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Market Summary

U.S. stocks plunged Thursday and Friday, capping a week of carnage that sent the Dow Jones Industrial Average into correction territory as fears about China's economy and global growth spurred heavy selling. The main indexes posted massive one-day selloffs and their biggest weekly declines in nearly four years. The selloff wiped out some $1.3 trillion in U.S. market value since Tuesday morning, according to a calculation by Yahoo Finance using the Dow Jones U.S. Total Market Index. Reuters reported that fears of a China-led global economic slowdown drove Wall Street to its steep one-day drop on Friday and left the Dow industrials more than 10 percent below its May record. Wall Street's selloff this week suggested investors are growing nervous about paying high prices for stocks at a time of minimal earnings growth, tumbling energy prices and an expected rate hike by the U.S. Federal Reserve that could gradually usher the end of almost a decade of easy money.

Treasury securities were the only major asset class to move higher last week. The S&P slumped 5.8% for the week, its biggest weekly decline since September 2011 and posted no new 52-week highs for the first time since Aug. 8, 2011. The index lost more than $1 trillion of its value this week, according to S&P Dow Jones Indexes. For the week, the Dow also dropped 5.8% and the Nasdaq tumbled 6.8%. The S&P 500 and Nasdaq have breached their 200-day moving averages. For many technical analysts, breaching of those levels means further declines. The Russell 2000 index also moved into correction territory, marking a 10% decline from its most recent closing high on June 23. Trading volume was heavy, with about 10.6 billion shares traded on U.S. exchanges, well above the 6.75 billion average this month, according to BATS Global Markets.

YTD Performance

The venerable Dow Theory, the oldest stock market timing system that remains in widespread use today, flashed a "sell" signal at Thursday's close. The Dow Theory was introduced gradually over the first three decades of the 20th century in editorials in The Wall Street Journal by its editor at the time, William Peter Hamilton. The three preconditions for a "sell" signal that he set out are:

  • Both the Dow Jones Industrial Average and the Dow Jones Transportation Average must undergo a significant correction from joint new highs.
  • In their subsequent significant rally attempt following that correction, either one or both of those Dow averages must fail to rise above their pre-correction highs.
  • Both averages must then drop below their respective correction lows.

As circled in the chart below, the DOW Industrials and Transports are crashing to confirm the current downtrend.

Dow Jones Industrial Average Daily Chart

The dollar finished lower for the second week in a row Friday as plunging U.S. stocks pushed volatility to uncomfortable levels, forcing investors to reevaluate their expectations for the timing of the first Federal Reserve interest-rate hike since 2006. The monetary policy divergence trade, the notion that the Federal Reserve is tightening monetary policy while other central banks remain in easing mode has helped the dollar appreciate over the past year. "We are seeing a lot of fear on Wall Street, but at the same time, investors are not running to Treasuries and gold, said Jim Paulsen, chief investment strategist & Economist at Wells Capital Management. Treasury yields dropped Friday for a third straight day amid concerns about a global growth slowdown. Thursday and Friday marked Thursday the largest two-day decline since Aug. 3. Treasury yields fall when bond prices rise and vice versa. Gold futures settled at a more than six-week high on Friday to score their biggest weekly gain since January as a slump in equities and a drop in the U.S. dollar buoyed the metal's investment appeal. The yellow metal settled at its highest level since July 8 as U.S. stocks sank and the U.S. dollar tumbled.

UUP Daily Chart

The Dollar and Commodity Indexes usually have an adverse relationship where they move in the opposite direction. The dollar, typically a safe-haven currency in times of uncertainty, remained under pressure after Federal Reserve minutes released Wednesday seemed to lower the likelihood the Fed will raise near-zero interest rates in September. Normally, you would expect commodities to rise when the dollar falls, but sinking energy prices continues to drag down the Commodity Index. U.S. crude dipped below $40 a barrel for the first time since the 2009 financial crisis and a wide range of commodities have been hammered this year as demand for raw materials has cool off.

US Dollar Index Daily Chart

Market Outlook

Markets began falling last week after China announced a surprise devaluation of its currency. Investors have interpreted China's move as a sign that flagging growth in world's second-largest economy could be worse than government reports suggest. Investors pointed to other reasons behind the recent sell-off, such as falling prices for oil and other commodities as well as the relatively high prices investors pay for U.S. stocks compared with corporate earnings. "All of this is coming at a time when we haven't had a correction in years. The last time the market slipped into a correction was in October 2011. Until recently, investors seemed willing to shrug off any negative news, confident that low interest rates from the Federal Reserve and rising corporate profits would continue pushing stocks higher. As a result, pullbacks were considered buying opportunities and the market would roll on its six-year run. The S&P 500 has more than tripled in value since the financial crisis. What is now so disconcerting is that when stocks sell off, volumes are higher than normal, and when prices go up, the volume slips.

