June 14th 2020
U.S. stocks wrapped a volatile week and due to single strong down-day, all three major U.S. averages finished the week finally in negative territory. On Thursday, all major indices recorded their biggest one-day losses since mid-March, posting declines of at least 5%. In the end, the Dow Jones Industrial Average declined 5.5% over the week to 25,605.54. The S&P 500 recorded a weekly loss of 4.7% to finish at 3,041.31. The Nasdaq shed 2.3% for the week to end at 9,588.81. 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 36.1.
In our last week’s market comment we expected to see some form of nasty washout day since most of our sentiment driven indicators had goon too far. Although the recent sell-off was in line within our expectations, the magnitude of the recent washout days turned out to be quite strong. Consequently, the big question is if we stick to our strategic bullish view which is already in place since late March (see Market Comment March 29th 2020: Further bottom confirmation! Time to raise exposure again) or is it now time to get more cautious?
Short-Term Technical Condition
Although the washout day was quite strong in terms of price, the overall impact on the readings of our short-term oriented trend indicators could have been by far worse. This is mainly due to the fact that the short-term oriented price trend of the market just turned from outright bullish to neutral (as the S&P 500 closed exactly between both envelope lines of the Trend Trader Index on Friday). Consequently, the recent sell-off was within statistical expectations if we consider the parabolic advance the week before. Thus – from a pure price point of view – the short-term oriented price trend of the market should remain supportive as long as the S&P 500 does not drop below 3,022. This also explains the fact that both envelope lines of the Trend Trader Index are still drifting higher on a quite fast pace, which is still another quite constructive price driven signal for now. On top of that we can see that the gauge from the Advance-/Decline 20 Day Momentum Indicator even succeeded to increase strongly for the week (although the S&P dropped 4.7% in that time). Thus, this reliable leading indicator showed a strong bullish divergence to the broad index, indicating that the washout-day can be still classified as a healthy breather (at least for now). The only negative signal is coming from a small bearish crossover signal in our Modified MACD. This is telling us that the trend momentum of an ongoing price trend is deteriorating. This signal often occurs when the price action of the market is slowing down or if the market is taking a breather (especially after a stronger and quite impulsive up-move). Consequently, we are not taking a negative Modified MACD too seriously as long as our other short-term oriented indicators remain quite supportive. The main rationale behind that fact is that the short-term oriented trend of the market shows only a limited picture about the current condition of the market (as it includes a lot of noise). Therefore, it is not unusual that some/all of our short-term oriented trend indicators tend to deteriorate, when the market has to digest sentiment driven washout-days. 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 it was only caused by too much market noise (profit taking or just from a few heavy weighted stocks in the index). In other words, it will determine our degree of confidence within these trend/momentum signals. If short- to mid-term market breadth remains strong, the impact of a short-term oriented trend-break should be quite limited in price and time. In normal circumstances, a consolidation period/sentiment driven washout-period is a healthy one as long as short-term to mid-term market breadth remains supportive or is at least forming some bullish divergences. In such a case, any short-term oriented trend break can be ignored as the market is just taking a (healthy) breather within an ongoing uptrend. Otherwise, it is highly likely that such a consolidation period is just a harbinger of a more significant pullback/correction.
From a current point of view, short-term market breadth still looks quite bullish biased although the recent washout-day was indeed above average in terms of price. Although the short-term gauges of the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily have lost some momentum recently, both indicators are far away from being bearish. This is telling us that the underlying breadth momentum of advancing issues and advancing volume remains strong. Consequently, the latest weaknesses can be still described as a healthy breather rather than being the result of a broad-based selling pressure. This can be also seen if we focus on the percentage of stocks which are trading above their short-term oriented simple moving averages (20/50). Even though the first one (SMA 20) dropped slightly below its bullish threshold, the second one (SMA 50) was holding up extremely well. If we consider the magnitude of the latest decline in combination with the quite bullish signal on a 50 days time period, we can be quite sure that the latest sell-off was only triggered by profit taking, rather than being the result of broad based selling pressure. This can be also seen if we focus on the NYSE New Highs/New Lows Indicator, as we have only seen a reduction in yearly new highs but not a bearish spike in new lows so far. As a matter of fact, the bullish signal from the High-/Low Index Daily remained unchanged (although it has lost a bit bullish momentum recently). So all in all, the underlying tone still remains quite supportive and, therefore, it might be a bit too early to get too concerned for now. Nevertheless, we can also not ignore the fact that the amount of new highs should be stronger if we consider the current levels of the S&P 500. As a matter of fact, it could be possible to see some form of volatile consolidation period ahead, although the underlying tone should remain bullish.
