May 29. 2016

Market Review

U.S. stocks posted a solid week of gains. The Dow Jones Industrial Average closed at 17,873.22 and rose 2.1 percent over the past five days for its best week since March 18. The S&P 500 gained nearly 2.3 percent for its best week since March 4 and ended at 2,099.06. The Nasdaq surged 3.5 percent for the week to close at 4,926, its best week since February 19. All key S&P sectors ended in positive territory for the week, led by techs. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, declined to trade near 13.1.

Strategy Review

In our last week’s comment, we highlighted the fact that we remained outright cautious as we had received a growing number of evidences within our short- to mid-term technical indicators that the risk of a fast paced correction was outright high. Moreover, we highlighted the fact that from a pure contrarian point of view a stronger oversold bounce looked extremely likely and if such a move was accompanied by faltering market breadth, it would be the ultimate piece of evidence for the last burst of strength in a typical top building process. As such a typical (large-cap driven) bounce could easily overshoot in terms of price, we advised our conservative members to wait for a significant negative down-move (towards 2,020/1,995) first, before taking any actions. After we saw the predicted oversold bounce last week, no stop levels have been triggered so far. Consequently, the big question is if we see further overshooting into summer or if we should use this strength to sell. To answer that question, the quality of the bounce and of the underlying market remains key area of focus right now.

Short-Term Technical Condition

Not surprisingly, the short-term oriented trend of the market turned mainly bullish last week. This is mainly due to the fact that the S&P 500 strongly rebounded for the week and managed, therefore, to close above the bullish envelope line from the Trend Trader Index. So from a pure price point of view, the short-term uptrend of the market remains intact as long as the S&P 500 does not drop below 2.053 (bearish threshold from the Trend Trader Index). Moreover, the Modified MACD also managed to flash a weak bullish crossover signal last week, indicating that the overall trend structure of the market turned slightly positive. On top of that we can see that the gauge from the Advance-/Decline 20 Day Momentum Indicator also managed to get slightly back into bullish territory, indicating some form of positive support. Nevertheless, the indicator has formed an outright bearish divergence, as its gauge is a way too low if we consider the current levels from the S&P 500. Additionally, both envelope lines of the Trend Trader Index are still decreasing, whereas the bullish signal from the Modified MACD is a bit too weak at the moment to take it too seriously (as any stronger down-day could easily produce a sell signal again). According to our investment process, in such a situation market breadth is key area of focus as it will give us guidance if the recent bounce will turn out to be significant or just shallow in its nature.

Despite the fact that the market finished the week with solid gains, the readings within our short-term breadth indicators have been developing moderately so far. As a matter of fact, most of them are still showing a huge bearish divergence if we consider the current levels from the S&P 500! This applies in particular to the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily as both indicators did not manage to flash even a small bullish crossover signal last week. This is telling us that the underlying tape momentum of the market remains quite weak-kneed and, therefore, the recent bounce still looks quite fragile. The case is slightly different if we focus on the percentage of stockss which are trading above their short-term oriented simple moving averages (20/50). Both tape indicators rebounded quite strongly last week, but nevertheless their absolute levels should have been much higher given the fact that the S&P 500 is trading near record highs. Another concerning tape signal is coming from the NYSE New Highs ? New Lows Indicator. This is mainly due to the fact that the total amount of NYSE new highs did not spike at all, although the market is trading only a few percentage below its record high! As a consequence, the High-/Low Index Daily is forming a huge bearish divergence, although it remains bullish from a pure signal point of view.

Last week, we highlighted the fact that we would expect to see a stronger corrective bounce as we had received a growing number of evidence within our contrarian indicators that short-term pessimism among the crowd had been too extreme. Such a bounce normally relieves oversold conditions and dampens short-term pessimism before further losses can be expected. In fact, the recent bounce has slightly started to have its designated impact on short-term pessimism, which is typical pattern if the market is within a distributive top building process. Especially, the Daily Put-/Call Ratio All CBOE Options Indicator slightly started to decrease from its extreme high levels, plus market sentiment slightly improved last week. Nevertheless, most contrarian indicators from last week still remain (somehow) supportive (WallStreetCourier Index Oscillator Weekly, Global Futures Put-/Volume Ratio Oscillator Weeky, All CBOE Options Put-/Call Ratio, All CBOE Options Put-/Call Ratio Oscillator Weekly and the Equity Options Call-/Put Ratio Oscillator Weekly) and, therefore, the current bounce might continue for a while. But in our opinion the pace is likely to slow down as the market is quite overbought (Advance-/Decline Ratio Daily and the Upside-/Downside Volume Ratio Daily), plus the WSC Capitulation Index is still indicating a difficult technical market environment for the time being.

