at the moment as we had received a growing number of evidences that the market reached an important top. Moreover we said that even if we would not see a correction immediately, we have not expected to see any sustainable gains ahead given the outright weak readings all across the board. On top of that we mentioned that as long as our entire indicator framework (especially on a mid-term time horizon) did not turn bullish again, we remain bearish as the current risk-/reward ratio remained too low. In fact, stocks posted their worst trading session since May on Thursday and also ended down for the week.

Short-Term Technical Condition

Consequently, the market is moving right in line with our recent outlook as the short-term down-trend of the market remains well in force and even gained more bearish ground last week. From a pure price point of view, we can see that the S&P 500 closed 35 points below the bearish threshold from the Trend Trader Index. Furthermore, we can see that both envelope lines of this reliable indicator formed a bearish rounding top and have started to decrease. This is telling us that within the past 20 days we saw lower highs and lower lows, which is another typical technical pattern for a strong short-term oriented down-trend. The same is true if we focus on the Modified MACD, which continued to gain more negative ground last week and additionally shows a widening gap. This indicates that further selling pressure on a very short-time frame looks quite likely. Another reason of concern is the fact that the gauge from the Advance-/Decline 20 Day Momentum Indicator remains in a bearish free fall and even dropped to the lowest level for months. As this indicator tends to be a leading one, its non-confirmation to the current levels of the S&P 500 is another indication that major troubles might be due soon.

More importantly, this negative view is also strongly confirmed by short-term market breadth and therefore, further selling pressure is highly likely. Especially, the short-term gauges from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily are telling us that the underlying tape momentum of the market remains extremely damaged. In other words, right now the number of declining volume and issues on NYSE are outpacing their bullish counterparts. With such weak readings, it would be a bit too early to bet on a stronger trend-reversal for the time being. This picture is widely confirmed by the NYSE New HighsNew Lows Indicator, as we have seen a pretty strong and confirmative spike in the amount of new lows, whereas the amount of new highs remains outright depressed! As a matter of fact, the High-/Low-Index widened its bearish gap, which is another proof of evidence for our pullback scenario. The same is true if we focus on the percentage of stocks which are trading above their short-term oriented moving averages (20/50). Both indicators (20/50) continued to deteriorate for the week and are therefore, trading at their lowest levels for months. This is telling us that the majority of all NYSE listed stocks are in a short-term oriented down-trend at the moment. So the main reason why we have not seen a stronger pullback yet, is due to the fact that large caps are still holding up quite well. However, such a situation can never be sustainable in the long run and therefore, we remain outright cautious as long as we do not see a significant improvement within the overall tape structure.

On the contrarian side, we can see that the informed crowd continued to reduce their equity exposure as the Smart Money Flow Index dropped significantly for the week and is therefore, increasing its bearish gap towards the Dow. This signal is basically in line with our general outlook. Another concerning fact is that the gauge from the WSC Capitulation Index spiked significantly for the week and is therefore, now showing a risk-off market environment. Basically, as long as we do not see a drop from this gauge by half of its risk, the overall market environment should remain challenging. Above all, we can see that the market is also facing cyclical headwinds as the Presidential Cycle indicates a major top in August! The only positive impulse is coming from the option market as the amount of puts soared (Global Futures Put-/Volume Ratio Oscillator and the Equity Options Call-/Put Ratio Oscillator). However, given the fact that the next option expiring date is in mid-September, we take those signals not too seriously at the moment.

Mid-Term Technical Condition

In line with our expectation, the mid-term oriented condition of the market also continued to deteriorate significantly last week. This is due to the fact that the gauge from the Global Futures Trend Index plummeted 21 percentage points into the middle part of the bearish consolidation area and has therefore, also reached the lowest level for months. As already mentioned a couple of times, from a formal point of view, the market remains highly at risk for a stronger correction as long as its gauge keeps trading below that important threshold! However, from a pure price point of view, the mid-term oriented uptrend of the market still remains intact as we have not seen a stronger pullback so far. Consequently, the WSC Sector Momentum Indicator still keeps trading in bullish territory. This indicates that most sectors within the S&P 500 are per definition still in a mid-term oriented up-trend. This can be also seen if we focus on our Sector Heat Map as the momentum score from the S&P 500 keeps trading above the one from riskless money market. Nevertheless, we can see that the momentum score of riskless money market has also increased within the last weeks, which is another major red flag at the horizon.

As per last week’s report, another major threat remains the current condition of mid-term oriented market breadth. There we can see that the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) dropped to the lowest level for months. On top of that we can see that the Modified McClellan Oscillator Weekly also widened its bearish gap last week, which is another indication for an outright weak tape momentum at the moment. In such a situation, we would be extremely surprised to see stronger (sustainable) gains ahead. Another outright concerning tape signal is coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly, as their bearish signals strengthened for the week. In the past, bearish readings within both indicators (together with a Global Futures Trend Index score below 60 percent) were mostly a reliable predictor for a stronger correction. So all in all, we have again a deteriorating tape structure all across the board and therefore, we received further evidences that the market has hit an important top recently. So even if we do not see a stronger pullback immediately, with such weak readings all across the board, there is absolutely no upside potential left as well. As a matter of fact we remain extremely cautious!

Long-Term Technical Condition

The long-term oriented uptrend of the market remains unchanged and therefore, we do not think that a stronger correction should lead to a new bear market at the moment. This is mainly due to the fact that the WSC Global Momentum increased in the last week and now indicates that 92 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. Also the readings from the Global Futures Long Term Trend Index still show solid levels. This can be also observed if we focus on the Global Relative Strength Index, as the relative strength of all risky markets (except commodities) keeps trading far above the one from U.S. Treasuries. However, we can also observe 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) again weakened last week. As already pointed out last week, this might be another piece of evidence that the market looks vulnerable on a short- to mid-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 Inflation Proof Retirement Portfolio and the WSC All Weather Portfolio. As the momentum score of utilities rose above average and above the one from the S&P 500 within our Sector Heat Map, we received a buy sell signal for that ETF within our WSC Sector Rotation Strategy and therefore, the portfolio is getting a more defensive in its nature. As the MSCI France dropped out among the top 10 markets within our Global ETF Momentum Heat Map, we received a sell signal for that specific ETF. On the other hand, as the MSCI Turkey now ranked within the top 5 markets within our Global ETF Momentum Heat Map, it is now being added to the portfolio.

Bottom Line

The situation remains unchanged compared to last week. Although the market only trades a few percentages below its all-time high, we remain outright cautious at the moment! This is due to the fact that the technical condition of the market looks quite damaged and therefore, the market is highly at risk for a stronger pullback at the moment. The main reason, why we have not seen any stronger losses so far is the fact that large-caps are still holding up quite well. So even though we might not see a stronger selling pressure immediately, we would be quite surprised to see sustainable gains ahead with such a weak readings all across the board. Consequently, any upcoming (large-cap driven) bounce should be limited in price and time. As a matter of fact, we would advise our conservative members to remain at the sideline as the current risk-/reward ratio is a way too low at the moment. As Aggressive traders should remain short as we are expecting a test of the next resistance level at 2,400.

Stay tuned!