September 18. 2016

Market Review

U.S. stocks finished the week in positive territory. The Dow Jones Industrial Average eked out a small weekly gain of 0.2 percent to close at 18,123.80. The S&P 500 recorded a weekly gain of 0.5 percent to end at 2,139.15. The Nasdaq climbed 2.3 percent for the week to 5,244.57. Among the key S&P sectors, technology led the gainers for the week, while energy slumped. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 15.4.

Strategy Review

After our members had successfully predicted/side-stepped the January correction, it was one of our key calls that 1,810 represented an important low, as our indicator framework was telling us that the market had definitely hit rock bottom. As a consequence, we advised our members to get back into the market quite quickly afterwards and since then our strategic bullish outlook has not been changed so far. However, the consolidation period which started almost six weeks ago, has pushed the S&P 500 down around 2.8 percent from its former multi-year high in mid-August. Normally, if the market is taking a healthy breather or remains within a consolidation period, market breadth should regain momentum and/or existing bearish divergences should be sorted out, helping the market to push higher afterwards. Two weeks ago, the readings of our short- to mid-term oriented breadth indicators remained quite supportive and, therefore, the ongoing consolidation period still looked quite healthy. Unfortunately, the technical condition of the market has changed quite fairly since then. This is mainly due to the fact that we saw a significant deterioration within our short- to mid-term indicator framework last week, although the S&P 500 gained 0.5 percent on a weekly basis. This indicates that the recent consolidation period could easily turn out to be more corrective in its nature and, therefore, it is time to get a more cautious stance.

Short-Term Technical Condition

Despite the fact that the S&P 500 finished the week on a higher note, the short-term trend structure of the market continued to deteriorate significantly last week. From a pure price point of view, the short-term oriented down-trend of the market remains well in place, as the S&P 500 closed 18 points below the bearish threshold from the Trend Trader Index. Furthermore we can see that both envelope lines of the Trend Trader Index formed a bearish rounding top last week, which is another piece of evidence that the recent consolidation period could easily turn out to be more corrective in its nature. This can be also seen, if we have a closer look at the Modified MACD. Both trend lines of that reliable indicator picked up even more bearish ground last week and remain in a free fall with a widening gap, indicating that more down-testing is quite likely. In addition, the gauge of the Advance-/Decline 20 Day Momentum Indicator broke below its bullish threshold on Friday and is, therefore, not confirming the current levels from the S&P 500 at the moment. In our previous market comment, we highlighted the fact that it was not unusual that some/all of our short-term oriented trend indicators tend to deteriorate or even turn completely bearish, when the market is consolidating. In such a situation, short- to mid-term market breadth will give further guidance as it helps to analyze if such a bearish short-term trend structure is the vanguard of a stronger correction or just part of the ongoing consolidation period. In other words, if short- to mid-term market breadth remains strong, the impact of a short-term oriented trend-break should be quite limited.

Unfortunately, this is not the case right now. This is due to the fact that short-term oriented market breadth had to take a hard hit during the last couple of trading sessions (or continued to deteriorate) although the market finished in positive territory last week. Especially, the Modified McClellan Oscillator Daily as well as the Modified McClellan Volume Oscillator Daily have wiped out their positive divergence as their bearish signals strengthened significantly last week. This indicates that the overall tape momentum turned quite bearish, plus the overall trend condition still looks quite damaged right now. This becomes quite obvious if analyze the percentages of all NYSE listed stocks which are trading above their short-term oriented moving averages (20/50) as both gauges have not shown any signs of improvements recently (although there was a price recovery). This can be also seen if focus on the NYSE New Highs-/New Lows Indicator as the total number of stockss hitting a fresh 52 weeks high remains outright low, whereas the number of stockss hitting a fresh 52 weeks low has started to show some persistence strength on low levels recently. Consequently, the High-/Low Index Daily turned almost bearish last week. So in the end, there was absolutely no recovery within the short-term oriented tape structure visible, although the market finished higher for the week. As a consequence, the current technical condition of the market looks quite weak-kneed at the moment.

