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October 19. 2014

Market Review

Last week all three major U.S. averages ended in negative territory again. For the week the Dow Jones Industrial Average dropped 1.0 percent to 16,380.41. The S&P 500 also dropped 1.0 percent to 1886.76 during the week. The Nasdaq Composite declined 0.4 percent from last Friday’s close, ending at 4258.44. All averages were down for the fourth week. Among the key S&P sectors, industrials were the best weekly performer, while health care dragged. The CBOE Volatility Index, a measure of investor uncertainty, ended at 21.99.

Short-Term Technical Condition

Over the last couple of weeks, we have warned our members from the current correction cycle and, therefore, we have advised them to place a stop-loss limit/go short around 1,980 by the S&P 500 (Market Comment from September 21st 2014). Furthermore, we highlighted the fact that from a pure trading point of view a final overshoot towards 1,820 was possible, which represented our worst case price target for the current correction cycle. In fact, the S&P 500 had reached our worst case price target on Wednesday as the bears took the broad index down to 1,822.29 on an intraday basis, before stocks strongly rebounded for the rest of the week.

Anyhow, the big question right now is if the recent bounce is the beginning of a major trend reversal, or was just a typical short squeeze? In our Technical Market Outlook 2014, it was one of our key calls that the market will face a stronger pullback on the beginning of the year (suggested by the Decennial Cycle), followed by a significant and strong rally into summer, which could push the S&P 500 towards 1,970 or slightly above, before a longer-lasting top-building/distribution process will finally lead to a stronger correction into the end of September/early October (Juglar Cycle). Furthermore, we stated, that any upcoming correction low should only act as basis for a volatile and complex multi-week rebound into late November/early December. After that, we could see another significant correction leg into Q1 2015, which should represent a major bottom in risky assets. Although the market is following our cyclical roadmap, our indicators are key area of focus right now, as our historical patterns are only representing a general guideline instead of a precise trading plan.

Despite the fact that the market showed some solid gains on Friday, the improvements in the readings of our short-term oriented trend indicators have been developing moderately so far. If we have a closer look at the Trend Trader Index, we can see that the S&P 500 was not even rudimentary able to break above the lower resistance line of this reliable indicator, which would be the first indication for a short-term trend reversal. Furthermore we can see that the envelope lines of the Trend Trader Index are drifting lower on a fast pace, indicating that the support/resistance levels for the S&P 500 are decreasing as well. In other words, as long as the market is not able to break through these strong resistance lines, we will see lower lows and lower highs, which is a typical pattern for a strong short-term down-trend. This can be also seen, if we have a closer look at the Modified MACD which continued to show a widening bearish gap and has, therefore, refused to confirm the recent bounce on Friday. The case is slightly different if we focus on the Advance-/Decline 20 Day Momentum Indicator. The indicator remains quite bearish from a pure signal point of view, but showed some small bullish divergences recently, indicating that 1,820 represent an important support level.

To evaluate if this critical support level will be broken/retested, short-term market breadth is also key area of focus. Despite the fact that our entire short-term tape indicators remain outright bearish from a pure signal point of view, we can identify some bullish divergences in their readings. Despite the fact that the S&P 500 dropped to 1,822 on Thursday, the percentage of stockss which are trading above their short-term oriented moving averages (20/50) gained some bullish ground on very low levels, although both gauges keep trading well below their bullish thresholds. This indicates that the tape structure remains extremely weak at the moment, although some form of bottom building might be in force. The same is true if we focus on the Modified McClellan Oscillator Daily, which showed some small signs of a recovery last week. Another interesting fact is that on Wednesday, short-term oriented down-volume was much lower than the days before, indicating some form of final wash-out. On the other hand, the recent bounce on Friday was mostly driven by short-covering, as we only saw a strong reduction in the amount of new yearly lows instead of a major increase in the amount of new yearly highs. As a matter of fact, the bearish gauge from the High-/Low Index Daily dropped significantly, although the indicator itself is far away from flashing any bullish crossover signal at the moment.

