August 13th 2017

Market Review

U.S. stocks finished the week with losses. The Dow Jones Industrial Average declined 1.1 percent over the week to 21,861. The S&P 500 recorded a weekly loss of 1.4 percent to finish at 2,441. The Nasdaq lost 1.5 percent for the week to end at 6,257. Most key S&P sectors ended in negative territory for the week, led by energy. Consumer staples were the only gainers. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded near 15.7.

Strategy Review

It has been a while since we saw the last correction succeeding minus 10 percent. Back then in 2015, we saw 2 sell-off cycles, which were chronologically very close to each other. The first one started in August 2015 and ended in October 2015 and the second one started in December 2015 and ended in February 2016. In between, there was an outright strong rally which pushed the market almost to its prior high back then. In both cases, we effectively warned our members on time (see Market Comment 9th August 2015: Further ingredients for a correction at hand and Market Comment 13th December 2015: Correction risk is increasing as market breadth had to take a hard hit!) and therefore, they were able to successfully sidestep both carnages. Above all, we our indicator framework even allowed us to participate from the strong rally in between (Market Comment October 11th 2015: Bottom confirmed – Buy the dips!) and also forced us to raise exposure after the second correction had hit rock bottom (Market Comment February 21st 2016: Further bottom confirmation! Get ready to raise exposure!). Despite the fact that the market faced some critical technical situations since then, we have not changed our bullish outlooks so far nor have we not seen any stronger pullbacks since then. Maybe until now! Despite the fact that the overall market environment was slightly different (as the overall market volatility was much higher back then), we can see almost the identical developments within our indicators today. This is mainly due to the fact that we saw a fast (within just a couple of days) and stronger deteriorating of our indicators all across the board, although the S&P 500 is just trading less than two percent below its all-time high. As a consequence, most of our indicators are forming a huge bearish divergence at the moment and additionally mid-term market breadth is also showing major signs of exhaustion. This is an extremely toxic situation as the market tends to be outright vulnerable for a stronger pullback in such a situation. So even if we do not see a stronger correction immediately, we think the upside potential should be also extremely limited as well (as long as we do not see a stronger recovery within our indicator framework). As a consequence, the risk-/reward ratio is extremely low at the moment.  But let’s have a closer look at our indicator framework first.

Short-Term Technical Condition

Not surprisingly, the short-term trend of the market started to deteriorate significantly last week. From a pure price point of view, this short-term trend clearly turned bearish last week as the S&P 500 closed 22 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 2,474 (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 that short-term oriented price trend. This becomes pretty obvious if we focus on the Modified MACD, which continued to gain more bearish ground last week and therefore, 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 dropped deeply into bearish territory last week, although the S&P 500 only lost 1.4 percent for the week! As already mentioned a couple of times, the short-term oriented trend of the market is 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 price action of the momentum of the market is slowing down. 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 too much market noise (or just from a few heavy weighted stocks in the index). In other words, it will determine our degree of confidence within those trend signals. 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 or continued to deteriorate on weak levels (although the market is trading shy below its all-time high). 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, indicating 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 minus New Lows Indicator, as we have seen a pretty strong spike in the amount of new lows, whereas the amount of new yearly highs remains outright depressed! Consequently, the High-/Low Index Daily flashed a serious bearish crossover signal, although it had traded at solid bullish levels two weeks ago. Thus the chances for a healthy 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) dropped deeper into bearish territory. To be more precise, right now there are only 23/30 percent of all NYSE listed stocks which are trading above their 20/50 days moving average and these readings are far away confirming the current levels from the S&P 500! So all in all, given the outright bearish short-term oriented market breadth structure of the market, we do not believe that the market has enough power to remain on those levels or that any upcoming oversold gains (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) will be sustainable in their nature.

From a pure contrarian point of view, the recent decline/tensions caused a lot of fear in the market as the NYSE Short Interest Ratio and the amount of puts have soared recently. As a matter of fact most of our option based indicators flashed a buy signal last week (Global Futures Put-/Volume Ratio, Global Futures Put-/Volume Raito Oscillator and the Equity Options Call-/Put Ratio Oscillator Weekly). Above all, we can see that the market is quite oversold at the moment (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily) and therefore, (from a pure contrarian point of view) a stronger and oversold bounce (even slightly below or above the latest high) cannot be ruled out (only). Given the outright weak market breadth structure, such a bounce would be a classical bull trap/suckers rally as the price information of such a move would cause a lot of greed among dumb money again. This would coincide with the fact that our reliable Smart Money Flow Index has definitely not confirmed the latest high from the Dow. Above all, we can see that the market is also facing cyclical headwinds as the Presidential Cycle indicates a major top in August!

Mid-Term Technical Condition

Another reason why we believe that the market is highly at risk for a stronger pullback is clearly 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 20 percentage points for the week and closed at 60 percent! This is exactly at the threshold of the bearish consolidation area. If this trend continues it is just a question of time until we see a drop of this reliable indicator below 60 percent. If this is the case, the risk of a fast paced correction is extremely high (of course only in combination with weak or bearish readings in mid-term oriented market breadth). Right now we are not completely there yet (just from a pure signal point of view) but nevertheless, it is definitely time to get a cautious stance as the gauge could easily drop very fast below this important threshold within days. 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! Not surprisingly, from a pure price point of view, the mid-term oriented uptrend of the market still remains intact as the WSC Sector Momentum Indicator keeps trading at solid bullish levels so far. This indicates that most sectors within the S&P 500 are still in a mid-term oriented up-trend. This can be also seen if we focus on our Sector Heat Map as the momentum score of all sectors (except energy like in the previous weeks) keeps trading above the one from riskless money market (currently at 12.2 percent).

Another reason why we believe that the market is at risk (to hit an important top) is due to the fact that also our entire mid-term oriented tape indicators deteriorated all across the board 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) closed significantly below their bullish threshold. 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. As a matter of fact, the current price information from the S&P 500 is definitely misleading. However, the most concerning signals are coming from the Advance-/Decline Index Weekly and the Upside-/Downside Volume Index Weekly, as both indicators turned bearish last week. This is a quite serious technical signal, if we consider the fact that the market just lost 1.4 percent and that both indicators were trading at confinable bullish levels last week. Moreover it tells us that a lot of purchasing power was pulled out of the market last week and therefore, the market internals have now definitely a bearish tilt. In the past, bearish readings within these indicators (in combination with a bearish Global Futures Trend Index) mostly led to a stronger correction or forced the market at least into a longer-lasting top-building process. Consequently, we remain pretty cautious at the moment.

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. This is mainly due to the fact that the WSC Global Momentum increased in the last weeks and now indicates that 88 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 (except commodities) 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.

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 Inflation Proof Retirement Portfolio, WSC All Weather Portfolio and the WSC Global Tactical ETF Model Portfolio. As the momentum score of materials dropped below average and below the one from the S&P 500 within our Sector Heat Map, we received a buy sell signal for that ETF within our WSC Sector Rotation Strategy.

Bottom Line

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 (as only a few large-caps are holing up quite well whereas the broad market is already faltering). As a matter of fact, the risk for stronger disappointments is extremely 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) looks like it will not be not sustainable in its nature. As capital appreciation is the most important driver for long-term success, we think the current risk/reward ratio of being invested is definitely now too low. As a consequence, we would advise our conservative members to stay on the sidelines until we see at least some positive improvements in our indicator board again. Aggressive traders should go short, if the S&P 500 drops below 2,435 and should increase their exposure if we see further down testing below 2,420/2,400.

Stay tuned!