February 07. 2016

Market Review

U.S. stocks finished the week in negative territory. For the week, the Dow Jones Industrial Average slid 1.6 percent to 16,204.97; the largest drop in three weeks. The S&P 500 finished at 1,880.05 and posted a weekly drop of 3.1 percent, also its largest in about a month. The Nasdaq dropped 5.4 percent from the week-ago close to 4,363.14. This was also the largest drop in a month. Most key S&P sectors finished in the red for the week, led by technology. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, finished above 23.

Strategy Review

In our last week’s comment, we highlighted the fact that any upcoming strength should only be seen as a corrective bounce (bull-trap) rather than the start of a new sustainable uptrend. This was mainly due to the fact that we received a lot of technical evidences that the market would follow a typical bottom building process. Therefore, we still expected to see another significant down-leg towards the latest correction low at 1,815 or even a break of that important threshold. Consequently, we advised our aggressive traders not to buy any upcoming rebound (or to use close stops) as we expected to see further strong selling pressure ahead. In fact, after the S&P 500 had bounced towards 1,946 on Monday afternoon, further significant downswings dominated the rest of the week. More importantly, after the S&P 500 had fallen below 1,900, it exactly reached our first suggested price target of 1,881.

So in the end, the market follows a typical textbook like stabilization/bottom-building phase and, therefore, it is extremely important to monitor the recent down-leg quite carefully as it would give us further guidance where the market is heading! To be more precise, if the current down-leg/retest will be accompanied with positive divergences in market breadth (shrinking downside volume/declining issues, decreasing new lows, increased tape momentum and fewer stocks below their moving averages ?) in combination with supportive buy signals within our contrarian indicators, we have the final confirmation for an important bottom. Otherwise further renewed waterfall declines can be expected!

Short-Term Technical Condition

If we focus on our short-term oriented trend indicators, we can see that S&P 500 closed 41 points below the bullish threshold from the Trend Trader Index. So from a pure price point of view, the short-term oriented trend of the market remains bearish biased as long as the S&P 500 does not manage to close above 1,921 (upper envelope line from the Trend Trader Index). Above all we can see that both envelope lines of this reliable indicator have not shown any major signs of stabilization yet, which is a typical technical pattern for a strong short-term oriented down-trend. This view is also widely confirmed by the Advance-/Decline 20 Day Momentum as its gauge did not manage to pass its bullish threshold so far and, therefore, further down-testing towards the latest correction low looks quite likely. On the other hand, we can also see that the Modified MACD remains outright bullish, although the S&P 500 lost more than 3 percent for the week. This can be definitely interpreted as quite bullish divergence for the time being as extreme heavy losses would be necessary to bring this short-term oriented gauge back to its former low! Above all, we can see that the bearish gauge from the Advance-/Decline 20 Day Momentum did not confirm the latest sell-off as it has shown strong signs of positive momentum recently. So all in all, the positive divergences within our short-term oriented trend indicators are increasing, although the overall short-term trend structure of the market remains quite bearish biased.

Basically, the same is true if we focus on our short-term oriented breadth indicators. Given the fact that the market finished the week in outright negative territory, the development within the readings of our short-term oriented breadth indicators could have been definitely worse. This becomes quite obvious if we focus on the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as their bullish readings strengthened for the week. This indicates that the underlying tape momentum of the broad market still remains quite supportive for the time being. Moreover, it tells us that the recent down-leg was mainly driven by the latest tech-rout rather than by the broad market. This can be also seen if we focus on the percentage of stockss which are trading above their short-term oriented moving averages (20/50), as both indicators finished the week on a higher note. Another positive sign is coming from the NYSE New HighsNew Lows Indicator, as there were only 160 new lows on Friday. The last time the S&P 500 dropped to similar levels (in mid-January), we saw more than 500 new lows. Above all, we can see that the total amount of new highs have also started to show some strength recently. As a matter of fact, the High-/Low Index Daily continued to narrow its bearish gap, which can be also seen as quite positive signal (given the current circumstances).

From a pure contrarian point of view, a lot of the bad news has been already priced in. This is mainly due to the fact that market sentiment remains outright negative, whereas the option market got back to normal levels. Moreover we can see that the CBOE Volatility Index stayed well below its previous high (in mid-January), although the market dropped to similar levels. Furthermore, it was good to see that the WSC Capitulation Index dropped back into bullish territory last week, whereas the WallStreetCourier Index remains supportive. On top of that, we can also see that smart money has started to build up positions again, which can be interpreted as another quite strong bullish signal for contrarians.

