March 26th 2017

Market Review

As expected in our last comment, U.S. averages finished the week with losses. For the week, the Dow Jones Industrial Average dropped 1.5 percent to finish at 20,596.72. The blue-chip index recorded its steepest decline since September. The S&P 500 plunged 1.4 percent for the week to close at 2,343.98, its biggest decline since November. The Financials sector suffered a 3.8 percent loss over the week, its largest decline since January 2016. The Nasdaq shed 1.2 percent during the week to end at 5,838.74, its largest since December. Most key S&P sectors ended in negative territory for the week, led by financials. Utilities were the only gainers. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 13.

Strategy Review

Since mid-March, we received a growing number of evidences that the latest rally was running out of steam dramatically. 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 an important market top have even increased over the past 2 weeks, the risk-/reward ratio (of being invested in equities) started to deteriorate even more. As a result, we advised our members to wait until we see some negative price action first (in combination with a deteriorating indicator framework), before taking any action. To be more precise, we mentioned that as long as the S&P 500 kept trading above 2,335, it was a bit too early to sell and too late to buy. On Wednesday and Friday, the S&P 500 dropped towards 2,337 but did not manage to break below that important threshold. Nevertheless, our indicator framework continued to deteriorate last week, which is another piece of evidence that the market is on the way to from an important market top.

Short-Term Technical Condition

Not surprisingly, the short-term trend structure of the market deteriorated significantly last week. The S&P 500 closed 19 points below the bearish threshold from the Trend Trader Index. Furthermore we can see that both envelope lines of the Trend Trader Index formed a bearish rounding top last week, which is another piece of evidence that this bearish price driven trend might continue for a while. 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 (although the broad index pulled back for the week). 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 stocks which are trading above their short-term oriented moving averages (20/50) are telling us that less than 32/36 percent of all NYSE listed stocks remain in a short-term oriented uptrend. 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 amount of stocks hitting a fresh 52 week low started to pick up momentum again last week, and therefore, the bullish signal from the High-/Low Index Daily deteriorated significantly last week. So all in all, 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 upside potential of the market is pretty capped at the moment. As already mentioned last week, the main reason why we have not seen stronger losses so far, is the fact that large caps are still outperforming small caps. 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 think that even if we do not see stronger selling pressure immediately, the upside potential of the market remains also pretty limited in such a situation.

From a pure contrarian point of view, the overall technical picture of the market is also getting increasingly non-confirmative. The Smart Money Flow Index has started to form a bigger bearish divergence to the Dow last week, indicating that big institutional investors have started to reduce their exposure significantly. Above all, we can see that the WSC Capitulation Index is far away from signaling a risk-on market environment, plus the gauge from the OEX Options Call-/Put Ratio Oscillator Weekly kept trading within its bearish territory, indicating that it might be a bit too early to bet on a major trend reversal at this point in time. Overall market sentiment remains a bit intermingled as the survey from market vane still looks quite complacent whereas the AII Bulls & Bears survey is indicating a lot of indecisiveness (which is also not a good sign).

Mid-Term Technical Condition

Despite the fact that the clouds are slightly gathering for the short-term, the mid-term uptrend of the market slightly recovered last week. This is mainly due to the fact that the gauge from the Global Futures Trend Index succeeded to get slightly back (from the bearish consolidation area) into its bullish consolidation area last week and therefore, a final but corrective rally attempt or at least further top building into early April cannot be ruled out at the moment (as its gauge closed above its important 60 percent bullish threshold). Nevertheless, we should not forget the fact that the main reason for that move was definitely based on the fact that we have seen a stronger reduction in the total amount of new lows recently. Therefore, the ratio between weekly new lows and weekly total issues on NYSE turned slightly positive again. Although this fact can be interpreted as quite positive signal, we do not think that this might be a sustainable situation over the long run (given the quite concerning readings on a very short time frame and if we consider the quite concerning developments within mid-term market breadth). As a consequence, we keep a close eye on the development of this indicator within the next couple of trading sessions! Despite the fact that the market lost significantly for the week, the pure price driven mid-term oriented trend of the market remains intact as the WSC Sector Momentum Indicator has not shown any signs of weaknesses so far. This can be also seen if we have a closer look at our Sector Heat Map, as the all sectors still have a higher momentum score than riskless money market which can be interpreted as quite bullish trend sign. Nevertheless, we can also see that most sectors have a lower momentum score than the S&P 500, which also indicates a growing selectivity among the market. This selectivity indicates that only some large-caps are holding up quite well, whereas the broad market is already lagging behind and therefore, the pure price driven trend information from the index might be a bit misleading at the moment.

