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October 09. 2016

Market Review

U.S. stocks ended the week with losses, snapping a three-week winning streak. For the week, the Dow Jones Industrial Average slid 0.4 percent to 18,240.49. The S&P 500 finished at 2,153.74 and posted a weekly drop of 0.7 percent. The Nasdaq dropped to 5,292.40 and finished the week 0.4 percent lower. Financials were the best weekly performer, while utilities dragged. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 13.4.

Strategy Review

In our last week’s comment we highlighted the fact that we remained outright cautious at the moment as we had received a growing number of evidences that the market was in the middle of a corrective top-building process. As already mentioned earlier, a classical top building process can take a couple of weeks, whereas the first stronger pullback (3-5 percent) after an important high is just part of a larger distribution top. After such a pullback, the market usually bounces back to its former high or just keeps trading sideways closely below its all-time high. If the quality of the underlying market breadth structure is increasing during that time period, a sustainable break out above previous all-time highs can be expected (as the process is considered to be healthy one). On the other hand, if the quality of the underlying tape structure continues to deteriorate significantly (especially on a mid-term time horizon), the chances for a stronger correction are extremely high. Thus, the developments within our short- to mid-term oriented breadth indicators are definitely key area of focus right now as they will give us further guidance!

Short-Term Technical Condition

From a pure short-term oriented price point of view, the trend status from the S&P 500 turned quite neutral after the broad benchmark had dropped back within both envelope lines of the Trend Trader Index. Nevertheless, we can see that both envelope lines of this reliable indicator are still drifting lower on a fast pace as we have seen lower highs and lower lows within the past 20 days. This is telling us that ? from a pure structural point of view ? the underlying trend structure of the market remains quite bearish biased. Basically, the same is true if we focus on the Modified MACD and the Advance-/Decline 20 Day Momentum Indicator. Both indicators have not shown any signs of major strength yet and, therefore, they are far away from confirming the current levels from the S&P 500! As a matter of fact, we think we would not be surprised to see further down-testing ahead.

Basically, the same is true if we analyze short-term market breadth as most of our tape indicators continued to deteriorate last week. This becomes quite obvious if we focus on the Modified McClellan Oscillator Daily as well as the Modified McClellan Volume Oscillator Daily. Both indicators remain or even strengthened their bearish signals, indicating that the underlying tape momentum of the market still remains extremely weak-kneed at the moment. The case is quite similar if we focus on the percentage of stockss which are trading above their short-term oriented simple moving averages (20/50). Although both tape indicators remain bullish from a pure signal point of view, their absolute levels should be much higher given the fact that the S&P 500 is trading near record highs! Another weak tape signal is coming from the NYSE New Highs ? New Lows Indicator. Despite the fact that the total amount of new highs remains supportive, their absolute number is a way too low given the fact that the market is trading only a few percentage below its record high! As a consequence, the High-/Low Index Daily gained some bullish ground on low levels but is far away from confirming the current level from the S&P 500. In such a weak short-term oriented tape environment, any upcoming gains should have more the character of a bounce rather than the start of a new sustainable short-term oriented up-trend!

On the contrarian side, the situation remains quite much the same compared to last week. The gauge from the Smart Money Flow Index continued to widen its bearish divergence to the Dow Jones Industrial Average, indicating that the big guys continued to reduce their equity exposure. Moreover, we can see that the WSC Capitulation Index remains quite bearish, WallStreetCourier Index is still giving some support and, therefore, the overall volatility level will remain elevated.

Mid-Term Technical Condition

As already mentioned last week, we have been quite worried about the strongly deteriorating readings within our Global Futures Trend Index over the last couple of weeks. Therefore, it was good to see that its gauge recovered over the past two weeks as it managed to close in the middle part of its bullish consolidation area. Despite the fact that this indicates that the immanent correction risk has slightly diminished, we still remain a cautious at the moment. This is due to the fact that we saw a negative spike in its gauge on Friday, plus the overall tape condition (short to mid-term) looks quite weak-kneed at the moment. As a matter of fact a quick move of its gauge below 60 percent within a few days cannot be ruled out at the moment. On the other hand, even if we do not see a stronger pullback immediately, as long as the gauge keeps trading within its bullish consolidation area and does not simultaneously show some signs of positive momentum, the upside potential of the market should remain limited as well. On the other side, we see that 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 remains supportive. This shows that the momentum score of the S&P 500 is still trading above the momentum score of riskless money market within our Sector Heat Map. However, the absolute momentum score of money market remains quite high. This can be seen as another piece of evidence that the technical market condition looks quite vulnerable at the moment!

More importantly, mid-term market breadth does not look rosy at all. Although the market is trading at record levels, the Modified McClellan Oscillator Weekly is about to roll over into bearish territory. This indicates that the overall breadth momentum of the market remains outright weak at the moment. This is not a big surprise at all, if we consider the fact that the market is just in the middle of a top building process at the moment. This can be also seen if we focus on the percentage of stockss which are trading above their mid-term oriented moving averages (100/150). Despite the fact that they remain bullish from a pure signal point of view, their readings should be much higher if we consider the current levels from the S&P 500. Anyhow, the most important tape signal is coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly. Last week, mid-term oriented up-volume dropped significantly and is, therefore, just trading slightly above mid-term oriented down-volume, indicating that a lot of purchasing power has been pulled out of the market. The same is true if we have a look at the Advance-/Decline Index Weekly, which shows that the amount of advancing issues on NYSE have also decreased fairly! So if this trend continues, it is just a question of time until this indicator will turn bearish as well! Normally, bearish or extreme weak readings of those two indicators in combination with a mid-term oriented trend-break within the Global Futures Trend Index mostly led to a stronger correction in the past. For that reason, we keep a close eye on those three indicators as we will issue a strategic sell signal immediately if this is the case! Right now we are not there yet, but we remain alerted!

Long-Term Technical Condition

The long-term uptrend of the market remains intact and, therefore, our long-term bullish outlook has not been changed so far. As a matter of fact we do not think that a correction should lead to a new bear market at the moment. The Global Futures Long Term Trend Index is still indicating a technical bull market whereas the WSC Global Momentum is telling us 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. As a consequence, the global trend structure still looks extremely supportive for the time being. On top of that we can see that the relative strengths of most risky markets remain above the one from U.S. Treasuries. More importantly, 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 (somehow) supportive (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stockss which are trading above their 200 day moving average) although they show already some signs of fatigue.

Bottom Line

The technical situation remains almost unchanged compared to last week. Although the market only trades a few percentages below its all-time high, we remain cautious. This is due to the fact that most of our indicators remain quite weak-kneed/non-confirmative. Therefore, we received further evidences that the market has entered a corrective top-building process. As we have seen further bearish crossover signals within our mid-term oriented indicators, the risk of a significant correction remains high. Nevertheless, we would like to see some stronger negative price action below 2,075 first, before we advise our members to take any actions. As a matter of fact, we would advise our conservative members to adjust their stop-loss limit towards 2,075. 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 2,075 and should increase their exposure if we see further down testing below 2,050/2,020. Stay tuned!