Next week, investors will focus on housing data, which has been strong of late, and the preliminary reading of second-quarter GDP, which could lead investors back towards riskier assets if they point to an improving U.S. economy.

Performance since July 1

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. The current Momentum Factor ETF indicates the market is ready for a countertrend bounce. As highlighted, the strength indicator is grossly oversold, plus its long-term support line holds up the current MTUM pullback. Also note the Momentum Factor ETF ended exactly at its 200-day SMA, which should provide further support.

MTUM Daily Chart

Doing further analysis by evaluating the Momentum Factor ETF weekly chart supports the analysis that prices are due for a rebound. As highlighted in the chart, the MTUM is displaying technical reversal signals at its 50 Week SMA. Notice how every time the ETF falls to the SMA it recoils higher.

MTUM Weekly Chart

The CBOE Volatility Index (VIX) is known as the market's "fear gauge" because it tracks the expected volatility priced into short-term S&P 500 Index options. When stocks stumble, the uptick in volatility and the demand for index put options tends to drive up the price of options premiums and sends VIX higher. Last week we said, "...Option traders have been relying on a 'Buy the Dip' scenario but the bounces higher have become thinner, which may be signaling a market top..." The updated chart below confirms this analysis as the VIX surged to its largest ever-weekly percentage increase as the major stock indexes sold off for four straight days.

VIX Daily Chart

Volatility spiked this month after China surprisingly devalued its currency. The CBOE Volatility index on Friday surged to levels not seen since December 2011. The VIX exploded more than 47% to 28.21 at Friday's close. For the week, the index is up nearly 120%, making it the largest weekly percentage jump in the VIX's history, according to FactSet data. The previous largest surge was back in early May 2010, when the VIX jumped nearly 86% on the week.

VIX Daily Chart 2

Put/Call Ratio is the ratio of trading volume of put options to call options. The Put/Call Ratio has long been viewed as an indicator of investor sentiment in the markets. Times where the number of traded call options outpaces the number of traded put options would signal a bullish sentiment, and vice versa. Technical traders have used the Put/Call Ratio for years as an indicator of the market. Most importantly, changes or swings in the ratio are seen as instances of great importance as this is commonly viewed as a change in the tide of overall market sentiment. Recently, we have been reporting "...The current Put/Call Ratio is extremely bearish as traders have invested heavily in put contracts to play the current market downtrend..."

Total Put/Call Ratio

The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 8/19/2015. The most recent AAII survey showed 26.80% are Bullish and 39.80% Bearish while 33.30% of investors polled have a Neutral outlook for the market for the next six months. Retail investors are sitting on the sidelines along with professional money managers. The current AAII survey contra-indictor signal indicates the market is oversold and due for a countertrend bounce.

AAII Sentiment

The Nation Association of Active Investment Managers (NAAIM) Exposure Index represents the average exposure to US Equity markets reported by NAAIM members. The blue bars depict a two-week moving average of the NAAIM managers' responses. As the name indicates, the NAAIM Exposure Index provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks. The current survey result is for the week ending 8/19/2015. Second-quarter NAAIM exposure index averaged 72.84%. Last week the NAAIM exposure index was 48.08%, and the current week's exposure is 41.48%. The current equity exposure is near all-time lows. Money managers usually take vacation during this slowest trading period of the year and algorithmic traders take over. Traders sitting on the sideline precipitated the market's current correction. Lack of participation equates to lack of buyers to bid up stocks when sellers start selling.

NAAIM Exposure Percent

Trading Strategy

The end of last week culminated in the worst rout of the year for U.S. markets. A bunch of analysts hinted a decline was a long time coming, precipitated by weak corporate earnings, a global economic slowdown and concerns over higher borrowing costs as the Federal Reserve prepares to raise official interest rates. As U.S. stocks suffered four consecutive days of losses, cyclical shares took the heaviest losses on the week, while defensive holdings were spared the worst of the selling. The energy, technology, and financial sectors fell by the widest margins, while the utilities, telecommunication and health-care sectors fell the least. You can see in the graph below that Utilities is the only sector with a positive return over the past month, as they offer the best yields in the current low interest rate environment.

The bottom line is that investors would be smart to get defensive now, because stocks are in a confirmed downtrend with no indication when it will reverse. After years of high correlation and stocks moving in lockstep, good stock pickers will be ahead of the pack. Don't panic and try to time the market's swings, said Quincy Krosby, market strategist for Prudential Financial. "The difficult thing is it's easy to get out of the market, but it's difficult to get back in," she said. "You can take the money out now, and then you sit and wonder 'wait a minute is the market going to go up?'"

S&P500 Sector 30-Day Performance

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