From a pure contrarian point of view, further bouncing on a very short-time frame looks quite possible. This is mainly due to the fact that the Smart Money Flow Index was holding up quite well, whereas the WallStreetCourier Index, the Uptick-/Downtick Ratio and the All CBOE Options Put-/Call Ratio Oscillator Weekly remain bullish or just have flashed a fresh buy signal last week. This is not a big surprise at all, if we consider the fact that the market was massively oversold after the two 9-to-1 down days we have seen recently. Nevertheless, we should not forget that the market is definitely facing some stronger cyclical headwinds until mid-October, plus the WSC Capitulation Index is still signaling a risk-off market environment.

Mid-Term Technical Condition

Another main reason why we believe that the market is at risk for a stronger pullback is clearly the fact that the mid-term oriented condition of the market continued to deteriorate significantly last week. This is mainly because the gauge from the Global Futures Trend Index dropped almost 20 percent for the week and has, therefore, closed in the middle of its bullish consolidation area. If this trend continues it is just a question of time until we see a drop (of this indicator) below 60 percent. If this is the case, the risk of a fast paced correction is extremely high (of course only in combination with weak or bearish readings in mid-term oriented market breadth). Right now we are not completely there yet but nevertheless, it is time to get a cautious stance as the gauge could easily drop quite quickly below that important threshold. On the other hand, it is also important to mention that from a pure signal point of view, the gauge remains in its bullish consolidation area. Consequently, there is still a small chance for a large-cap driven overshoot, but we would be really surprised to see sustainable gains ahead as long as its gauge (and short-term market breadth) remains depressed. However, from a pure price point of view, the mid-term oriented uptrend of the market still remains intact as the WSC Sector Momentum Indicator keeps trading at quite bullish levels so far. 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 remains weak but still keeps trading above the one from riskless money market.

Another reason why we believe that the market is highly at risk to form an important top is due to the fact that most of our mid-term oriented tape indicators also deteriorated significantly last week. Especially, our Modified McClellan Oscillator Weekly looks like it is about to roll over into bearish territory soon, whereas the percentage of stockss which are trading above their mid-term oriented simple moving average (100/150) also came down substantially last week. Consequently, if this development continues with that speed we saw last week, it might be just a question of time until we see further bearish readings here. The same is true if we have a look at the Upside-/Downside Index Weekly and the Advance-/Decline Index Weekly. Despite the fact that both indicators still remain supportive from a pure signal point of view, their bullish gauge dropped significantly for the week. In the past, bearish readings within those indicators (in combination with a bearish Global Futures Trend Index) mostly led to a stronger correction. Consequently, we remain quite cautious at the moment.

Long-Term Technical Condition

On a very long-time frame, the technical picture of the market remains quite bullish at the moment and, therefore, we do not think that a correction should lead to a new bear market at the moment. This is mainly due to the fact that the WSC Global Momentum indicates that 80 percent of 35 local equity markets all around the world (which are covered from our WSC 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 signs of improvements last week. This can be also monitored if we focus on the Global Relative Strength Index, as the relative strength of most risky markets remains positive. Moreover, this long-term oriented uptrend of the market is still widely confirmed by long-term market breadth. This is due to the fact that the readings from our entire long-term oriented tape indicators remain bullish (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stockss which are trading above their 200 day moving average). Nevertheless, we can also see some exhaustion in their readings which might be another piece of evidence that the market looks vulnerable at the moment.

Bottom Line

Although the market only trades roughly less than 3 percent below its all-time high, we think it is now time to get a more cautious stance. Given the fact that our tape indicators continued to deteriorate significantly all across the board, in combination with quite concerning seasonal patterns, it looks like that the recent consolidation period is about to transform into a corrective top building process. Therefore, the risk of a stronger pullback is also increasing (especially if we consider developments within our mid-term oriented tape structure) at the moment. On the other hand, as we have not seen any major bearish crossover signals within our mid-term oriented indicators yet, there is still a chance left to see at least one more rally attempt by the market. Consequently, it might be a bit too early to pull the trigger immediately and, therefore, we think it is time for our conservative members to place a stop loss limit around 2,020. This stop loss limit should be in place until our mid-term indicator framework turns positive again! Aggressive traders should go short, if the S&P 500 drops below 2,020 and should increase their exposure if we see further down testing below 2,010/2,000. Stay tuned!