The major indexes have traded sideways since July 14th. It is time for a directional decision.

The S&P has traded in a very narrow 40-point range since July 14th. That is the lowest prolonged volatility since the financial crisis. The Volatility Index ($VIX) has been trading in the 11-12 range for nearly two months. Volatility spiked slightly last week as the various Fed speakers voiced their opinions on rate hikes. Despite the bounce, volatility is still low on a historical basis.

The weekly S&P chart is showing weakness developing and the momentum indicators worsening. The index has support at 2,160, 2,160 and 2,100. On the daily chart the indicators are in full decline. The very narrow trading range since July 14th is destined for a breakout in the days ahead. Only the direction is unknown. The S&P nearly traveled the entire range on Friday.

The Russell 2000 is the only index still rising and it has yet to reach its prior highs. As long as the Russell continues to make gains the broader market will not collapse. The day it appears the Russell is rolling over will be the day the big cap indexes die.

The Russell gains have been steady and other than the first three weeks of the rebound they have been minor. Those are the type of gains that stick. Slow and steady wins the race.

The S&P-600 small cap index made a new high last week after a string of new highs. The 600 is much narrower and weighted differently. It is an invitation only index so the low quality stocks are not represented. The Russell 2000 is simply the 1,000 smallest stocks in the Russell 3,000. There is no quality methodology on the Russell 2000.

The S&P 600 suggests the market is going higher. However, the trend is your friend until it ends and it is really overextended.

The S&P-400 Midcap index is also at new highs but with far less conviction than the S&P-600. The midcap stocks appear to be weaker than the small caps and we already know the big cap S&P-500 is even weaker. There is a clear pattern here and that enforces the focus on the small cap indexes.

The relationship between the semiconductor index and the Nasdaq has peaked. The various semiconductor stocks appear to have begun to fade and the Nasdaq and $SOX are on the verge of rolling over.

I have talked a lot lately about the Nasdaq getting support from the biotech sector. The correlation is not nearly as equal as the semiconductor stocks but the dollar value of the biotech stocks are significantly higher than the semiconductor stocks. Even a distant correlation has a significant impact on the Nasdaq.

Put the semiconductors and biotechs together moving in the same direction and the Nasdaq has no chance.

The Russell 3000 is the widest index covering the top 3,000 stocks by market cap. The R3K stalled at uptrend resistance and has failed to make a new high for two weeks. A failure at 1,272, which was the prior high from early 2015, could be catastrophic with a potential decline to 1,200. While I do not expect that to happen, we are in the six most volatile weeks of the year.

The volume should be very light next week and that can emphasize volatility because a normal buy/sell program can look like a fat finger trade and move the markets. Fund managers have to be careful trading in an extremely thin market and they "should" put off any major restructuring until after Labor Day.

There are plenty of economic headlines on the calendar so there is the risk of a headline triggering some unwarranted Fed hysteria. That is very likely late in the week as we approach the employment report on Friday.

However, the next five 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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