Market internals reversed from slightly bullish to bearish last week.

The major indexes all posted losses for the week from 1% to 3% and some of the sector indexes lost nearly 5%. That is a major reversal from the prior week. The Dow lost -317 points, Nasdaq -74, NYSE -170 and the Dow Transports -216. The worries about the health care bill and its impact on future administration policies caused the market to weaken on Tuesday and that weakness continued to appear the rest of the week. Even after the bill was pulled and vote cancelled on Friday, the initial rebound was blunted by strong volumes of market on close sell orders. Institutions were heading for the exits. These sells may have been planned and initiated while the vote was still scheduled and we will not know the real market reaction on the shift to tax cuts until next week.

If you are a regular reader you know I like to look at the very broad indexes to see what the market is really telling us. The narrow composition of the Dow means it can be pushed around by gains and losses in only a couple stocks. On the Nasdaq 100 the top six components account for 41% of the weighting. That means those stocks dictate the index direction.

With the next several weeks typically volatile in normal years, we could see some real volatility in what has become an abnormal year for the markets. That means we need as much confirmation as possible as to possible market direction.

We have only had one day with a 1% decline since October. The streak without a 1% decline ended at 109 days with the Tuesday market drop. A 1% decline is not unusual. It is unusual to go 109 days without a 1% decline. When this type of scenario appears, there is normally a minor rebound from the initial drop and then that rebound eventually fails to allow the drop to continue. This does not always happen but it is a normal occurrence.

The Russell 3000, the top 3,000 stocks in the market, has seen a significant decline in the technical indicators. The MACD is in full decline and the RSI is near a five-month low. It would take a major rebound to turn these indicators positive again.

There is a caveat in the Russell 3000. This index is made up of the combination of the Russell 1000 and the Russell 2000 so two thirds of the index is small cap stocks. The small cap sector has been weak since the March 1st high with the exception of four days. That corresponds to the mid March bounce in the Russell 3000.

The NYSE Composite Index is holding right over support at 11,400 with risk to 11,100 if a real bout of market weakness appeared. The NYSE has a lot of small cap stocks but it also has some of the largest stocks like Exxon and General Electric.

The Vanguard Total Stock Market Index ETF (VTI) tracks 3,578 stocks that represent the number of "investable" stocks in the U.S. market. The VTI closed at a five-week low on Friday. The prior support at 120.60 has become resistance. The uptrend support was broken on the Tuesday decline. The RSI and MACD are in full decline. Based on this chart alone, the outlook is bearish.

To put this back in perspective to the S&P-500 I am using a smoothed version of the S&P chart and the risk is clearly visible. The index violated weak support on Friday and appears to be on the verge of a material decline.

Obviously, Friday's intraday move was headline driven so using a glass half-full view that could suggest it will rebound off that support on Monday now that the focus is shifting to tax reform. However, the index is well off the market high from March 1st and even an untrained investor could look at this chart and see a potential support break. The market exists to make fools out of as many people as possible so this could be a huge trap for those expecting the worst. I prefer to let the market pick its own direction and we can follow the trend. I suspect the next couple of days could see the S&P go directional and the path of least resistance is down.

The advance decline lines on the Dow and the S&P have rolled over and are about to make a five-week low. Without a miraculous recovery on Monday, the internals are going to trigger a technical sell signal with new lows.

I realize that reading the charts is effectively looking at market expectations. True technicians will tell you that the charts have already factored in every conceivable outcome. That may be true in normal situations. However, the decision to pull the health care bill came at 3:30 on a Friday. The expectations were for the bill to fail and with that failure incur all sorts of negative connotations about future administration policies, goals, roadblocks and timing. Now that the bill is dead, the market will have to adjust to the new reality of a focus on tax cuts and deregulation. While that may be positive overall, the actual time line is counted in months, not days or weeks. With the new target for action closer to August than April, the market may decide to take a rest during this normally volatile period.

Factor in the coming expiration of government funding on April 28th and a ten-day congressional recess in the middle of April as well as taxes coming due in two weeks and investors will have a lot to consider this week.

Enter passively and exit aggressively!

Jim Brown

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