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November 06. 2016

Market Review

U.S. averages finished the week with losses. For the week, the Dow Jones Industrial Average dropped 1.5 percent to finish at 17,888.28. The S&P 500 shed 1.9 percent for the week to close at 2,085.18. The S&P’s losing streak is the longest in almost 36 years. During that streak, the index has fallen nearly 3 percent. The Nasdaq plunged 2.8 percent during the week to end at 5,046.37. Among the key S&P sectors, the materials sector was the best weekly performer, while technology dragged. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, rose more than 40 percent during the week, to trade near 22.9.

Strategy Review

Over the past couple of weeks, we received a growing number of evidences that the market was in the middle of a corrective top-building process. Our indicator framework showed that only due to the strong performance of a few large- and mega-caps, the market was trading more or less sideways back then, although the underlying tape structure was already faltering. We warned our members that in such a situation the upside potential of the market remained capped as long as we do not see any improvement within our tape indicators. As the ingredients (within our indicators) for a stronger pullback had even increased within the last 3-4 weeks, the risk-/reward ratio started to deteriorate even more. As a result, we advised our members to wait until we see some negative price action first, before taking any action. To be more precise, we mentioned that as long as the S&P 500 kept trading above 2,095, it was a bit too early to sell and too late to buy. On Thursday, the S&P 500 closed below 2,095 and, therefore, our strategic outlook clearly turned bearish on that day. So even if we do not see selling pressure afterwards/immediately, we think that any upcoming rebound should turn out to be corrective as long as we do not see any significant improvements within our indicator framework. Therefore, our short- to mid-term oriented indicators will be key area of focus right now.

Short-Term Technical Condition

Right in line with our recent call, the short-term down-trend of the market remains well in force. This is mainly due to the fact that the S&P 500 closed 39 points below the bearish threshold from the Trend Trader Index. Above all we can see that both envelope lines of this reliable indicator are dropping on a very fast pace. This indicates an outright underlying bearish trend-structure at the moment, as we have seen significant lower lows and lower highs within the past 20 days. The same is true if we focus on the Modified MACD and on the Advance-/Decline 20 Day Momentum Indicator. Both gauges gained even more negative momentum last week and plunged to their lowest levels for months. As a consequence, both indicators have formed an outright bearish divergence to the current levels from the S&P 500. In such a situation, stronger gains tend to have a corrective character rather than being the start of a new sustainable breakout.

More importantly, this view is also strongly confirmed by short-term market breadth, as we have not seen any major bullish crossover signals or even some small signs of positive divergences yet. Especially the percentage of stockss which are trading above their short-term oriented moving averages (20/50) are telling us that less than 23/24 percent of all NYSE listed stocks remain in a short-term oriented uptrend. The last time when we saw such weak numbers was in early August, where the S&P 500 was trading 85 points below its current level. Another concerning fact is that both trend lines from the Modified McClellan Oscillator Daily reached their lowest levels for months, indicating that the underlying breadth momentum is outright bearish at the moment. With such weak readings, we would be quite surprised to see sustainable gains ahead! In addition, the number of stockss hitting a fresh 52 week low started to increase significantly, causing that the High-/Low Index Daily was rolling over into clearly bearish territory last week! Although the market finished the week with losses, the bearish divergences between the market and our entire short-term oriented breadth indicators have not been sorted out so far. This is another important indication that the market is still highly vulnerable for stronger losses. As already mentioned last week, the main reason why we have not seen a stronger correction so far, is the fact that large caps are still outperforming small caps (Charts of Interest). Therefore, major capital weighted indexes are holding up quite well, although the broad market is already strongly lagging behind. Such a situation can never be sustainable in the long run and, therefore, we remain outright cautious at the moment!

From a pure contrarian point of view, a (corrective) bounce into next week cannot be ruled out at. This is due to the fact that the market is slightly oversold, in combination with soaring put/call ratios (Daily Put/Call Ratio All CBOE Options and the Global Futures Put/Volume Ratio), and bullish readings within the WallStreetCourier Index. After such strong bullish readings within our option based indicators, a rebound for a couple of trading days (5-10 days) cannot be ruled out, before further losses can be expected. This view would be in line with our Smart Money Flow Index, which is still not confirming the current levels from the Dow indicating further troubles ahead on a mid-term time horizon. Above all, we can see that the WSC Capitulation Index spiked significantly, which is another super red flag on the horizon.

Mid-Term Technical Condition

The most concerning fact is that the mid-term oriented condition of the market continued to deteriorate significantly last week. This is primarily based on the fact that the gauge from the Global Futures Trend Index dropped deeper into its bearish trading range area last week and is, therefore, definitely not confirming the current levels from the S&P 500! As already mentioned last week, in such a scenario the risk of a (fast paced) correction remains outright high and/or stronger gains tend to have only a corrective character rather than being the start of a new sustainable breakout. Only, from a pure price point of view, the mid-term oriented uptrend of the market has not been broken yet as the WSC Sector Momentum Indicator has not turned bearish yet. This indicates the momentum score from the S&P 500 is still trading above the one from riskless money market within our Sector Heat Map. Nevertheless, if we have a closer look at this reliable scoring tool, we can see that the momentum score from the sectors within the S&P 500 have already started to underperform riskless money market. This is another indication that only some heavy weighted stocks (within the S&P 500) are holding up quite well, whereas the broad market is strongly lagging behind! In our opinion, such a situation can never be sustainable in the long run.

More importantly, mid-term oriented market breadth continued to gain more bearish ground last week and is, therefore, not confirming the current levels from the S&P 500! In particular, the percentages of NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150) are trading well below their bullish thresholds and have additionally reached their lowest levels for months. On top of that we can see that the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly strengthened their bearish signals last week. Normally, as long as both, advancing issues as well as up-volume are trading below their bearish counterparts, the underlying tape structure of the market remains outright weak. In such a scenario, the market is extremely vulnerable for a stronger correction and, therefore, the current risk/reward ratio is extremely low at the moment.

Long-Term Technical Condition

The long-term up-trend of the market remains intact so far, although we can see already some signs of exhaustions. 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 62 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, as the long-term relative strength score of most risky markets remain below their bullish threshold. This is another indication that the global equity markets are highly at risk for disappointments at the moment. This view is now also confirmed by long-term oriented market breadth as we have not seen any signs of recovery in the current tape structure of the market recently. Especially, the Modified McClellan Volume Oscillator Weekly showed a widening bearish gap last week, indicating that the momentum of the market internals remains outright weak. Another serious bearish divergence can be seen if we focus on the percentage of stockss which are trading above their 200 day simple moving average, as they are about to pass the bearish threshold soon! On top of that, we can also see that long-term new lows have also started to strengthen recently and, therefore, the High-/Low Index Weekly has shown some signs of weaknesses recently.

Bottom Line

The bottom line: after the market had dropped below 2,095 last week, we received the final confirmation that an important top is in place! Since capital appreciation is the most important driver for long-term success, we think the current risk/reward ratio is a way too low to take too much risk at the moment. As a consequence, we would advise our conservative members to stay on the sidelines until we see at least some positive improvements in our mid- to long-term oriented trend- as well as -breadth indicators. As some of our contrarian indicators flashed a buy signal last week, an oversold bounce might be possible. Nevertheless, we think that any upcoming bounce should be limited in price and time as our entire short-term trend- as well as breadth indicators remain bearish. For that reason, we would advise our aggressive traders close their profitable short positions, if the S&P 500 manages to close above 2,115 and to reopen a short-position again if we see the first meaningful bearish reversal candle. Stay tuned!