The prior week the market was showing a potential topping pattern with a Dow close at 21,179.

This week we have a new high at 21,640. The difference is a 461 point rebound after three weeks of heightened volatility. The potential topping pattern turned into a consolidation ahead of the Yellen testimony. When she finally spoke, she turned the doves loose and Fed expectations are declining rapidly. Don't fight the Fed.

Is this market breakout different? Will we just have several days of new highs and then fall back into the volatility and consolidation from the prior three weeks or will we see continued gains and higher highs? Obviously nobody knows for sure.

The five days of highs back in mid June were followed but three weeks of consolidation. The new highs back in March was followed by three months of consolidation. I would be perfectly happy if we could continue that trend and suffer only three days of consolidation this time before moving to higher highs. What I would like to see seldom comes to pass.

The key this week is the market breadth. Something changed last week and the market breadth increased significantly. Over the last week new highs jumped from the 150-200 level per day to over 600 new highs on Friday. Advancers beat decliners 4,876 to 2,242 and it was a summer Friday. Volume was weak at 5.3 billion shares.

The best way to illustrate the market breadth is with the cumulative advance decline line on the S&P. The AD line has hit a new high for the post financial crisis recovery period. This is very bullish if it can maintain this trend.

Another positive for this rally is that it is not being led by a handful of big cap techs. In the rally to the June high, the FANG stocks were the leaders. Nearly 50% of the market gains heading into the June 19th high were produced by only 20 stocks, which were mostly tech stocks.

This time we have all the indexes breaking out to new highs except the Nasdaq. The tech stocks are following rather than leading although it is a close race.

The Russell 3000, the broadest index of tradable stocks, also broke out to a new high and the chart suggests it could continue. This is another example of market breadth when you can get most of the 3,000 stocks moving in the same direction.

The Dow led the charge last week with a nice move over 21,500 to get the party started and then a confirmation move over 21,600. The MACD has been negative for three weeks and it turned positive again on Friday. With nine Dow components reporting earnings this week there is plenty of opportunity for excitement, disappointment and volatility.

The S&P surged over the resistance at 2,450 and that is critical because that level was the year-end price target for several big name analysts. Nothing prevents the S&P from falling back below that level later in the year but this was a bullish event. This should trigger additional short covering on Monday and further confirm the bullish bias. Like the Dow, the MACD turned positive again and the velocity is increasing.

The Nasdaq did not close at a new high but it is very close. The index held over critical support at 6,100 and has rallied more than 2230 points from the July 6th low. The big cap techs are positive but they are not leading. The A/D ratio was much closer on Friday with 1,466 advancers and 1,188 decliners on the Nasdaq. Advancing volume was less than 2:1 over declining volume. The index was bullish but underperforming the rest of the market.

The Russell 2000 managed to close +2 points over its old high. The index was held back by the weakness in financials. If the Russell could surge to a higher high and put several days of back to back gains on the books, we could have an old fashioned summer rally.

The problem area for the market is the Volatility Index. The VIX closed at a 24-year low on Friday at 9.51. Numerous analysts have warned that long periods of abnormally low volatility are normally followed by periods of abnormally high volatility. The VIX has not been over 20 since October when the election fears were causing a spike. We are working on nine months of abnormally low volatility so you can rest assured there is an unexpected rebound in our future. We will not see it coming and it will be painful. With August and September the worst months of the year for the market, we could be getting close to that volatility event.

The next three weeks "should" be positive as the focus on earnings continues to lift stocks. It is the week that starts on August 7th that the post earnings depression could begin. Be prepared.

Enter passively and exit aggressively!

Jim Brown

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