China is showing strength where there should be weakness and that is a good sign for the market.

The U.S. markets and the Federal Reserve have been watching for signs of improving global weakness. The Fed warned about it again in the recent Fed minutes. The Brexit event is behind us and as expected there was no immediate economic impact. The UK Prime Minister said last week they could actually file the papers in April to start the two-year countdown clock.

Europe continues to plod along with lackluster growth and the ECB piling on the QE. Japan remains economic quicksand but it has been flat to recessionary for so long nobody expects anything different. They also continue to load up on QE and buying equity ETFs along the way.

The key country this quarter is China. The economic numbers continue to get worse but with every depressing statistic the chances increase for even more stimulus. This is not lost on the Chinese equity markets.

The Shanghai Composite closed at the high for 2016 last week. The dip to 2,750 in January has been followed by a slow recovery to close at 3,108 on Friday. That is significantly lower than the 5,166 high in 2015 but at least it is moving in the right direction. The chart below is a picture of a market in recovery despite the long road ahead.

Every night that the Chinese markets do not meltdown is another chance for the U.S. markets to rally. The Japanese market is struggling but apparently, nobody cares anymore. The Nikkei was down hard last week and the U.S. markets barely reacted. The Chinese economy, even with the possibly fraudulent government economic numbers, is still the driving force.

The Dow Jones Global Index is in breakout mode and at a 52-week high. It would be very unlikely for the U.S. markets to decline with the global index rising along with the Chinese markets.

The German DAX has broken out to the high for the year and broken through a two-year downtrend. This move is in spite of the Brexit vote.

The FTSE 100 is also in breakout mode and nearing two-year highs. Apparently Brexit had no impact on equities despite all the gloom and doom spread around before and after the event.

In the U.S., the S&P-500 has stalled and is trading in a very narrow range. Normally when tight consolidation ranges appear the pattern ends with a continued move in the original direction. In this case the target would be 2200-2225. About the only thing we can count on is that the breakout/breakdown will occur in a spectacular fashion. There will be a big move, only the direction is unknown. At this point, the most likely direction is higher.

The percentage of S&P stocks with a buy signal on a Point and Figure chart has plateaued at 76%. That is still relatively high and indicates there is good breadth and stocks have not retreated significantly from their recent highs.

The percentage of S&P stocks over their 50-day average has begin to weaken at 68.6% but that is still a healthy number. The lack of upward progress in the market in August has allowed the average to catch up with the price and without a sudden market surge higher, this percentage should decline.

The percentage of stocks over the longer-term 200-day average has reached a two-year high at 81.6%. This is bullish BUT it also signals the market has moved into an overbought range. I have written about this before and it would be very unusual for this indicator to continue higher. If we continue to languish in this tight market range, the average will catch up with the current price eventually and the percentage will weaken. However, at this level it would take a material market decline to cause any severe damage.

The Volatility Index continues to hold at multiyear lows. This is showing extreme complacency because investors are not buying puts as insurance against a future decline. That suggests any unexpected headline could cause a significant decline because there is no insurance and investors are using stop losses instead. Something similar to the Flash Crash could occur because the early stops would be hit causing further selling and a cascading decline. While this has only a remote chance of occurring, there is always a risk.

With no signs of selling, rising global markets, a falling dollar and one candidate well ahead of the other, the uncertainty for the market is minimal. The speech by Janet Yellen next Friday is the next hurdle to cross and assuming she does not go rogue, the market could continue to consolidate into an eventual move higher.

However, the next six weeks are "normally" the most volatile of the year with second half lows made in September and October. Normal seasonal patterns have been absent this year so we cannot simply move to the sidelines and wait for a September decline. I continue to recommend refraining from being overly long and suggest we keep some cash in case a buying opportunity arrives.

Enter passively and exit aggressively!

Jim Brown

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