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October 21th 2018

Market Review

U.S. stocks finished the week with a mixed performance. For the week, the Dow Jones Industrial Average gained 0.4 percent to close at 25,444.34; its first weekly gain in four. The S&P 500 finished the week nearly unchanged at 2,767.78. The Nasdaq dropped 0.6 percent for the week to end at 7,449.03. The Dow Jones Industrial Average and S&P 500 have fallen more than 3 percent each in October, while the Nasdaq is down more than 7 percent. Among the key S&P sectors, consumer staples was the top performer and energy the worst. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded lower, near 19.9.

Strategy Review

In our last week’s comment, we highlighted the fact that any upcoming strength should not be sustainable in its nature, as we had not received any signs for a typical bottom building process within our indicator framework back then. Consequently, we advised our members not to buy into any upcoming rebound, as we expected further selling pressure ahead. In fact, after the S&P 500 strongly bounced towards 2,816 until Wednesday, further down testing dominated the rest of the week. As a matter of fact, the S&P 500 managed to close nearly unchanged for the week. However, the big question is if we have seen the worst already or if another correction leg into Q4 can be expected?

Short-Term Technical Condition

Not surprisingly, the short-term down-trend of the market remains well in force and has not shown any signs of stabilization so far. From a pure price point of view, we can see that the S&P 500 closed 74 points below the bearish threshold from the Trend Trader Index. Additionally, both envelope lines of the Trend Trader Index are dropping on a quite fast pace. 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. In this context, the S&P 500 is extremely far away from getting back into a short-term oriented price driven uptrend. The same is true if we focus on the Modified MACD, which remains in a bearish free fall and reached the lowest level for months and has, therefore, not shown any positive divergences so far. Another reason why it might be too early to call for a bottom is the fact that the gauge from the Advance-/Decline 20 Day Momentum Indicator plummeted to the lowest level for months. As this indicator tends to be a leading one, its non-confirmation would be the first indication that a major trend-reversal might be due.

This picture is confirmed by our entire short-term oriented market breadth indicators. The short-term gauges from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily continued their bearish rides and plummeted once again to their lowest levels for months. This signals that the underlying momentum and volume of advancing stocks on NYSE literally collapsed. With such weak readings, it is quite unlikely that any upcoming bounce would lead to a major and sustainable trend-reversal. Another interesting fact is that we did not see any signs of a stronger recovery within those two indicators at the beginning of the week, although the S&P 500 managed to rally almost 1.6 percent until Wednesday. Therefore, the recent sell-off on the following day was quite obvious too. Moreover, the NYSE New HighsNew Lows Indicator, showed again a strong spike in the number of new lows, whereas we hardly saw any increase in the number of new yearly highs (not even at the beginning of the week). Consequently, the chances for a healthy (and sustainable) rebound are extremely low at the moment (as a strong reduction in new lows, in combination with further down-testing would be the first sign for a sustainable bottom). This can be also seen if we focus on the High-/Low Index Daily, as its bearish gauge keeps trading at outright bearish levels and, therefore, we would not expect to see a V-shaped recovery. Also the percentage of stocks which are trading above their short-term oriented moving averages (20/50) are still trading at the lowest levels for months. To be more precise, only 9/14 percent of all NYSE listed stocks are trading above their 20/50 days moving average!

From a pure contrarian point of view, a longer-lasting consolidation period into mid-November looks quite possible. This is mainly due to the fact that most of our option based indicators (All CBOE Options Call-/Put Ratio Daily, All CBOE Options Call-/Put Ratio Oscillator and the Equity Options Call-/Put Ratio Oscillator Weekly) grew into quite bullish territory last week. This indicates a lot of hedging activity, which is a quite bullish signal on a short-term time perspective. Apart from these facts, the picture on the contrarian side looks quite grim. The Smart Money Flow Index clearly confirmed the sell-off from last week and even indicates that the current correction could easily turn out to be much stronger in its nature. Another concerning fact is that the WSC Capitulation Index has not shown any signs of weaknesses so far. So from a pure contrarian point of view, it looks like that the worst is not over yet (although further bouncing into late October cannot be ruled out).

