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October 26. 2014

Market Review

U.S. stocks rallied for the week. The Dow Jones Industrial Average achieved a 2.6 percent gain during the week and closed at 16,805.41. The S&P 500 rocketed 4.1 percent in five trading days to end at 1,964.58. The benchmark snapped a four-week losing streak and had its biggest weekly percent gain since January 2013. The Nasdaq gained 5.3 percent for the week to end at 4,483.72. All key S&P sectors ended in positive territory for the week, led by health care. The CBOE Volatility Index, a measure of investor uncertainty, dropped to 16.11.

Short-Term Technical Condition

Right in line with our recent call, U.S. stocks strongly rebounded for the week and, therefore, the market is moving in line with our cyclical roadmap! Not surprisingly, our entire short-term oriented trend indicators got back on track last week. The Trend Trader Index flashed a neutral trend scenario on Monday, which was then followed by a bullish signal on Thursday. To be more precise, the S&P 500 is now trading 51 points above the bearish envelope line of the Trend Trader Index and, therefore, the market remains in a short-term oriented uptrend as long as the S&P 500 does not drop below 1,913. Nevertheless, we can see that both envelope lines of the Trend Trader Index are still decreasing and, therefore, the latest move can be interpreted as a bounce, as the underlying trend structure of the market has not completely turned bullish.

A quite encouraging signal is coming from the Modified MACD which flashed a strong bullish crossover signal on Thursday. Given the fact that we saw a strong surge in both trend lines of this reliable indicator, we strongly believe that any upcoming weakness/retest would most likely produce a bullish divergence in its readings, as extreme heavy losses would be necessary to bring this short-term oriented gauge back to its former low! Therefore, we are quite sure that 1,820 represent an outright strong bottom (at least for the time being)! In addition, it was good to see that the Advance-/Decline 20 Day Momentum Indictor managed to flash a small bullish signal last week. Nevertheless, its gauge is a bit too low to confirm the latest move by the S&P 500. Given the fact that the Trend Trader Index is still structurally bearish (with its decreasing trend lines), together with a bearish divergence within our Advance-/Decline 20 Day Momentum Indicator, plus a quite bullish Modified MACD, the current short-term oriented up-trend still looks a bit weak-kneed.

To evaluate, if any upcoming pullback will lead to significant losses or will be just part of a normal recovery (and, therefore, represents a good opportunity to expand exposure), short- to mid-term oriented market breadth is key area of focus. The bounce from last week led to quite encouraging improvements within our short-term oriented tape indicators and, therefore, the quite fragile looking uptrend of the market turns out to be much stronger in its nature. Short-term oriented up volume is trading well above short-term down-volume and more importantly, the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily turned bullish on Thursday, indicating that the broad market is regaining strong momentum. Again, we saw a strong surge in both trend lines, which can additionally be seen as a quite positive breadth signal. The same is true if we have a closer look at the High-/Low Index Daily. This reliable short-term tape indicator also flashed a bullish crossover signal last week, as the number of stockss which are hitting a fresh 52 week low have reduced significantly, whereas the amount of new highs have started to show some strengths recently, indicating some green shoots of recovery. If we focus on the broad short-term oriented trend structure of the market, we also can see some signs of strength, as the percentage of stockss which are trading above their 20 day moving average turned strongly bullish or showed strong signs of strength last week (50). As a matter of fact, most NYSE listed stocks have participated within the latest bounce, which can be seen as quite constructive tape signal.

On the contrarian side, we received a lot of evidences that the strong pessimism within the option market remains persistent, as the z-score of the Daily Put/Call Ratio All CBOE Options remains within its extreme bullish territory. This indicates that the current Daily Put/Call Ratio is two standard deviations away from its historical mean, which can be seen as an extremely bullish signal. The same is true if we focus on the Uptick-/Downtick Ratio Oscillator Daily. Moreover, dumb money (Global Futures Dumb Money Indicator) is far away from being bullish, whereas the Odd-Lot Sales Ratio remains on high levels, indicating that the small fry is betting on further declines. On the other hand, we can see that the Smart Money Flow Index has not completely confirmed the latest move, whereas the WSC Capitulation Index did not drop by half of its rise yet and, therefore, increased volatility might be likely. If we consider all those facts mentioned above, we think that the recent bounce could be stronger than previously expected. As the S&P 500 managed to close above 1,960, it could be possible that the market is retesting its old September top again, before major troubles might be due again.