Mid-Term Technical Condition

Unfortunately, on a mid-term time horizon, the technical condition of the market still looks quite vulnerable at the moment. This is mainly due to the fact that the gauge from the Global Futures Trend Index has not managed to pass its bullish 60 percent threshold yet! As already mentioned a couple of times, from a formal point of view, the current correction cycle will not be over as long as its gauge keeps trading below that important threshold! Nevertheless, its gauge has shown a strong form of momentum recently as it climbed to almost 40 percent last week and has, therefore, formed a quite bullish divergence as well! If this trend continues it might be just a question of time until we receive a bullish signal within that indicator. Above all, this signal is also telling us that the recent down-leg from the S&P 500 does not look quite powerful as well. Consequently, the chances that the market has entered the final stage of its bottom process are increasing as well. Nonetheless, from a pure price point of view, the market still remains in a mid-term oriented down-trend as the WSC Sector Momentum Indicator has not turned bullish yet. This is telling us that the momentum score of most sectors within the S&P 500 keep trading below the momentum score of riskless money market within our Sector Heat Map. In such a scenario, most sectors tend to underperform riskless money market. As a matter of fact, it was good to see that the indictor showed some signs of stabilization last week, although the market dropped almost towards a new low.

Despite the fact that the positive divergences are increasing, we can see that mid-term oriented market breadth remains quite weak-kneed at the moment. This is mainly due to the fact that our entire mid-term oriented tape indicators remain outright bearish and have, therefore, not shown any signs of bullish divergences yet. Especially, the Modified McClellan Oscillator Weekly kept trading at quite low levels, signaling that the overall mid-term oriented tape momentum remains outright weak at the moment. This can be also observed if we focus on the percentages of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150). Both indicators are telling us that there was still no recovery within the broad market so far as most NYSE listed stocks remain in a strong mid-term oriented down-trend at the moment. Another concerning tape signal is coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly, as their bearish signals remain quite persistence. As a matter of fact both indicators are, therefore, trading at quite bearish levels and, therefore, the risk for further disappointments is still given.

Long-Term Technical Condition

On a long-term horizon, the situation remains almost unchanged compared to last week. The Global Futures Long Term Trend Index slightly strengthened its bearish signal last week, indicating that the US equities remain in an extremely risk-off environment at the moment. This can be also seen if we focus on the WSC Global Momentum Indicator as only 10 percent of all local market indexes around the world are still in a long-term oriented up-trend at the moment. However, given the fact that we saw almost a new low on Friday, it was good to see that the readings of that indicator where holding up quite well. Nevertheless, we can see that the relative strength of all risky markets kept trading far below the one from U.S. Treasuries and, therefore, the market remains in a risk-off mode at the moment. Above all, we can see that long-term oriented market breadth has also not shown any signs of bullish divergences yet. As per last week’s report, the Modified McClellan Volume Oscillator Weekly continued to gain more bearish ground, whereas the percentage of stockss which are trading above their long-term simple moving averages and the High-/Low Index Weekly are far away from being supportive.

Bottom Line

So in all in all, the bullish divergences within our short-term oriented indicator framework are increasing and, therefore, the ingredients for a typical (ultimate) bottom are cumulating as well. Nonetheless, we should not forget that the readings from most of our short-term oriented indicators are still bearish from a pure signal point of view. So even if the market hits a final low within the next couple of days, we would like to see at least some further improvements/bullish signals within our indicator framework (especially within the Global Futures Trend Index), before we would advise our conservative members to get back into the market again. This ensures that the overall risk-/reward ratio of such a bet remains attractive. Moreover, we are still more than 10 percent ahead of the curve (as we side-stepped the current correction) and, therefore, we have still enough risk budget available. From a pure trading perspective, a break of the S&P 500 above 1,900 would give way towards 1,920 and worst case towards 1,950. On the other hand, a break below 1,870 would call for further down-testing towards 1,845, whereas a break of that level would give way towards the latest correction low. So in this context we would advise our aggressive traders to use extremely close stops. Stay tuned!