Mid-Term Technical Condition

Moreover, the mid-term oriented trend-condition of the market is also far away from showing any signs of bullish divergences at the moment and, therefore, we remain outright bearish for the time being. This is mainly due to the fact that the gauge from the Global Futures Trend Index plummeted to 7 percent – to the lowest level since January 2016. As already mentioned in our previous market comments, as long as we do not see any stronger upside-momentum in the gauge of this reliable indicator or at least some bullish divergences, any upcoming gains will definitely be corrective nature rather than the start of a new sustainable uptrend! Moreover, we can say that the current correction cycle will be definitely not over as long as its gauge remains far below its bearish 60 percent threshold. Also from a pure price point perspective, the mid-term oriented uptrend of the market deteriorated again, as the WSC Sector Momentum Indicator continued to drop. But still most sectors (42 percent) within the S&P 500 are outperforming riskless money market on a relative basis. Our Sector Heat Map indicates that the momentum score of riskless money market jumped to 28 percent (from 0 percent two weeks ago), which is another indication that it might be a bit too early to bet on a major trend-reversal at the moment.

More importantly, the current mid-term oriented tape condition of the market also continued to deteriorate a last week. Particularly, the Modified McClellan Oscillator Weekly widened its bearish gap last week, which is another indication for an outright weak tape momentum at the moment. Also our entire advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line in Percent, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line) have not shown any bullish moves recently. This can be also observed if we focus on the Advance-/Decline Index Weekly and the Upside-Downside Volume Index Weekly as both indicators have not shown any signs of a stronger recovery yet. On top of that the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) have not shown any strengths so far and stay at the lowest level for months. This indicates an outright damaged tape condition at the moment. As a matter of fact nearly all our mid-term oriented tape indicators are trading at outright bearish levels. In such a scenario, the market remains extremely vulnerable for further disappointments and thus, we think the current risk-/reward ratio is a way too low to act contrarian at the moment.

Long-Term Technical Condition

The long-term oriented trend of the market also weakened. The WSC Global Momentum Indicator dropped to the lowest level for years (10 percent). This is telling us that only 10 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. As already pointed out several times, this is a very clear indication that the current correction could easily turn out to be much stronger in its nature. In contrast, also our Global Futures Long Term Trend Index was holding up quite well and is trading in solid bullish territory. This signals that the long-term oriented trend of U.S. equities also started to stall on elevated levels. Our WSC Global Relative Strength Index shows that the relative strength of nearly all risky markets is trading below the one from U.S. Treasuries (which is another indication for a risk-off market environment). Once again, our long-term oriented tape indicators had to take a hard hit last week. The Modified McClellan Volume Oscillator Weekly and the High-/Low Index Weekly significantly widened their bearish gaps. And the percentage of stocks which are trading above their 200 day moving average dropped to lowest level for more than two years. In our opinion, this is another indication that the latest pullback was just the beginning of a longer-lasting correction cycle.

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 Global Tactical ETF Portfolio, WSC All Weather Portfolio and the WSC Inflation Proof Retirement Portfolio. As the momentum score of consumer discretionary fell below average and below the one from the S&P 500 within our Sector Heat Map, we received a sell signal for that ETF within our WSC Sector Rotation Strategy.

Bottom Line

The overall outlook remains almost unchanged compared to last week. In line with our recent call, the market is in the middle of a correction. Therefore, conservative members should keep staying on the sideline as the current risk-/reward ratio is too low at the moment to act contrarian. This is mainly due to the fact that we have not seen any major positive signals/divergences within our indicator framework yet to call for an important bottom at the moment. Nevertheless, from a pure contrarian point of view an oversold but corrective bounce or a longer-lasting consolidation period looks quite possible, before further down-testing can be expected. As a matter of fact, aggressive traders should sell into strength rather than chasing the market too aggressively on the upside.

Stay tuned!