September 13th 2020

Market Review

All three major U.S. averages finished the holiday-shortened week with losses. The Dow Jones Industrial Average lost 1.7% over the week to close at 27,665.64. The S&P 500 lost 2.5% for the week to finish at 3,340.9. The Nasdaq fell 4.1% for the week to end at 10,853.55, its biggest weekly decline since March. Nearly all key S&P sectors ended lower for the week, led by energy. The materials sector was the only gainer. The Chicago Board Options Exchange Volatility Index, the gauge of S&P 500 options prices known as the VIX, closed near 27.

Strategy Review

In our last week’s market forecast we said that the tape condition of the market looked too weak to justify stronger gains but also too supportive to challenge our strategic bullish view. Moreover we mentioned that – on a very short-term time frame – further sentiment driven volatile consolidation/down-testing could not be ruled out. Indeed it was an outright volatile week as the S&P 500 fell almost 3% until Tuesday, recouped all its losses on Wednesday before retreating 2.5% for the week. Given the elevated sentiment within the option market back then, the recent decline was definitely within expectations (at it is quite usual to see such stronger swings during a volatile consolidation period). However, what turned out to be a huge surprise was the strong deterioration of our entire indicator framework (although the market only lost 2.5% for the week). Consequently, it looks like that the current consolidation period is about to get a more corrective tilt. As already stated several times – from a pure technical point of view – a trading consolidation period is always a fork in the road. Because during such a time period, we either see (1) improving readings within our indicator board (increase in new yearly highs, higher percentage of stocks trading above their SMA 20/50 …) which would be then the basis for a strong bullish break-out, (2) or the tape (market breadth) condition worsens, which is then the vanguard for a significant correction leg (e.g. 2020, late 2019, early/mid 2018, early 2016, mid 2015 or 2011 …). Worth mentioning is the fact that such a process could normally take a couple of days or even weeks, whereas the tilt between corrective and supportive consolidation could get sometimes quite narrow. Although not every weak tape condition automatically led to a stronger correction, every (!) correction started with a weak tape condition. Consequently, the market is about to head into a quite critical make or break-set up, whereas our indicator framework will give us further guidance.

Short-Term Technical Condition

The short-term price trend of the market has clearly turned bearish last week as the S&P 500 closed 64 points below the bearish threshold from the Trend Trader Index. Consequently, the market remains short-biased until the S&P 500 does not manage to close above 3,404 (lower envelope line of the Trend Trader Index). Additionally, the short-term oriented momentum of this down-trend continued to gain further bearish ground as the Modified MACD widened its bearish gap. Basically, the same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator, which has clearly confirmed the latest price action of the S&P 500. Another concerning fact is that both envelope lines of the Trend Trader Index are about to flatten out, which might be another signal that the recent trend-break will be more sustainable in its nature. Although these signals look quite grim at the first sight, it is not quite unusual to see a lot of bearish or even fast changing signals within our short-term oriented trend indicators during a volatile market environment. As a matter of fact, short- to mid-term market breadth is a key area of focus to evaluate if any kind of a stronger move in a specific direction is just a realization of volatility or the beginning of a more sustainable trend in a specific direction.

Despite the fact that the latest decline was mainly tech-related, the broad market took also a hard hit last week (as short-term market breadth showed major signs of exhaustion last week). This is quite astonishing, as the S&P 500 only lost 2.5% for the week. Thus, it looks like that the market is getting increasingly vulnerable for further disappointments. More specifically, the percentage of stocks which are trading above their short-term oriented simple moving averages (20/50) decreased last week and dropped fully into the bearish territory (especially the 20 SMA). This shows a stronger deterioration within the broad market, since most stocks are now per definition already in a short-term oriented price driven down-trend. Additionally, the short-term oriented momentum of this broad based down-trend also strengthened last week. This can be seen if we focus on the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as both indicators continued their bearish rides last week. Another negative signal is coming from the Upside-/Downside Volume Index Daily, showing that the selling pressure was not only focused on a few heavy weighted stocks in the index. On the other hand, we can see that most of these selling pressure was mainly driven by profit taking so far (which can be interpreted as still a quite positive signal). This becomes obvious if we focus on the NYSE New Highs/New Lows Indicator, since the number of new yearly highs (32) is still higher than the ones dropping to a new yearly low (24). As long as we do not see a strong negative spike in new lows (outpacing new highs), the market internals still remain somehow supportive. Consequently, the High-/Low-Index Daily remains positive, albeit on low bullish levels. In the end, the short-term oriented market internals got definitely a more bearish tilt, although a strong spike in new lows is still missing to complete that picture.