Mid-Term Technical Condition

Over the last couple of weeks, we have been quite worried about the strongly deteriorating readings within our Global Futures Trend Index since a drop below its 60 percent threshold would have told us that the risk of a fast paced correction was extremely high (of course only in combination with weak or bearish readings in mid-term oriented market breadth). Therefore, it was good to see that the recent bounce from last week caused a small recovery within that reliable indicator. Consequently, the gauge from the Global Futures Trend Index is now trading in the middle part of its bullish consolidation area and, therefore, the immanent correction risk has slightly diminished. Despite the fact that this can be seen as a quite positive development, we should not forget that the upside potential of the market remains also quite capped in such a situation (if we do not see any further positive momentum within that indicator). Therefore, the future development will be quite crucial to monitor as a new high from the S&P 500 in combination with readings below or slightly above 60 percent within the Global Futures Trend Index would be a clear indication for a suckers rally. However, if we focus on the WSC Sector Momentum Indicator, we can see that from a pure price point of view the mid-term oriented up-trend of the market remains intact. This indicates that most industries within the S&P 500 strengthened their mid-term oriented trend signal. This can be also seen if we have a closer look at our Sector Heat Map, as the momentum score of the S&P 500 added some bullish ground last week.

Apart from the quite bullish Modified McClellan Oscillator Weekly, mid-term oriented market breadth also showed some signs of recovery last week. In particular, the percentage of stockss which are trading above their mid-term oriented moving averages (100/150) reached quite encouraging levels, indicating that the broad market has started to recover. As a consequence, their gauges have also started to diminish their bearish divergence, which we worried about last week. Basically, the same is true if we focus on the Upside-/Downside Index Weekly and the Advance-/Decline Index Weekly as both gauges have stopped to deteriorate last week. Therefore, both indicators remain supportive for the time being although their absolute levels should be much higher if we consider the current level from the S&P 500. Thus, it looks like that the market does not have enough power to break substantially above its old record high and, therefore, further consolidation looks quite likely.

Long-Term Technical Condition

The long-term oriented technical picture of the market remains almost unchanged compared to last week. Finally, the Global Futures Long Term Trend Index managed to flash a small positive signal, whereas most local market indexes around the world continued to regain their footing. This is mainly due to the fact that the gauge of the WSC Global Momentum Indicator increased to 85 percent and, therefore, the recent bounce was globally in scope. Only the Global Relative Strength Index showed a negative picture last week, as the relative strength of most risky markets continued to drop. More importantly, long-term oriented market breadth also showed some signs of recovery as the percentage of stockss which are trading above their 200 day simple moving average and the Modified McClellan Volume Oscillator Weekly continued to strengthen last week. Only the total amounts of stocks which are hitting long-term oriented new highs should be much stronger if we consider the current levels from the S&P 500.

Bottom Line

Despite the fact that the latest bounce was in-line with our outlook, the improvements within some of our tape indicators have been quite surprising. Consequently, the corrective top building process could even transform back into a healthy consolidation process. Therefore, given the quite contradicting readings (especially short-term oriented trend-/breadth vs. mid-term oriented trend-/breadth), we think the up- as well as the down-side potential of the market still looks quite capped at the moment. Therefore, it could be possible that the market will drop back into its trading range, after it slightly reached a new high (if we do not see any further strength in our indicator framework). In general, such a distribution phase/trading range is always a fork in the road. Therefore, we will monitor the development of our indicator framework closely within the next couple of days/weeks to get more confirmation if the market is heading into a make- or break set-up. All in all, we would advise our conservative members to keep adjust their stop-loss limit around 2,035 as the technical condition could change quite fast. Stay tuned!