All the fence sitters waiting on the sidelines this weekend are wondering if the market breakout is the real deal or just another head fake that draws investors in just to crash a day or two later.

Nobody, and I mean nobody, can ever guarantee whether the market is going up or down on a short-term basis. If somebody tell you the market will go up on any specific day, ignore them.

The market will do whatever it wants and we are simply participants along for the ride. Next week could be a nice ride IF the breakout continues. Friday's close was the perfect setup with all but one of the major indexes closing at a new high and several made multiple new highs for the week.

For all intents and purposes, it definitely looks like the real deal but we can never be sure. If it were easy, everyone would be a millionaire and beach space would be at a premium.

The S&P chart is picture perfect for a breakout. The index consolidated for seven weeks, tested resistance at 2,300 on the first break and failed. The weeklong decline allowed new investors to establish positions and then another four-day resistance test followed. On the fifth day, the breakout occurred on headlines of an impending corporate tax cut plan. The continued gain on Friday was icing on the cake.

Traders should not expect another leg higher like the post election bounce. In the current market and our position on the calendar, any further gains are likely to be 2-3 days up, 2-3 days down and repeat. This is the way a normal market works.

The uptrend resistance at 2,319 is similar to that same line on the Dow and both Nasdaq charts. All three of those other indexes closed above that resistance. This suggests the S&P will do that as well.

While I would be perfectly happy to see the S&P power through that level for a couple days of additional gains, I would also be fine with a pullback to use 2,300 as support before launching a rally to new highs. I am sure everyone reading this would agree. The only thing we all want is for the S&P to make new highs.

There is only one small problem with a continued market rally.

Analysts updated their 2017 S&P forecasts in light of the post election rally. These are the highest estimates on the street today. Note that the top six have already been met and this is just February.

2,275 Fundstrat, Tom Lee
2,300 Bank of America, Savita Subramanian
2,300 Credit Suisse, Lori Calvasina
2,300 Goldman Sachs, David Kostin
2,300 Morgan Stanley, Adam Parker
2,300 UBS, Julian Emanual
2,325 Jefferies, Sean Darby
2,340 Canaccord, Tony Dwyer
2,350 BMO, Brian Belski
2,350 Deutsche Bank, David Bianco
2,400 JPMorgan, Dubravko Lakos-Bujas
2,400 Barclays, Jonathan Glionna
2,400 Societe Generale, Roland Kaloyan
2,424 Piper Jaffray, Craig Johnson
2,425 Citigroup, Tobias Levkovich
2,450 Oppenheimer, John Stoltzfus
2,500 RBC Capital Markets, Jonathan Golub

There has not been a rush to upgrade those targets. When numerous analyst targets are hit, the market tends to fade in intensity because traders are thinking, "target hit, I need to take profits."

However, I think analyst thinking was poisoned by the political headlines in Dec/Jan and they were expecting the market to fade in January and that did not happen. There were numerous analysts calling for a post inauguration decline. Oops!

Given the recent economics and the lightning speed of the new president in getting pro-business actions started, I expect analysts to begin upgrading their targets rather than the market falling back to meet them.

Tony Dwyer at Canaccord remains adamant that we are facing a 5% to 7% correction and the S&P will then rebound to 2,340 by year-end. All I can say is, "Tony I hope you are wrong."

Note on the chart above that the RSI (Relative Strength Index) is nearing 70. The RSI is classified as a momentum oscillator, measuring the velocity and magnitude of directional price movements. Momentum is the rate of the rise or fall in price. The RSI computes momentum as the ratio of higher closes to lower closes: stocks which have had more or stronger positive changes have a higher RSI than stocks which have had more or stronger negative changes. Readings over 70 are considered overbought territory.

We exceeded 70 for two weeks back in December but the majority of the post election rally in November was from lower levels.

The MACD has also turned barely positive. Since both of these are momentum indicators, the sideways motion over the last two months is still being felt in the indicator. If the gains continue for several more days, both indicators should accelerate significantly.

What all this means is that the market strength is improving even though we are moving towards slightly overbought levels.

This is also seen in the advance/decline line for the S&P. This is the highest level in years and suggests very strong market breadth. There were 778 new 52-week highs on Friday compared to 69 new 52-week lows. That is the most new highs since December 9th when the post election rally peaked.

The percentage of S&P stocks over their 200-day average is finally rising after five weeks of dormancy. At 75.8% that is the highest level since September. The percentage over their shorter 50-day average is also rising but more slowly since the average has been rising since November. The market stall in January let the average catch up with a lot of stocks.

On the Dow chart, the index has closed above the longer-term uptrend resistance, the MACD has turned positive and the RSI is approaching 70. Note that back in December the RSI was over 70 for an entire month but that was the result of the rally's velocity going into December.

The Nasdaq surged to a new closing high for the last four days. Friday's close was above longer-term uptrend resistance. Note the RSI is well over 70 and the highest level since November 2014. Based on the chart and the RSI, I would say the Nasdaq is overbought and at risk. However, we have seen Nasdaq rallies in the past that went weeks past normal overbought levels. There is risk for a Nasdaq pause in the coming weeks. However, the mix of stocks leading the index higher on Friday was broad based and not a specific subsector. The Nasdaq A/D line is also at a new high.

The most overbought index is the Nasdaq 100 ($NDX) big caps. The index has rallied 12.1% since the election and most of that gain (7.7%) has been since December 30th. That is a very long way to run in a very short period of time. Note the RSI at 75.75.

These are the FAANG stocks, Facebook, Amazon, Apple, Netflix and Google leading the charge higher. They had help from companies like Priceline, Amgen and Baidu. This group of big cap tech stocks led the broader market higher and should they decide to rest, the broader market is likely to rest as well.

The small cap Russell 2000 is the laggard in this market rally. The Russell made a new high by less than a point on Friday but it was a fight. The Russell stocks are still consolidating from the 30%, 40% even 50% gains post election. It was not all the small caps but quite a few and they are slowly bleeding points and making it tough for the broader index to post any gains.

If the Russell were to breakout over 1,400 next week, it would be a welcome sight and a trigger that would pull fence sitters off the sidelines.

The rally is not a fake. It has overcome declining sentiment from two weeks ago and could be on the verge of a sprint higher. This coming week will be pivotal. A rally built on political expectations is dangerous. Those expectations can be changed in a heartbeat with a headline or in this case a tweet. I want the bullish sentiment to continue to build as we move higher but I do think the Nasdaq is due for a rest. Whether the rest of the market can continue making new highs is the $64 question.

I do believe we will see higher highs in the months ahead but I also believe we will see some short-term setbacks, which are normal even in wildly bullish markets. Consider them buying opportunities.

Enter passively and exit aggressively!

Jim Brown

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