Mid-Term Technical Condition

This is mainly due to the fact that the mid-term oriented condition of the market remains quite bearish biased, although we saw some improvements on low levels last week. This is caused by the fact that the gauge from our reliable Global Futures Trend Index still remains below its very important 60 percent threshold, although it grow into the middle part of its bearish consolidation area. As already mentioned a couple of times in our previous Market Comments, as long as the gauge remains below that important threshold, any upcoming bounce should be limited in price and time or remains in a bounce mode. So even if the market will manage to retest its old September top again, we would remain quite cautious if this retest will not be confirmed by this indicator (levels clearly above 60 percent) as it would be another piece of evidence that another down leg might be due! Moreover, we can see that the WSC Sector Momentum Indicator dropped to its lowest level for months, although the indicator itself remains quite bullish. This indicates that some sectors within the S&P 500 have clearly broken below their mid-term oriented moving averages. This can be also seen if we focus on our Sector Heat Map, as energy has a lower scoring than riskless money market.

More importantly, mid-term market breadth still remains quite bearish and is, therefore, not confirming the recent bounce. This is mainly due to the fact that the Modified McClellan Oscillator Weekly has not shown any signs of stabilization so far, indicating that the overall tape momentum remains outright weak. This can be also seen if we focus on the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly, as both still remain bearish from a pure signal point of view. As long as both indicators remain bearish, the long-term upside potential of the market should be capped and, therefore, we think that the market has not the power to break substantially above its September top.

Long-Term Technical Condition

As per last week’s report, the long-term condition of the market remains quite weak. This is another indication that the recent bounce is just part of a larger rebound pattern before further troubles can be expected. Apart from the fact that the Global Futures Long Term Trend Index is still indicating a technical bull market for the S&P 500, most global market indexes are trading well below their long-term oriented trend-lines. This can be seen if we focus on the WSC Global Momentum Indicator, which states that only 30 percent of all global equity markets are still in a long-term oriented up-trend. This picture is widely confirmed by the Global Relative Strength Index, which indicates that the relative strengths of U.S. Treasuries are higher than any other risky market at the moment. This is another indication for a mature bull market. More importantly, long-term oriented market breadth has not shown any signs of recovery so far. Especially, the Modified McClellan Volume Oscillator Weekly dropped to a new low, signaling that the underlying tape momentum of the market is outright bearish at the moment. Moreover, the majority of all NYSE listed stocks remains well below their long-term oriented trend-lines, whereas the High-/Low Index Weekly still remains bearish although it showed some signs of stabilization last week. So all in all, we have received even more confirmation that the current bounce might be just the start of a complex rebound pattern which should then lead to renewed weaknesses afterwards

Bottom Line

Although the current rebound could turn out to be stronger than previously expected, the market remains in a bounce mode so far. As a matter of fact, as long as the market trades above 1,940 in combination with constructive readings within our short-term market indicators, a retest or a move towards the September top can be possible. Nevertheless, as already mentioned in our previous market comment, we think that the current move is just part of a complex corrective rebound pattern. Therefore, it is likely to see renewed weaknesses again, although we would not expect to see a break below 1,820 by the S&P 500. Afterwards, a December rally could bring some relief before another final tactical decline into Q1 can be expected. So right now, we would advise our aggressive traders to keep their long positions as long as the S&P 500 trades above 1,940 and as long as our short-term indicators remain constructive. On the other hand, if the S&P 500 breaks below 1,940 in combination with bearish crossover signals within our short-term oriented indicators, we think further troubles might be due (not our preferred scenario at the moment). As the gauge from the Global Futures Trend Index did not pass the bullish 60 percent threshold, the current risk/reward ratio still remains quite depressed. As a matter of fact, conservative members should place a stop-loss order around 1,920 if they bought in last week. Moreover, those who are still waiting on the sideline should wait until the Global Futures Trend Index is getting back on track. Stay tuned!