The most hated rally ever just keeps edging higher but with all the timidity of a sophomore boy at the prom.

The pattern has been five points forward, 3 point backwards, repeat. The Dow only gained 33 points for the week, the Nasdaq +12, the S&P gained +1 and the Russell 2000 lost a point. That is hardly an abundance of conviction and more of an over abundance of caution.

The reluctant teenager is being pushed out onto the dance floor by his peers but immediately runs back to cower on the sidelines afraid to approach the opposite sex. The market is being pushed ever so slightly higher by dip buyers but once that new high threshold is pierced they scalp their gains and run back to the sidelines before the closing bell.

The Volatility Index ($VIX) continues to hover just over 11 and a level not seen since July 2014. The VIX is supposed to look 30 days into the future and if that is the case, traders are expected to be very complacent. That is the perfect setup for an unexpected volatility event that catches everyone asleep.

The S&P only traded in a 15-point range for the week with the highs on Tuesday and Thursday and the low on Wednesday. The momentum indicators recovered after the volatility event on the 2nd but they are still suggesting a lack of conviction. The MACD is still negative despite the new highs last week on the index.

The Dow made a new high over the July 20th high of 18,595 by roughly 18 points. After three weeks of trading at its highs, that is hardly a monster breakout and could just as easily be a double top at 18,635 considering the potential for seasonal weakness.

The Nasdaq finally broke over 5,200 but that is where the momentum died. That short squeeze the prior Friday catapulted the index from 5,166 to 5,221 and the index only added a total of 11 points for the entire week. It did close at a new high at 5,232 and it has been positive for the last seven consecutive weeks. However, the index looks tired. The Nasdaq has been supported by the biotech sector and the semiconductors. After Nvidia's blowout earnings there are no chip stocks of note left to report. That could produce some weakness in the sector and weigh on the Nasdaq. The biotech sector appeared to run into resistance at the 300-day average and came to a dead stop.

The correlation between the $SOX and the Nasdaq is in lock step at 100% and the SOX helped lead the Nasdaq higher. If the SOX weakens we can expect the Nasdaq to follow. Jeff Bailey always called the SOX the head of the snake. Wherever the SOX went the Nasdaq was sure to follow.

The biotech sector needed to rest after it rallied out of the June bottom. It could be in a position to continue higher now that profits have been taken. The 300-day average will be the hurdle it has to cross.

The Russell 2000 small caps lost 1.5 points for the week and is well away from new high territory at 1,296. The Russell 3000, the largest 3,000 stocks in the market, only gained half a point for the week. These significantly broader indexes are showing a serious lack of upward momentum and could roll over at any time.

The negative economics caused another flight to quality in the treasury market with the yield on the ten-year falling to 1.515% at the close for a -3.68% drop after touching 1.48% intraday. Investors from overseas and probably from the U.S. as well are looking for a safe return on their money rather than the potential for loss in the equity markets if the economics continue to weaken.

The percentage of S&P stocks over their short-term 50-day average has fallen from 87.4% in mid July to 71% in August despite the market being at record highs. This is clear evidence that only a few big caps are leading the markets higher while the broader markets are weakening. That is probably a poor choice of words because the market is not weak but the internals are declining despite the new highs.

The percentage of stocks over their 200-day average is holding at 79% but that number has not risen since mid July. This is where the market topped in 2015 and only slightly higher in 2014. As the long term averages move higher to catch up with the current stock price, the overall percentage will begin to decline.

The correlation between high yield bonds and the S&P continues to be right at 100% as the bonds lead the S&P higher. This documents the search for yield where investors are using the HYG ETF to escape the risk in equities. The HYG normally leads the SPX as you can see in the chart. I do not know what could impact that ETF other than an unexpected Fed rate hike but equities could break away and that would make the HYG even stronger.

I am continuing to focus on the broadest indexes in the Russell 3000 and the VTI and neither posted more than a fractional gain for the week. This supports the generals leading, troops dragging behind scenario. When the generals finally fall in battle the troops are going to beat a hasty retreat.

I would remain long until we are forced out of our long trades by tight stops. The markets sometimes moves up strongly in August because everyone was expecting the opposite direction. However, volume is going to decline dramatically over the next three weeks as summer winds down. Low volume means a lack of conviction and directions can become volatile. Be prepared and try not to buy the first dip.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email