Another reason why we believe that the market is highly at risk to form an important top is due to the fact that most of our mid-term oriented tape indicators also deteriorated significantly last week. In our last comment, we foresaw the Modified McClellan Oscillator Weekly rolling over into bearish territory. And it did so last week and consequently flashed a bearish crossover signal. Also the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) came down substantially last week. Consequently, if this development continues with that speed we saw last week, it might be just a question of time until we see further bearish readings here. The same is true if we have a look at the Upside-/Downside Volume Index Weekly and the Advance-/Decline Index Weekly, as their bullish gauges dropped significantly for the week. As already pointed out last week, in the past, bearish readings within those indicators (in combination with a bearish Global Futures Trend Index) mostly led to a stronger correction. Consequently, we remain outright cautious at the moment as the quality of the mid-term uptrend remains outright weak and therefore, we think the upside potential of the market remains pretty capped. As a matter of fact, the risk-/reward ratio (for being invested in equities) is also deteriorating significantly at the moment!

Long-Term Technical Condition

As per last week’s report, the long-term uptrend of the market remains intact and therefore, we do not think that any upcoming correction should lead to a new bear market at the moment. The Global Futures Long Term Trend Index is trading at the highest levels for months and thus, indicating a technical bull market. Also the WSC Global Momentum Indicator increased last week (4 percentage points) and indicates that 85 percent of all global markets remain within a long-term oriented uptrend. Unchanged compared to last week, we can see that the relative strengths of all risky markets keeps trading far above the one from U.S. Treasuries. Also, long-term market breadth is giving no reason to worry currently and therefore, we think that the current long-term uptrend of the market is not in danger at all (for the time being). Especially our long-term oriented High-/Low Index Weekly is still trading at solid levels (although it have come down a bit recently), indicating that the long-term tape of the market remains well intact. This can be also seen if we have a look at the number of stocks which are trading above their longer-term oriented moving averages (200)! Only the Modified McClellan Volume Oscillator Weekly has lost some steam recently and flashed a bearish crossover signal, which is somehow supporting our quite cautious short- to mid-term oriented view.

Model Portfolios

If we have a closer look at our Model Portfolios, we can see that there have been no changes in the allocation advice from the WSC Sector Rotation Strategy, the WSC All Weather Portfolio and the WSC Inflation Proof Retirement Portfolio. The WSC Global Tactical ETF Portfolio is selling the Russell 2000 ETF (IWM) and is therefore, adding the MSCI South Korea ETF (EWY). The main reason for the sell signal for the Russell 2000 is the fact that its relative strengths score dropped out of the top 10 within our WSC Global ETF Momentum Heat Map and therefore, the next highest relative score market (EWY) will be added.

Bottom Line

The situation remains unchanged compared to last week. Although the market only trades a few percentages below its all-time high, we remain outright cautious at the moment! This is due to the fact that the technical condition of the market looks quite damaged and therefore, the evidences for an important intermediate market top are increasing at the moment. As a matter of fact, we are quite cautious as the market looks quite vulnerable for disappointments. The main reason, why we have not seen any stronger losses so far is the fact that large-caps are still holding up quite well (and due to the fact that our indicator framework has not completely turned bearish yet). So even though we might not see a stronger selling pressure immediately, we would be quite surprised to see sustainable gains ahead with such a weak indicator framework. Consequently, any upcoming (large-cap driven) rally attempt is highly likely to turn out to be corrective in its nature. Moreover, we would like to see some stronger negative price action below 2,335 first, before we advise our members to take any (countertrend) actions. As a matter of fact, we would advise our conservative members to keep/place a stop-loss limit at 2,335. 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 closes below 2,335 (in combination with bearish readings within our short-term oriented indicator framework) and should increase their exposure if we see further down testing below 2,316/2,300.

Stay tuned!