On the contrarian side, we can see that the latest washout-day has started to have its designated impact on short-term optimism. As already mentioned several times, when sentiment is getting too extreme in combination with strong bullish readings across the board, nasty washout-days are quite common. Although these days are hard to time, they relieve overbought conditions and dampen short-term optimism, which is then the basis for further growth. Indeed, the latest washout-day relieved overbought conditions (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) and triggered a strong spike in put options, indicating a lot of fear among market participants. Consequently, most of our option-based indicators softened their bearish signals (All CBOE Options Put-/Call Ratio, WSC Put-/Volume Ratio, Equity Options Put-/Call Ratio Oscillator, All CBOE Put-/Call Ratio Oscillator) although all of them are still quite bearish from a pure signal point of view. As a matter of fact, we would not be surprised to see further down-testing into expiration next Friday, to wipe out all these massive amount of call options. On the other hand, we can see that the WSC Capitulation Index still indicates a risk-on market environment, plus there is still enough purchasing power around to drive prices higher (AII Bulls & Bears survey), once the dust settles. Consequently, we would not be surprised if the market will run into a minor low next week before further gains can be expected.
Mid-Term Technical Condition
Another major reason why we believe that the underlying tone remains bullish is because the mid-term-oriented trend-condition of the market remains well intact. As a result, it is still a way too early to get bearish from a pure strategic point of view, although a period of increased volatility is likely. To be more precise, the Global Futures Trend Index is still trading in outright bullish territory and above the 90% threshold. In such a situation, any (sentiment driven) pullback tends to be limited in price and time since it has not the power to trigger a longer lasting trend reversal. This view is also confirmed from a pure price point of view, as the WSC Sector Momentum Indicator increased once again for the week. This is indicating that most sectors within the S&P 500 remain in a mid-term-oriented uptrend (although the S&P 500 lost almost 5% for the week). This can be also seen if we examine our Sector Heat Map as the momentum score of riskless money market dropped by almost 10 percentage points during the week to 6.2% (the lowest level for months). All these facts are another indication that the underlying trend-force remains quite strong (and, therefore, our strategic bullish view remains unchanged).
This view is also widely confirmed by mid-term-oriented market breadth, which still shows a quite healthy picture for now. Especially, the Modified McClellan Oscillator Weekly continued to widen its bullish gap last week, indicating that the overall tape momentum remains positive for the time being. Probably the most important mid-term-oriented tape signal is the fact that mid-term oriented advancing issues as well as mid-term oriented up-volume were holding up quite well last week. This is showing that the demand on NYSE remains quite bullish, although we saw a stronger down-day last week. Consequently, the mid-term-oriented tape condition of the market still looks quite healthy for the time being. We would be surprised to see another significant and sustainable correction with such bullish readings in both indicators and readings above 60 percent in our Global Futures Trend Index. However, the only weaker signals are coming from our advance-decline indicators and from the percentage of stocks which are trading above their mid-term oriented simple moving average. The first ones are showing a quite mixed picture in some extend (Advance-/Decline Line Weekly, the Advance-/Decline Line Daily and the Advance-/Decline Volume Line) and the latter ones (100/150) dropped for the week. However, given the quite supportive mid-term-oriented signals across the board, we think it is too early to turn bearish from a pure strategic point of view.
Long-Term Technical Condition
The long-term oriented trend of the market shows nearly the same picture as in the previous week. Our Global Futures Long Term Trend Index, which has been decreasing for weeks, continued its bearish ride. This is indicating that the long-term oriented trend of U.S. equities remains bearish for the time being. A small positive sign, in contrast, is coming from our WSC Global Momentum Indicator which was holding up quite well – especially if we consider the fact that a few weeks ago its gauge was trading at the absolute bottom. In more detail, this gauge indicates that 32.3% of all local equity markets around the world – which are covered by our Global ETF Momentum Heat Map – managed to get back above their long-term oriented trend lines. If we focus on the WSC Global Relative Strength Index, we can see that they remained nearly unchanged compared the previous week. Our long-term oriented tape indicators show a quite intermingled picture. While High-/Low Index Weekly strengthened and the Modified McClellan Volume Oscillator Weekly even managed to flash a bullish crossover signal, the SMA 200 dropped significantly.
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.
Even though further sentiment driven consolidation/down-testing could not be ruled out into expiration next week, there is no major reason to change our strategic bullish view for now. To be more precise, with quite supportive/bullish readings (especially on a mid-term time perspective), any upcoming weaknesses should turn out to be limited in price and time. Thus, it is definitely a way too early to get concerned about the latest price action we saw. A fact that can be also observed if we focus on our Big Picture Indicator, which is still moving around it its bullish quadrant. As long as this is the case, and as long as we do not see any negative spikes in new lows, in combination with a strong weakening Global Futures Trend Index, any upcoming pullback should turn out to be limited in price and time. Hence, we would advise our conservative members to hold their equity exposure, whereas aggressive short-term traders should remain also bullish as long as our short-term oriented indicators remain supportive.