February 4th 2018
U.S. stocks finished the week in negative territory with the main benchmarks posting the steepest weekly losses in about two years. The Dow Jones Industrial Average slumped 4.1 percent over the week to 25,520.96. The S&P 500 recorded a weekly loss of 3.9 percent to finish at 2,762.13. The Nasdaq lost 3.5 percent for the week to end at 7,240.95. The weekly declines for the S&P 500 and the Dow were the largest since the week ending Jan. 8 2016, while the drop for the Nasdaq was the biggest since the week ending Feb. 5, 2016. All key S&P sectors ended in negative territory for the week, led by energy. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 17.3.
Short-Term Technical Condition
Despite the fact that we expected some kind of consolidation period or a stronger washout day, the magnitude of the latest declines turned out to be quite surprising. However, from a pure price point of view, the short-term trend clearly turned bearish last week. This is due to the fact that the S&P 500 closed 28 points below the bearish threshold from the Trend Trader Index. Consequently, the short-term oriented price trend of the market remains bearish as long as the S&P 500 does not close above 2,811 (upper threshold from the Trend Trader Index). Nevertheless, from a pure structural point of view, the short-term oriented price trend of the market has not completely broken yet, as both envelope lines of the Trend Trader Index are still holding up quite well. The situation looks quite different if we analyze the underlying momentum of this short-term oriented price trend. This becomes quite obvious if we focus on the Modified MACD, which flashed a very strong bearish crossover signal last week. This signals that further down-testing can be expected. Basically, the same is true if we focus on the Advance-/Decline 20 Day Momentum Indicator as its gauge plunged deeply into bearish territory last week! But the short-term oriented trend of the market is only a limited picture about the current condition of the market. Therefore, it is not unusual that some/all of our short-term oriented trend indicators tend to deteriorate after a strong wash-out day. In such a situation, short- to mid-term market breadth will give guidance if the current short-term oriented bearish trend will lead to further stronger losses or if was only caused by a handful of a few heavy weighted stocks in the index. So if short- to mid-term market breadth remains strong, the impact of a short-term oriented trend-break should be pretty limited.
Unfortunately, this is not the case right now as our entire short-term oriented market breadth had to take a hard hit during the last couple of trading sessions. Especially, the short-term gauges from the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily continued to show major signs of exhaustion and plummeted significantly. This indicates that the underlying momentum and volume of advancing stocks on NYSE literally collapsed. This picture is now also widely confirmed by the NYSE New Highs – New Lows Indicator, as we have seen a quite strong spike in the number of new lows, whereas the number of new yearly highs dropped significantly! Consequently, the High-/Low-Index Daily flashed a serious bearish crossover signal, although it had traded at solid bullish levels one week ago. Thus, the chances for a healthy (and sustainable) rebound are extremely low at the moment. On top of that it also tells us that the latest decline was driven by the whole market and was not only caused by a few heavy weighted stocks within the S&P 500! As a matter of fact, it was also not a big surprise that the percentage of stocks which are trading above their short-term oriented moving averages (20/50) slumped deeper into bearish territory. To be more precise, right now there are only 21/40 percent of all NYSE listed stocks which are trading above their 20/50 days moving average! So in the end, most of the selling pressure was coming from the broad market rather than from a few large-caps, and therefore, it is a way too early to bet on a sustainable bullish trend-reversal (at least for the time being).
From a pure contrarian point of view, the recent decline/tensions caused a lot of fear in the market as we saw a 9-to-1 down-day (which indicates a selling climax). After such an event, the market tends to rebound for a couple of days before further losses can be expected. In addition, the market is becoming increasingly oversold (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) and given the bullish signal from the Global Futures Bottom Indicator an oversold bounce is likely. Nevertheless, the upside potential of any potential bounce should be quite limited as the option market is still a way too optimistic in our point of view.
