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January 11. 2015

Market Review

Last week all three major U.S. averages ended in negative territory again. The Dow Jones Industrial Average dropped 0.5 percent from last Friday’s close to 17,737.37. The S&P 500 dropped 0.7 percent to 2,044.81 during the week. The Nasdaq Composite recorded a 0.5 percent loss for the week and closed at 4,704.07. Among the key S&P sectors, health care was the best weekly performer, while energy dragged. The CBOE Volatility Index, a measure of investor uncertainty, fell to 17.55.

Short-Term Technical Condition

In last week’s comment we highlighted the fact that we expected to see either a sharp wash-out day or a short-lived period of consolidation that should dampen short-term optimism before further gains can be expected. In fact, it was an outright volatile week! On Monday, the S&P 500 and Dow Jones Industrial Average suffered their worst daily declines since last October, but sentiment turned on Tuesday afternoon, and shares rallied strongly over Wednesday and Thursday before losing ground again at the end of the week. In the end, U.S. stocks were modestly lower for the week and in total the S&P 500 is just trading 1.5 percent below its former multi-year high in late-December. Moreover, we highlighted that as long as the short-term uptrend of the market remained intact and as long as our short- to mid-term oriented breadth indicators remained strong, we did not fight the tape. Apparently, having a look at our indicators, the technical condition of the market started to show some signs of fatigue recently, especially on a mid-term time horizon, and, therefore, we are quite alerted at the moment.

On a short-term time frame, the trend of the market remains almost unchanged compared to last week. From a pure price point of view, the current short-term oriented trend remains quite neutral as the S&P 500 managed to close within both envelope lines of the Trend Trader Index. Nevertheless, we can see that both envelope lines of this reliable indicator have slightly started to drift lower, indicating that ? from a pure structural point of view – the underlying trend structure of the market slightly turned bearish. The same is true if we focus on the Modified MACD, which flashed a bearish crossover signal last week. Only the Advance-/Decline 20 Day Momentum remains bullish from a pure signal point of view, although its gauge is trading at outright low levels and has, therefore, not confirmed the latest levels from the S&P 500. As already mentioned last week, during a consolidation period it is not quite unusual to see a lot of bearish or even fast changing signals within short-term oriented trend indicators as there is no specific trend within a broad based trading range. Therefore, short- to mid-term market breadth is a key area of focus to evaluate if a given consolidation period should be considered as healthy or if it will turn out to be more corrective in its nature.

If we focus on our short-term oriented breadth indicators, we can see that their readings slightly deteriorated for the week and are, therefore, quite intermingled at the moment. The Modified McClellan Volume Oscillator Daily flashed a small bearish crossover signal last week, whereas the readings from the Modified McClellan Oscillator Daily remain quite neutral at the moment. As a matter of fact, the underlying tape momentum of the broad market can be described as quite flattish, as it has no clear direction for the time being. This can be also seen if we focus on the percentage of stockss which are trading above their short-term oriented moving averages (20/50). Both gauges just closed shy below their 50 percent threshold, indicating that the underlying trend force of the market turned bearish from a pure signal point of view but still remains somehow neutral if we focus on their absolute levels. A quite encouraging tape signal is coming from the High-/Low Index Daily, as it is far away from being bearish. This indicates that the recent down-testing was mainly driven by large caps, as we have only seen a strong decline in the number of stockss hitting a fresh yearly high whereas the number of stockss which was pushed to a new yearly low remains quite depressed. Even on Tuesday, the amount of new lows was outright low, given the fact that the S&P 500 faced its worst daily decline since last October! So all in all, the current short-term oriented tape condition is quite mixed at the moment.

The situation on the contrarian side is quite similar. After the increased volatility/down-testing from last week, most of our contrarian indicators got back to their normal levels. Nevertheless, the bearish divergence between the Dow and the Smart Money Flow Index continued to increase significantly last week. This indicates that the big guys have started to reduce their equity exposure fairly and this is another reason why we are getting increasingly alerted. Moreover, we can see that the WSC Capitulation Index is still indicating a risk-off scenario and, therefore, further increased volatility is highly likely. On the other hand, from a pure cyclical point of view, we can see that pre-election years tend to be outright supportive for the equity market and especially the first months of such a year should be quite supportive.

Mid-Term Technical Condition

Moreover, the mid-term uptrend of the market remains intact so far, as the Global Futures Trend Index is still trading far above its bearish 60 percent threshold. Therefore, it is too early to issue a strategic sell signal at the moment as the indicator remains within the upper range of its bullish consolidation area. On the other hand, 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. As a consequence further sideways trading with increased volatility is quite possible. Anyhow, we would get quite cautious if the gauge will drop below 60 percent (in combination with weakening market breadth, especially within the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly), as it would be a clear indication that a stronger correction lies ahead! Therefore, those indicators are clearly key area of focus within the next 1-3 weeks! Moreover, from a pure price point of view, the mid-term oriented uptrend of the market remains intact as the WSC Sector Momentum Indicator is far away from being bearish. This is telling us that most underlying sectors within the S&P 500 have not broken below their mid-term oriented uptrend yet. This can be also seen if we have a closer look at our Sector Heat Map. Apart from energy, the relative strength score of all major sectors is trading well above the riskless money market!

More importantly, mid-term oriented market breadth deteriorated significantly last week and this is another reason why we are a bit alerted at the moment. Apart from the Modified McClellan Oscillator Weekly, most of our mid-term oriented tape indicators deteriorated last week. The percentage of stockss which are trading above their mid-term oriented moving averages (100/150) lost some bullish ground last week, but both gauges closed slightly above their bearish 50 percent threshold. Although their readings are far away from confirming the current level from the S&P 500, they still remain supportive from a pure signal point of view. More importantly, mid-term oriented up-volume dropped significantly last week 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 both indicators turn bearish! 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 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

From a pure technical point of view, the long-term oriented up-trend of the market remains intact as the Global Futures Long Term Trend Index has not turned bearish yet. Nevertheless, we can see that the global bull market remains quite selective as only 25 percent of all local equity markets around the world (all quoted in USD) remain within a long-term oriented up-trend for the time being. From a pure asset allocation point of view, U.S. equities remain the place to be as they are still leading all other risky markets in terms of relative strength. More importantly, long-term oriented market breadth remains quite supportive and is, therefore, confirming the current long-term oriented up-trend of the market. This is mainly due to the fact that the percentage of stockss which are trading above their long-term oriented moving average (200) as well as long-term new highs remain quite bullish. At the same time, the Modified McClellan Volume Oscillator Weekly is about to flash a bullish crossover signal soon, indicating that the underlying tape momentum of the market is about to get back on track (at least on low levels). As a matter of fact our long-term bullish outlook has not been changed so far, although our entire long-term oriented breadth indicators should be much stronger, if we consider the current levels from the S&P 500.

Bottom Line

Given the quite intermingled readings within our short-term oriented indicator framework, we think the market is caught in a tug-of-war for the very short-time frame. As a matter of fact further sharp swings in both directions are highly likely. Although, this consolidation period still looks somehow supportive, we cannot ignore the fact that we saw a significant deterioration in mid-term market breadth. As a matter of fact we stay outright alerted at the moment as the risk of a correction is increasing. Right now it is a bit too early to issue a strategic sell signal as we want to see further confirmation within our mid-term oriented indicator framework (readings within the Global Futures Trend Index below 60 percent and/or bearish crossover signals within the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly). Nevertheless, we think it would make sense for conservative members to place a stop level around 1,985, as two of those three indicators are only updated on a weekly basis. Stay tuned!