From a pure contrarian point of view it looks like that we have seen the worst already (at least on a very short time frame). This is mainly due to the fact that the Daily Put-/Call Ratio All CBOE Options Indicator and the Odd-Lot-Differential Index have definitely reached outright contrarian territory, indicating that the small fry was throwing in the towel last week. Above all, the gauge from the Global Futures Bottom Indicator dropped even further into its buy zone, whereas the WallStreetCourier Index and the Market Timer Index flashed a buy signal or remain bullish, respectively

Mid-Term Technical Condition

Obviously, the technical mid-term oriented picture of the market remains quite damaged at the moment, although we saw some form of stabilization last week. This was mainly due to the fact that the gauge from the Global Futures Trend Index is about to break above its outright bearish 20 percent threshold, if we see further strengths ahead. This is an important technical signal, as it would indicate that 1,820 should act as intermediate bottom. Nevertheless, even if its gauge will get back into its bearish biased trading range area, the technical condition of the market would remain outright vulnerable. Therefore, such a situation would be in-line with our cyclical roadmap, where we are expecting to see a volatile multi-week rebound, before another significant down leg might be due. Moreover, we can see that some sectors within the S&P 500 broke below their mid-term oriented up-trend, as the WSC Sector Momentum Indicator has lost some momentum on high levels recently. This can be also seen if we focus on our Sector Heat Map, as the relative strength score of riskless money grew to 22 percent! This is another indication that the current bull-market is running out of steam.

More importantly, the current bearish biased mid-term oriented trend of the market is widely confirmed by bearish market breadth. Especially, the Modified McClellan Oscillator Weekly dropped to a new low last week and is, therefore, 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 percentage of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150). Both indicators are trading far below their bullish threshold and, therefore, the overall market condition remains outright fragile at the moment. Nevertheless, we have observed some form of bullish divergences in their readings (100/150) last week, which might be another indication for our bounce scenario. Moreover, it was interesting to see that the negative signals from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly did not gain more bearish ground, although the market dropped to a new low last week. This can be also seen as some form of silver lining on the horizon, although it might be still a bit too early to chase the market aggressively higher. As already mentioned last week, a typical bottom tends to occur as a process rather than as a V-shaped recovery. If the market hits an important bottom, we usually see a strong counter trend rally, which normally lasts about 5 to 10 trading sessions. After that, the market tends to show renewed weaknesses, which could then lead to a retest or even a break of its previous low. If this weakness comes along with more positive divergences within our market breadth indicators, we can be quite sure that the market hits rock bottom. Right now, it looks like the market is still in a bounce mode and, therefore, renewed weaknesses can be expected, as the current short-term oriented down-trend is still supported by negative market breadth. Nevertheless, we think that any upcoming renewed weakness should turn out to be much softer in its nature as we have received a growing number of evidences that 1,820 represent an important intermediate bottom!

Long-Term Technical Condition

Not surprisingly, the deterioration within the long-term horizon continued last week and is, therefore, in-line with our cyclical roadmap. This is mainly due to the fact that apart from Global Futures Long Term Trend Index, our entire long-term oriented trend indicators remain (WSC Global Momentum Indicator) or turned bearish (WSC Global Relative Strength Indicator). The WSC Global Momentum Indicator is telling us that the majority of all global equity markets around the world have broken below their long-term oriented trend-lines, whereas the relative strengths from U.S. Treasuries are outperforming all risky markets at the moment. More importantly, long-term oriented market breadth turned completely bearish last week, which is another indication that the current bull-market might have ended. Especially, the Modified McClellan Volume Oscillator Weekly dropped to a new low, indicating that the underlying tape momentum of the market is outright bearish at the moment. Moreover, most NYSE listed stocks remain well below their long-term oriented trend-lines, whereas the High-/Low Index Weekly flashed a bearish crossover signal last week. All in all, we think that it will take a couple of weeks/months to bring all those indicators back on track, which is another piece of evidence that 2,010 was the ultimate high of the current bull-market! This also suggests that any upcoming complex multi-week rebound will only produce a lower high, before another significant correction cycle into Q1 should act as major bottom for risky assets.

Bottom Line

Although our entire short-term oriented indicators remain quite bearish from a pure signal point of view, we received a lot of evidences that 1,820 marked an important intermediate low. Therefore, we think it would make sense that aggressive traders should cover their short-positions if the S&P 500 breaks above 1,875. Furthermore, they should focus on the long side again (with tight stops), if we see the first meaningful bullish crossover signals within our short-term oriented indicator framework. On the other hand, if the S&P 500 breaks below 1,820 again, we cannot rule out a further down testing towards 1,800/1,780, even though this scenario is not our preferred one. Although we think that we might have seen the worst already, conservative members should still stay at the sideline as the risk/reward ratio still remains too low. Moreover, we think that any upcoming multi-week rebound will only produce a lower high (1,960/1,980), before renewed troubles might be due. As a matter of fact, it is up to them if they want to play any upcoming rebound. If so, we would advise them to wait until our short-term oriented indicators are back on track! Stay tuned!