The big cap tech stocks continue to lead the market but we are starting to see some significant divergence.

The Dow closed at a two-month low on Wednesday because of earnings disappointments in several big cap stocks. The rebound on Thursday was a massive short squeeze after positive tax reform comments out of the new administration. Unfortunately, talk is cheap and it will not hold up the market long term.

The strength of a few big cap stocks is disguising the broader market weakness. The top ten big cap stocks in the S&P are responsible for more than 20% of the recent market gains.

The health of the broader market can be seen in the declining number of stocks trading over their 50-day average. That percentage has declined from 82% at the beginning of the year to 51.8% today. That is a significant difference and the decline began in early March and sank to 49% in early April. The minor bounce last week is not relative. The trend is negative unless we see a significant rebound in the broader market.

The S&P-500 itself fell below the 50-day average on April 11th and has yet to recover. The S&P dipped to 2,330 the prior Friday and rebounded immediately on Monday but the week was choppy and the index gained only 18 points for the week to end at 2,348. The 50-day average is currently 2,357. The index is still in decline despite the rebound for the week. However, as long as it can avoid a close under 2,330 there is hope for the bulls.

However, even the Nasdaq big caps have started to weaken. The percentage of stock in the Nasdaq Composite over their 50-day has fallen to 50.18%. The percentage in the Nasdaq 100 has fallen to 57%. For the Nasdaq 100 that means 43 of the big cap stocks have declined below their 50-day.

Think about that in context with the Nasdaq 100 Index, which closed only 1 point below its record high on Thursday. The index is at a record high but 43 of the stocks are below their 50-day average. A very few stocks are leading the charge higher.

Both Nasdaq indexes made new highs on Thursday and both only pulled back a very minor amount on Friday despite the weekend event risk. This suggests any event volatility on Monday should be bought even with nearly half the index components under their 50-day average.

Nasdaq Composite

Nasdaq 100

Note the strengthening of the RSI/MACD on both of the Nasdaq charts.

The Dow remains the weakest index with a new two-month low on Wednesday and trading well below its 50-day average. The indicators are still negative with very little uptick from last week. The Dow is hostage to its 30 stock price weighted composition. Any single stock can cause the index to have a bad day. This coming week there are 12 Dow components reporting earnings. Some will beat, some will disappoint. However, the ones with the biggest share prices like MMM, BA, UTX and MCD will have more impact than INTC, MSFT and KO. As a rule of thumb, you can figure a $1 price move in a stock equates to a 7-point move in the Dow.

Here is the killer point. Only 15 of the Dow 30 stocks are over their 50-day average. Several others are right on the line and could fall below at any time. On the positive side, 12 of the Dow stocks are at or just below their recent highs. Half the index is weak and the other half is strong. Unfortunately, in recent weeks it was the weak half dragging the index lower.

The small caps have been relatively flat for two months. Note the 50-day average has flatlined. However, over the last week the small caps have seen some increased buying interest. If the Russell could move over that solid resistance at 1,388 it would be very bullish for the broader market since the Russell represents 2,000 stocks.

The charts are not likely to determine our fate for next week. The market reaction to the French elections and the government funding battle in Washington will likely provide direction. However, with 194 S&P stocks reporting earnings along with several hundred not S&P stocks there will be plenty of headlines to distract from the political events.

If there is a volatility event and the market declines sharply, I believe it will be a buying opportunity. Remember the Brexit rebound. Remember the Trump election rebound after the Dow futures were down nearly 1,000 points. Knee jerk reactions are dangerous if you have stop losses on your positions. If you have available cash, I would be ready to put it to work on a dramatic drop.

Enter passively and exit aggressively!

Jim Brown

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