On the contrarian side, the picture is also getting increasingly bearish. Even though the latest volatility had its expected impact on our option based indicators (All CBOE Options Put-/Call Ratio, WSC Put-/Volume Ratio and the WSC Dumb Money Indicator), their readings still remain a bit too positive in our point of view. Consequently, there is still enough room left for negative surprises. Another concerning fact is that the Smart Money Flow Index dropped significantly for the week. This shows that the big guys have started to take the chips from the table. This view is confirmed by the WSC Capitulation Index, which shows that the market has now entered a risk-off market environment. Even from a seasonal point of view (President Cycle and Decennial Cycle), the market remains at risk for further disappointments until end of October. However, on a very short-time frame we would not be surprised to see another stronger bounce as the market is getting increasingly  oversold (Advance-/Decline Ratio Daily, Upside-/Downside Ratio Daily, Equity Options Call-/Put Ratio Oscillator and the All CBOE Call-/Put Ratio Oscillator).

Mid-Term Technical Condition

From a pure signal point of view, the mid-term oriented uptrend remains well intact. This is mainly due to the fact that the Global Futures Trend Index closed in the middle part of its bullish consolidation area bracket. So from a pure definition signal point of view, the underlying consolidation period can be still classified as bullish biased. Normally, as long as the gauge from this indicator remains above its 60% threshold, any short-term oriented weaknesses tend to be limited in price and time (only in combination with confirmative market breadth readings). However, what really concerns us at the moment is the speed at which this indicator is losing bullish ground. If this trend continues it might be just a question of time until this gauge drops below the important 60 percent bullish threshold. In such a situation, the market is highly at risk for further significant and more importantly, sustainable losses. Consequently, we remain alert as such a move below 60 percent could happen within days. Moreover, this is another indication that the market is heading into a make or break set up soon. On the other hand side, we can see that most sectors within the S&P 500 remain in a strong mid-term oriented price driven uptrend as the WSC Sector Momentum Indicator has been holding up quite well so far. This can be also observed if we examine our Sector Heat Map, as the momentum score of all sectors (except energy like in the previous weeks) remains above the one from riskless money market.

Basically, the same is true if we focus on mid-term market breadth. Despite the fact that our entire tape indicators remain bullish from a pure signal point of view, most of them have showed major signs of exhaustion last week. Thus, it looks like the recent weaknesses might be just the beginning of a top building process. First of all, the Modified McClellan Oscillator Weekly started to form a rounding top, showing that the underlying mid-term oriented tape momentum is fading away. This is another indication, that the market might face further volatility over the next couple of months. However, the most concerning signals are coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly. Despite the fact that both indicators remain quite bullish from a pure signal point of view, they deteriorated significantly for the week. If this trend continues it might be also just a question of time until we see a bearish crossover signal in these two indicators. In the past, bearish readings within both indicators (together with a Global Futures Trend Index score below 60%) were mostly a reliable predictor for stronger losses down the road. Right now we are not there yet, but this is still a reason to worry right now (if we consider the speed of the deterioration). Basically, the same is true if we focus on the percentage of stocks which are trading above their mid-term oriented moving averages (100/150). In addition, we can see that our advance-decline indicators (Advance-/Decline Line Daily, Advance-/Decline Line Weekly and the Advance-/Decline Volume Line) have not shown any signs of bullish divergences yet.

Long-Term Technical Condition

So far, the long-term oriented trend of the market remains positive. Although the WSC Global Momentum Indicator decreased last week, it indicates that still 58 percent of all local equity markets around the world (which are covered by our Global ETF Momentum Heat Map) are trading above their long-term oriented trend lines. Also our Global Futures Long Term Trend Index increased once again for the week, signaling that the long-term oriented trend of U.S. equities remains intact. In addition, the relative strength of all risky markets where still holding up quite well compared to treasuries. On the other hand, we can also see that long-term market breadth is also weakening as the Modified McClellan Volume Oscillator Weekly is also about to form a rounding top, whereas the percentage of stocks which are trading above their 200 day moving average also decreased last week. Only the High-/Low Index Weekly remained nearly unchanged.

Model Portfolios

Last week, there were no changes within the WSC All Weather Model Portfolio, the WSC Inflation Proof Retirement Portfolio, the WSC Dynamic Variance Portfolio and the WSC Sector Rotation Strategy.

Bottom Line

The technical picture of the market detoriated significantly last week. Especially, the weaker readings within our mid-term oriented indicators are telling us that the latest declines could be definitely just the beginning of a longer-lasting bearish biased market environment or the beginning of a top building process. Even if we do not see further selling pressure immediately, with such weak readings across the board the upside potential of the market also looks quite capped at the moment. As a result the risk-/reward ratio is decreasing on a fast pace. On the other hand, it might be also a bit too early to aggressively short the market as there are still some bullish signals around which do not fit into the puzzle right now (plus painful volatile days are quite common in such a market environment). Consequently, there is still a chance that the current fragile market environment will transform back into a healthier set-up (albeit not our preferred scenario). However, in the end we think it is definitely time to get a more cautious strategic view. As things could change quite quickly during the week, we think it is time to place a stop loss limit at 3,315 (intraday). This stop-loss should remain in place as long as we do not see any improvements within our indictor framework. Stay tuned!