The S&P made a new high on Friday but only by 2 points. Even that minor amount was unexpected.

The dip buyers were out in force on Friday and it was probably a combination of shorts covering and portfolio managers buying the dip to keep the market from running away from them. Markets do not tend to rally on Fridays but all the major indexes finished in the green. The Nasdaq was up a decent amount to end right at the beginning of a resistance band at 5,100. That could be some serious resistance with traders reluctant to buy with so many high profile tech stocks reporting earnings this week. The potential for a disaster or two is very high. We already saw a monster decline in Netflix. If Amazon, Apple or Google repeated that disappointment the tech sector could be knocked for a loss.

Whatever the reason the market gains basically recovered Thursday's losses but failed to really push the indexes higher. I am not surprised portfolio managers would be reluctant to put money to work ahead of the weekend event risk.

The big mover on Friday was the Dow Transports ($TRAN). The index bounced off resistance at 8,000 on Wednesday with a big loss on Thursday. The index rebounded from that decline and closed at 7,965 and very close to a breakout over that 8,000 level next week. That would be bullish for the Dow industrials and confirmation of a broadening of the overall rally. The spike in the dollar pushed oil down to $44.25 and that is bullish for the transports, with the exception of the railroads. American Airlines (AAL) also posted strong earnings despite falling revenue per mile and that helped the airline sector.

With oil prices plunging and now expected by many to dip back into the high $30s I would have expected a bigger decline in the energy stocks. The Energy Select SPDR (XLE) has been battling resistance at $70 since last August. Even with crude oil down the XLE actually posted a minor gain on Friday. Short covering maybe? The dip in crude prices is expected to accelerate the closer we get to Labor Day and the end of the driving season. Oil prices normally peak in August but the big production outages earlier in the summer, led by the Canadian wildfires, pulled the peak forward and the next couple of months could be rocky for prices.

The oil/dollar correlation continues as you can see in this chart. The dollar is spiking higher and oil prices are collapsing. Add in the return of the oil glut and the new glut in refined products and the outlook for oil prices is negative.

The financial sector is also struggling with resistance at $23.70 on the XLF. The financials have reported decent earnings but their fundamentals are shrinking. The very low interest rates and the slowdown in trading for everything except currencies and bonds has put a damper on guidance. With $13 trillion in overseas bonds trading with a negative yield and lingering uncertainty over the actual Brexit damage, the banks cannot catch a break. They did pass the stress tests and got approval for buybacks and dividend increases but other than the post Brexit bounce the sector has stalled again. I do not know why investors are so bearish about banks that routinely make $5 billion a quarter in profits.

The chip stocks are leading the Nasdaq higher. The Semiconductor Index ($SOX) is only 4 points below its historic high at 746.08. The index has been banging on that resistance high level all week and Friday was the highest close. This came despite disappointing earnings from Intel and a sharp drop in Intel shares.

The percentage of S&P stocks over their 200-day average rose to 79.4% and the highest level since December 2014. On Friday an analyst, whose name I forgot, said whenever the percentage moves over 80% it suggests the rally has legs and could run for several more weeks if not months. However, there was no mention of how that would work ahead of the seasonal weakness in Aug/Sept.

The percentage of stocks over the 50-day average rose to 86.2% and close to the level we saw back in March. Note that the rise stalled over the last two weeks despite the indexes continuing to make new highs. We may have reached the point where being overbought is beginning to take its toll.

Another indicator of overbought is also fading. The McClellan Oscillator has declined for the last two weeks suggesting the volume of advancing stocks has begun to fade compared to the overall volume.

Lastly the percentage of S&P stocks with a buy signal on a Point & Figure chart has risen to 74.2%. That is very near to the highs since August 2014. The 76-80% range is a likely peak in this indicator. As we work through the earnings cycle the decline in the stocks that disappoint will weigh on the overall percentage.

Houston, we have ignition. I have posted this chart several times in the past. This shows the 324 point range the market was locked into over the last two years. Technically a breakout of that range should move either higher or lower by the points in the range. Since we broke out of the top the eventual target would be a move to 2,458. However, this is a MONTHLY chart so do not expect this to happen over the next couple of weeks. I will be more than happy to wait for it as long as the progression is steady and we do not have a retracement back below 2,000. Bank of America believes we could drop back to 1,860, which would put us back at the bottom of the range. I believe that would be the mother of all buying opportunities and I would back up the truck.

I am repeating this paragraph from last week.

The mutual fund business is a very competitive business and managers cannot afford to be too cautious when the market is breaking out. They have to hold their nose and buy something. If fund A and fund B are buying the hot stocks in a breakout then fund C through ZZZZ also have to buy to keep from being left behind. This herd mentality means they will all perform about the same and there is comfort in numbers. If the market were to suddenly reverse, they would all be in the same boat when it came time to produce the year-end numbers.

This would be the primary reason for a continued rally. Unfortunately, it also means a rollover could be especially violent if they all ran to the exits at once ahead of the seasonal weakness in August and September.

Enter passively and exit aggressively!

Jim Brown

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