The Dow rallied back over 20,000 on Friday but it was one more monster short squeeze powered by the financial sector.

Actually, it was powered by four financial stocks on the Dow that contributed 125 points of the 186-point gain. The rest of the financial sector contributed and helped to push the Nasdaq and Russell 2000 higher as well.

If it seems like the financial stocks have either been strongly up or strongly down for weeks, it is because that is correct. They have been leading the market up or leading it down and many times on alternating days.

The chart of the Financial Sector SPDR ETF (XLF) looks a lot like the Dow chart for a reason. Since the election, the two charts have been in lock step. The only material difference is the breakout over 20K for the Dow the prior week when several Dow components reported earnings and another short squeeze pushed the index through that 20K level for a couple days.

Since the XLF has a lot more stocks than the Dow, the sharp gain in only 4-5 stocks cannot cause that short squeeze movement through resistance. Other than those two short squeeze spikes the charts are nearly identical.

We have been hearing a lot about fake news lately. You could almost call Friday's breakout a fake move. When only 4 stocks add 125 points to the Dow, it is not a broad market move. However, once the indexes gapped higher at the open it causes a lot of nervous shorts to cover whatever they are holding. A violent open causes a "cover first, ask questions later" move by anyone holding short position on anything.

While the Dow and S&P stopped right at resistance, there is no guarantee they will immediately retrace their steps next week. Sometimes short squeezes actually trigger additional buying and in some cases, significant rallies are born.

We are in a unique period for the markets. The pro business administration is fueling hopes for a real economic boom. Whether that actually happens or not is immaterial. It is the perception of reality at this point in time that is powering the market. The lack of any material selling over the last two months after a major sprint higher, suggests investors are looking at the future through rose colored glasses. They are buying any dip regardless of how small.

Earnings have been ok but not outstanding and the outlook for the rest of 2017 is strong. Expectations for a corporate tax cut in some form are causing increased buying interest because corporations will almost immediately increase earnings by 10% to 15% if that cut comes to pass. That is a strong lure for eager investors.

These expectations have produced a rising pattern on the S&P as each dip was shallower than the prior dip. Investors are eager to buy despite no material profit taking.

The S&P chart suggests the breakout will continue. I wrote earlier in the week before the breakout occurred, that the S&P was wedging up suggesting a breakout was imminent.

The S&P 2,300 level is the new Dow 20,000. This is strong resistance and all eyes are focused on that level. A break out here could cause significant short covering and price chasing by fund managers that do not want to be left behind.

The Nasdaq has been the strongest index and despite Amazon losing -30 points on Friday, it still managed to close at a new high but 3 points below the intraday high. If the Nasdaq can continue its gains past 5,700 we could see some explosive moves in the weeks ahead.

The Russell 2000 is the weakest index. The heavy impact of its financial components helped lift the index +1.5% on Friday but it is still well below resistance. The chart does show a short-term double bottom over the last three weeks that could provide a launch point for further gains but the resistance is still strong. If the big cap indexes succeed in moving higher, the small cap stocks could catch the bovine sentiment virus as well.

The biggest threat to the potential for a continued rally is post earnings depression. Three of the last four Februarys have seen declines as earnings begin to fade. Investors close positions in stocks they held for an earnings ramp and move on to other strategies. Other investors begin to extract money from the market to pay their taxes. There are multiple reasons why market excitement fades around option expiration week, but maybe this time it is different. It is entirely possible that the Trump honeymoon will extend through his first 100 days. It has already outlived most normal presidential transition periods.

There are many things that can move a market and with earnings, economics, taxes and stimulus all working in the market's favor this year, there may be further gains ahead.

Enter passively and exit aggressively!

Jim Brown

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