Mid-Term Technical Condition
Another reason why we believe that the market is at risk for further disappointments is due to the fact that the mid-term oriented condition of the market also deteriorated significantly last week. This is mainly because the gauge from the Global Futures Trend Index dropped almost 25 percentage points for the week and closed at 59 percent! This is already in the bearish consolidation area and below the very important threshold of 60 percent. In such a case, the technical condition of the market is highly at risk for further disappointments: of course only in combination with weak or bearish readings in mid-term oriented market breadth. As this is already the case, it is definitely time to get a cautious stance. So even if we do not see a stronger pullback immediately, as long as the gauge of this indicator remains near or below 60 percent (in combination with weak mid-term market breadth), the upside potential of the market should be limited as well! This means that any upcoming relieve rally might be just part of a larger distribution top. This would coincide with the fact that the WSC Sector Momentum Indicator still remains quite bullish for the time being. In other words, the latest decline had no impact on the pure mid-term oriented price-trend of the market. This can be also seen if we focus on our Sector Heat Map as the momentum score of all sectors (except utilities like in the previous weeks) keeps trading above the one from riskless money market (currently at 5.6 percent).
Another reason why we believe that the market is about to enter a top building process is due to the fact that also our entire mid-term oriented breadth indicators deteriorated last week. Especially, our Modified McClellan Oscillator Weekly rolled over into bearish territory last week and also the percentage of stocks which are trading above their mid-term oriented simple moving average (100/150) dropped and closed significantly below their bullish threshold (100). This indicates that the underlying trend momentum of the market turned clearly bearish, plus most of all NYSE listed stocks are definitely not in an uptrend anymore. However, the most concerning signal is coming from the Advance-/Decline Index Weekly, as it clearly turned bearish last week. This indicates that a lot of purchasing power was pulled out of the market last week, and therefore, the market internals have now a more bearish tilt. On the other hand, we can see that the Upside-/Downside Volume Index Weekly still remains quite supportive, which would undermine our view that the market has entered an intermediate but corrective but top building phase.
Long-Term Technical Condition
On a very long-time frame, the technical picture of the market remains bullish at the moment, and therefore, we do not think that a stronger correction should lead to a new bear market at the moment. The WSC Global Momentum is still trading in solid bullish territory and indicates that 85 percent of 35 local equity markets all around the world (which are covered from our Global ETF Momentum Heat Map) are still in a long-term oriented up-trend at the moment. Moreover, it was good to see that the readings from the Global Futures Long Term Trend Index also showed some solid levels last week. This can be also monitored if we focus on the Global Relative Strength Index, as the relative strength of all risky markets keeps trading far above the one from U.S. Treasuries. Nevertheless, we can also see some exhaustion in long-term market breadth, as the readings from our entire long-term oriented tape indicators (High-/Low Index Weekly, Modified McClellan Volume Oscillator Weekly and the percentage of stocks which are trading above their 200 day moving average) weakened last week. This might be another piece of evidence that the market looks vulnerable on a short- to mid-term time horizon.
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 Inflation Proof Retirement Portfolio, WSC All Weather Portfolio and the WSC Global Tactical ETF Model Portfolio. As the momentum score of energy and materials dropped below average and below the one from the S&P 500 within our Sector Heat Map, we received a sell signal for those ETFs within our WSC Sector Rotation Strategy.
Although the market only trades just a few percentages below its all-time high, we think it is time to get a more cautious stance at the moment. As mentioned above, the current technical condition of the market looks extremely damaged at the moment, and therefore, the risk for further disappointments remains pretty high at the moment. However, even if we do not see a stronger pullback immediately, we think the upside potential of the market looks extremely limited. Consequently, any upcoming (large-cap driven) oversold and contrarian driven bounce (even towards new highs) would only be part of a larger top building process. In other words, even if we do not see further selling pressure ahead, the market has now definitely a corrective tilt. Since capital appreciation is the most important driver for long-term success, we think it is time for our conservative members to place a stop-loss limit around 2,690 (as we would like to see a move below that important threshold before we finally issue a strategic sell signal).