February 18th 2018

Market Review

U.S. stocks ended the week with solid gains. The Dow Jones Industrial Average gained 4.3 percent over the week to close at 25,219.38. The blue-chip index recorded its biggest one-week percentage rise since November 2016. The S&P 500 also jumped 4.3 percent for the week to finish at 2,732.22. The weekly gain was the best since January 2013. The Nasdaq ended at 7,239.4 and advanced 5.3 percent over the past five days, its best weekly percentage gain since December 2011. Also at current levels, the Dow Jones Industrial Average is 5.3 percent below its all-time high, hit last month. The S&P 500 is 4.9 percent below its own record, while the Nasdaq stands 3.6 percent shy of its own. All key S&P sectors ended in positive territory for the week, led by technology. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, closed near 19.5.

Strategy Review

In our last week’s comment, we highlighted the fact that our indicator framework was telling us that we had seen the worst already. To be more precise, we believed that the market had hit an important intermediate low as the second down-leg on Friday towards 2,532 was accompanied by positive divergences within our short-term oriented tape indicators. Consequently, we believed that the market followed a typical textbook like bottom-building process (waterfall decline -> bounce -> retest of the previous low in combination with positive divergences/signals within our tape/contrarian indicators -> bottom). In fact, after the S&P 500 had hit rock bottom at 2,532, it jumped 4.3 percent for the week (posting its best weekly performance in five years). The main reason why we mentioned intermediate and not final low was due to the fact that the latest correction cycle has definitely left its mark on some of our tape indicators. In such a situation it is not unusual that the first down-leg and the subsequent counter trend rally are just part of a larger and longer-lasting top building process. So in other words, if the current recovery is not accompanied by strong improvements within our market breadth indicators, another correction leg in early Q2 cannot be ruled out at the moment. Even from a pure cyclical point of view (Presidential Cycle), such a scenario looks quite likely. According to those reliable past patterns, a typical February low often acts just as a basis for another strong counter trend rally towards new record highs into mid-March. After that, we often see another significant correction leg, which is then followed by another rally into April. Although the market has been following those historical patterns quite closely so far, we should not forget that those historical patterns should just be seen as a rough guideline instead of a precise trading plan. As a matter of fact, our indicator framework will give us further guidance where the market is heading. So if our cyclical roadmap is correct, any upcoming rally should be accompanied by a growing number of bearish divergences within our indicator framework (which would give us the final confirmation for such a scenario).

Short-Term Technical Condition

Despite the fact that the market finished the week with solid gains, the readings within our short-term oriented trend indicators have been developing moderately so far. From a pure price point of view, the short-term oriented trend of the market turned pretty neutral, as the S&P 500 managed to close within both envelope lines of the Trend Trader Index. To be more precise, it just closed slightly above the bearish threshold. We can also see that both envelope lines of the Trend Trader Index are still decreasing and, therefore, the current recovery is still a bit fragile in its nature. Apart from that fact, we can see some positive developments within our remaining short-term oriented trend indicators. The gauge from the Advance-/Decline 20 Day Momentum Indicator clearly confirmed the latest rally as it showed a strong recovery last week. Another quite encouraging signal is coming from the Modified MACD. Despite the fact that it has not flashed a bullish crossover signal so far, we saw a strong surge in the short-term oriented trend line of this reliable indicator. Consequently, any upcoming weakness would most likely just produce a bullish divergence in its readings, as extremely heavy losses would be necessary to bring this short-term oriented gauge back to its former low! As a matter of fact, we can be pretty sure that we have seen the worst already.

Moreover, it was good to see that our short-term oriented market breadth indicators showed some strong signs of recovery last week, although they have not turned bullish yet. The most encouraging signal is coming from the High-/Low-Index Daily, which almost flashed a bullish crossover signal last week. The main reason for this bullish crossover signal is the fact that we have recently seen a quite strong reduction in the number of new yearly lows, in combination with a quite encouraging increase of new highs. This indicates that the market internals are strengthening as the latest recovery was driven by strong demand rather than by short-covering. This can be also seen if we focus on the percentage of stocks which are trading above their short-term oriented moving averages (20/50) as both gauges recovered significantly last week. Nevertheless, we cannot ignore the fact that both gauges keep trading well below their bullish thresholds. Basically, the same is true if we focus on the Modified McClellan Oscillator Daily and on the Modified McClellan Volume Oscillator Daily. This indicates that the recent rally is still a bit weak-kneed it its nature. As a consequence, some nasty pullbacks cannot be ruled out at the moment, although we might have seen the worst already!

