February 14. 2016

Market Review

U.S. stocks finished a turbulent week with losses. The Dow Jones Industrial Average dropped 1.4 percent over the week to 15,973.84. The S&P 500 declined 0.8 percent for the week to finish at 1,864.77. The Nasdaq lost 0.6 percent for the week to end at 4,337.51. Most key S&P sectors ended in negative territory for the week, led by financials. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 26.

Strategy Review

In our last week’s comment, we highlighted the fact that the market followed a typical textbook like bottom-building phase (bounce and bottom pattern) and, therefore, we expected to see further down-testing towards the latest correction low at 1,815 or even a break of that important threshold. Moreover, we mentioned the fact that was extremely important to monitor such a down-leg quite carefully as it would give us further guidance where the market is heading! So, if such a down-leg/retest was accompanied with quite strong 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 would have the final confirmation for an ultimate bottom. Otherwise further renewed waterfall declines could be expected and the process starts all over again. Consequently, it was quite encouraging that we saw at least some minor bullish divergences developing last week and, therefore, we said that there might be a good chance that the market would hit a final low in the following week. In fact, after the S&P 500 dropped 2 points below its previous low on Thursday, the big question is if that event marked the final bottom or if further strong losses can be expected? To answer that question, short- to mid-term market breadth is key area of focus right now!

Short-Term Technical Condition

After the strong rally on Friday, the pure price driven short-term oriented trend of the market turned almost neutral. This is mainly due to the fact that the S&P 500 slightly closed within both envelope lines of the Trend Trader Index. Nonetheless, we should not forget that both envelope lines of that reliable indicator are still drifting lower on a very fast pace. This is telling us that within the past 20 days we saw lower highs and lower lows, which is another typical pattern if the market remains extremely short-biased from a pure structural point of view. This can be also seen if we focus on the Advance-/Decline 20 Day Momentum and the Modified MACD, as both indicators remain or just turned bearish last week. As a consequence, the current rally on Friday can be still categorized as bounce rather than the start of a new sustainable short-term oriented up-trend at the moment. Nevertheless, it was good to see that the minor bullish divergence within the Advance-/Decline 20 Day Momentum and the Modified MACD remain persistent (as both indicators refused to drop towards a new low).

Basically, the same is true if we focus on short-term market breadth as most of our short-term tape indicators refused to reach new extreme bearish readings, although the market dropped towards a new marginal low on Thursday. This indicates that the recent overshoot towards the new marginal low was mainly driven by large-caps rather than by the broad market. This becomes quite obvious if we focus on the NYSE New HighsNew Lows Indicator, as there only about 750 new lows on Thursday, compared to slightly more than 1250 new lows, the last time the S&P 500 reached similar levels. As a matter of fact, the bearish gauge from the High-/Low Index Daily refused to reach a new high as well! This can be also seen if we focus on the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as well as on the percentage of stockss which are trading above their short-term oriented moving averages (20/50) (as their readings were holding up quite well, especially on Thursday). Although this can be interpreted as further ingredients for an ultimate bottom, we should not forget that the readings from our entire short-term oriented tape indicators remain quite bearish from a pure signal point of view. So despite the fact that the ingredients for an ultimate bottom are accumulating, we should not forget that the broad market remains in an outright weak/bearish condition! Consequently, as long as we do not see further improvements within our short-term oriented tape indicators, the recent rally attempt from the S&P 500 still looks corrective for the time being.

The situation on the contrarian side is also increasingly supportive at the moment. This is mainly due to the fact that we saw a lot of fear within the market last week. As a matter of fact, we received fresh buy signals within our option based indicators (WallStreetCourier Index, Bottom Indicator, Global Futures Put/Volume Ratio and the OEX Call-/Put Ratio Oscillator Weekly). Above all we can see that a lot of purchasing power has been pulled out of the market recently, as market sentiment remains outright bearish at the moment. On the other hand, we can see that the big guys have started to increase exposure, as our reliable Smart Money Flow Index did not confirm the latest low of the Dow. Above all, from a pure cyclical point of view (Presidential Cycle), we can see that the market often tends to hit an important intermediate low in mid-February! So if our cyclical roadmap is correct, then it could be possible that a low in February will just act as basis for another strong but corrective counter-trend rally into April!

Mid-Term Technical Condition

However, the situation on a mid-term time horizon still looks outright weak/vulnerable and, therefore, it is bit too early to bet on a new sustainable gain at the moment. This is mainly due to the fact that the gauge from the Global Futures Trend Index kept trading far below its bullish 60 percent threshold. As already mentioned a couple of times, from a formal point of view, the market remains at risk for stronger pullbacks as long as its gauge keeps trading below that important threshold. Nevertheless, it was also good to see that its gauge was holding up quite well recently, which might be another indication that a trend reversal might be due soon. However, as bullish divergences can be wiped out quite easily, we still remain cautious as the as long as its gauge does not close above 60 percent (in combination with strengthening tape-readings). Above all, from a pure price point of view we can also see that the mid-term oriented down-trend remains well intact as the WSC Sector Momentum Indicator remains quite bearish. This is telling us that the momentum score of most sectors within the S&P 500 are still underperforming the momentum score of riskless money market within our Sector Heat Map. In such a scenario, most sectors tend to perform negative on an absolute basis!

More importantly, the current bearish mid-term oriented trend is still strongly confirmed by mid-term oriented market breadth. 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 major bullish divergences yet. Especially, the short-term oriented gauge from the Modified McClellan Oscillator Weekly dropped to a new low, signaling that the overall mid-term oriented tape momentum of the market remains outright weak. 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). Despite the fact that both indicators did not drop towards a new significant low, they are also telling us that there was no major recovery within the broad market so far as. Consequently, 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 slightly strengthened for the week. In such a scenario, the market remains extremely vulnerable for further disappointments and, thus, we think the current risk-/reward ratio is too low to act contrarian at the moment.

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 kept trading far below its bullish threshold, indicating that the U.S. 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 13 percent of all local market indexes around the world managed to close above their long-term oriented trend-lines. In a global context, we, therefore, received further confirmation that global equity markets are at risk for further disappointments. Consequently, it is not a big surprise at all that the relative strength of all risky markets kept trading far below the one from U.S. Treasuries. On top of that, we can see that this negative long-term trend is widely confirmed by long-term market breadth. 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 at the moment.

Bottom Line

The bottom line: despite the fact that we saw some typical patterns for a major bottom last week, we think it is still too early for conservative investors to get back into the market. This is mainly due to the fact that the impulses for a significant rally are still missing as well! Consequently, the opportunity costs for conservative members of not being invested still remain extremely low for the time being. So even if the market hit a final low last week, 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. From a pure trading perspective, a break of the S&P 500 above 1,880 would give way towards 1,900/1,925 and worst case towards 1,950. On the other hand, a break below 1,845 would call for further down-testing towards 1,830, whereas a break of that level would give way towards new lows. So in this context we would advise our aggressive traders to use extremely close stops. Stay tuned!