The predictions for profit taking from numerous analysts have all proven wrong. Just because it has been 489 days since the last 5% decline on the S&P it does not mean another one is imminent even though the average is twice a year. Conventional wisdom suggests that historical trends will eventually reappear but the major indexes are ignoring that possibility.

With earnings growth rising, the economy rising, interest rates rising exceedingly slowly, the global economy rising and tax reform becoming a daily headline, it would appear there are no roadblocks for the rally. Personally, I believe that when everything looks too good to be true, it normally is.

Many investors have gone broke betting against an existing trend whether that trend was bullish or bearish. Trends can and do continue far longer than analysts expect. Market analysts tend to focus on the wave theory. The markets rise and fall in a pattern similar to waves regardless of the direction of the overall trend. Bullish markets can gain hundreds of S&P points but nothing moves in a straight line. There are days of gains and days of weakness but the overall trend is positive.

The problem with the current market is that those waves have disappeared. There may be a couple days where the indexes lose a handful of points but there has not been any real selling on the Dow and S&P since August. Everyone expects another decline to appear but the Dow just keeps going and going.

Portfolio managers are afraid to enter new positions or add to old ones but they are also afraid of missing the boat and having a competing fund manager outperform them. They are forced to buy every minor market hiccup and that prevents any real retracements from occurring.

Eventually we are going to see some actual selling that overpowers the dip buyers. The sooner the better because there is a lot of money on the sidelines waiting for a real buying opportunity. If we saw a sudden 3% decline over several days, it would recharge the market and allow us to move to even higher highs.

This coming week is typically when the post earnings depression phase appears. Traders are closing positions in stocks they held before earnings and looking for new stocks that have not reported. This happens every week of earnings season but starting this week there are significantly fewer stocks to play that have not reported. Roughly 407 S&P stocks have already reported and another 49 report this week. The remaining 46 are smaller companies and their earnings will be stretched out over the next month.

This scenario produces sellers but not as many buyers. Investors are going to be more cautious about where they put their money with the market at new highs and the intraday volatility growing. The lengthening of the intraday candles is an expression of indecision and a lack of market conviction.

The Nasdaq Composite has had 6 material dips since early May. The summer volatility gave way to a fairly sustained up trend starting in late August with only 2 minor dips of about 1.5% each. In the chart below note the size of the candles compares to the Sept/Oct candles. We went from small gains/losses to major moves starting the prior Friday. That returning intraday volatility is indecision and short covering. That is not a million investors suddenly wanting to own big cap tech stocks at new highs.

A decent 3% decline on the Nasdaq would put it back around 6,550 and that would be a buying opportunity. It would not damage the bullish trend since we survived several of those declines in Jun/Jul/Aug.

It would also fill the gap from Oct 27th when the Nasdaq gapped open from 6,555 to 6,708. That gap needs to be filled. I say "needs to be filled" because the vast majority of gaps are always filled and the sooner it happen the less damaging to the market. The July gap was not filled until mid August and it was a 271-point decline.

The Dow gained only 22 points on Friday and the top 3 gainers added 54 Dow points. The Dow has lost its momentum because 25 Dow components have already reported earnings and there is nothing left to provide lift. Disney reports after the bell on Thursday so no earnings lift for the first 4 days of the week and Disney is more likely to be a drag than a lift.

Initial support is around 23,340 followed by 23,250.

The S&P is not showing the surges and the progress other than the prior Thr/Fri has been rather calm. The index is pulling away from prior uptrend resistance, which is now support. Based on the chart the S&P could continue higher one small step at a time. The lack of any material earnings this week and next could hinder its gains.

Initial support is back at 2,555-2,565.

The small cap indexes are still struggling. The S&P-600 closed at a 5-week low and right on the verge of a potential breakdown. The S&P-600 is a managed index where each stock is chosen for inclusion into the index. This is more representative of the quality small cap stocks rather than the lump sum inclusion of 2000 stocks into the Russell 2000 on market capitalization alone.

The Russell is more of a broad market index that has a lot of small cap stocks included.

Both are flashing warnings if the consolidation patterns fail and support levels break.

The earnings calendar is shrinking but there are still some big caps left to report. Priceline, Monster Beverage, AstraZenaca, Nvidia and Dow component Disney are the highlights for the week.

The economic calendar is void of any material reports. After last week's tsunami of events, this is like a holiday week.

We are also approaching tax loss selling season. This is where investors sell losers to offset gains in their winners or take advantage of their losses to sell winners and reduce their tax liability. The key word in that sentence is sell. There are multiple reasons why investors restructure their portfolios before the end of the year and November is the month. They want to be repositioned to take advantage of any ramp into Q4 earnings in January.

I would be cautious about buying any dip this week. If one appears, I would not buy it on the first day. Eventually we will see some weakness that last more than a day or two and that will be a buying opportunity. Look for support to appear and then buy a rebound.

Enter passively, exit aggressively!

Jim Brown

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