On the contrarian side, we received even further confirmation that we have seen the worst already (at least on an intermediate basis). This is mainly due to the fact that the gauge from the Global Futures Bottom Indicator bounced back into normal territory, whereas the Smart Money Flow Index and the WSC Capitulation Index have clearly confirmed the latest rally we saw. Moreover, we can see that the Equity Options Call-/Put Ratio Weekly grew into outright bullish territory, indicating that the fear among the crowd remains persistent. Another encouraging signal is coming from the NYSE Member Margin Debt as it has not shown any signs of negative momentum so far. This is another indication that the current rally could easily lift the market towards new record highs, before further troubles might be due.

Mid-Term Technical Condition

On a mid-term time horizon, the technical condition of the market still looks pretty vulnerable at the moment. This is mainly due to the fact that the gauge from the Global Futures Trend Index is far away from passing its 60 percent bullish threshold! As already mentioned a couple of times – from a formal point of view – the current correction cycle will be not be over as long as its gauge keeps trading below that important threshold! Therefore, it was good to see that its gauge has shown some positive momentum recently, as it climbed almost 10 percent last week! Nevertheless, we cannot ignore the fact that its gauge has not confirmed the latest rally from the S&P 500! Consequently, the risk of another strong pullback remains quite high (although we strongly believe that we have seen the worst already). The main rationale behind this fact is that the mid-term oriented price trend of the market still remains intact. This can be seen if we focus on the WSC Sector Momentum Indicator, which is still trading at solid levels and has not shown any signs of weakness so far. This is telling us that most sectors within the S&P 500 are still outperforming riskless money market on a relative basis. This fact can also be observed by looking at our Sector Heat Map. The momentum score of all sectors (except utilities like in the previous weeks) keeps trading above the one from riskless money market (currently at 15.6 percent).

Examining mid-term oriented market breadth reveals a quite encouraging recovery as the picture generally improved compared to the previous weeks. This becomes obvious if we focus on our advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line in Percent, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line), as all of them gained bullish ground last week and are confirming the latest move from the S&P 500. Also the percentage of stocks which are trading above their mid-term oriented simple moving averages (100/150) increased for the week, although the gauge on a 100 days frame is still trading slightly below the bullish threshold. On top of that, we can see that also the readings from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly improved compared to the previous weeks. The only weak signal is coming from our Modified McClellan Oscillator Weekly, which is not a big surprise if we consider the current circumstances. So all in all, these signals are telling us that we have seen the worst already (at least on an intermediate basis), and therefore, any upcoming pullback within the ongoing rally should be limited in price and time!

Long-Term Technical Condition

As per last week’s report, the long-term uptrend of the market remains intact. The Global Futures Long Term Trend Index is still indicating a technical bull market for the S&P 500 and trading at the highest levels for years. As we can see from the WSC Global Momentum Indicator (and like in the previous weeks), 85 percent of all local equity markets around the world remain within a long-term oriented uptrend. This can be also monitored if we focus on the WSC Global Relative Strength Index, as the relative strength of all risky markets keeps trading very far above the one from U.S. Treasuries. Also, long-term oriented market breadth still looks quite constructive at the moment. The percentage of stocks which are trading above their 200 day simple moving average gained bullish ground last week. Also the number of stocks which are hitting a fresh 52 weeks high are trading above their bearish counterparts – having a positive impact on our High-/Low Index Weekly. In addition, the signal from the Modified McClellan Volume Oscillator Weekly also improved.

Model Portfolios

If we have a closer look at our Model Portfolios (WSC Inflation Proof Retirement Portfolio, the Global Tactical ETF Portfolio, the WSC Sector Rotation Strategy and the WSC All Weather Portfolio) we can see that there were no changes in the allocation last week.

Bottom Line

In our last week’s comment we highlighted the fact that there was a good chance that the market had hit rock bottom (at least on an intermediate basis) as we had seen typical technical patterns for such an event. This week, we even received further confirmation for such a scenario. But that does not mean that the current rally will be a one-way street towards new highs. Especially, if we consider the quite supportive but weak readings within our short-term oriented indicator framework, nasty pullbacks cannot be ruled out at the moment – although we think they should be limited in price and time. As a consequence, we think it is time for our conservative members to get back into the market (by buying the dips rather than chasing the market too aggressively on the upside) as we think we have seen the worst already. Aggressive traders should remain long as we do see a reduction in the number of new lows and/or an increase in new highs.

Stay tuned!!!