The second week of August started with a bang with new highs on the Dow and S&P.

Unfortunately, it ended with a whimper in what could have been the start to the normally weak August/September period. There are no guarantees and there are plenty of bullish signs so do not bet the farm that a continued decline is imminent.

There are bearish signs as well. Some 40% of the S&P or 200 stocks are already in correction territory. A "correction" is when a stock or index declines at least 10% from its 52-week high. The majority of the 200 stocks were off significantly more with almost 100 stocks having declined more than 20%.

The chief market technician at MKM Partners pointed out that less than 60% of the Russell 3000 stocks are trading above their 200-day average. The Russell 3,000 represents 98% of tradable U.S. equities.

On the flip side, more than 70% of companies are beating their earnings estimates with earnings growth for Q2 at 12%. We are seeing a lot of those companies slide even after reporting great results. The post earnings depression seems to be worse this cycle because of the strong gains prior to earnings.

A chart I have been showing the last couple months as evidence of a continued strong rally has been the advance/decline line on the S&P. As long as that line was rising, the rally was intact. Unfortunately, it stopped rising and posted the biggest decline since March.

This is not a chart I would buy. The trend has definitely changed for the worse. The A/D line on the Dow is just as bad.

When you consider both indexes are only about 2% below their recent highs, it suggests there could be more weakness ahead. The severity of the A/D decline is significant.

The percentage of S&P stocks over their 200-day average has fallen to 68.5% and a three-month low. Only 1% lower and it will be a 7-month low. That is not good for market sentiment because this metric is closely watched.

The 50-day average is normally seen as a short-term trading signal by hedge funds and portfolio managers. When stocks fall below that average it triggers a sell and they buy again when stock move back above the 50-day. On the S&P the percentage of stocks over their 50-day has fallen to only 43.7%. That is only 6 tenths of a percentage from being a 9-month low.

The S&P closed under its 50-day average for two consecutive days and without a quick rebound over the 2,448 level, the sell orders will begin to appear. The indicators are solidly negative.

The Dow chart is still positive until a close under support at 21,500 with the 50-day at 21,550. The Dow has benefitted from a solid pattern of individual stocks rotating into the leadership position. However, post earnings depression could increase next week as we move farther away from the earnings events.

The Nasdaq was the leader to the downside last week and the biggest gainer on Friday. The index hit an intraday high on Monday at 6,423 and an intraday low on Thursday of 6,214 for a 209-point drop in four days. Traders were itching to buy the dip after that big of a decline. However, impatience is not a strategy. If you are fast on your feet, you might be able to pick up a couple points but a one day rebound does not reverse a trend. We need to see 2-3 days of gains before we can focus on upside again. That is especially true in August.

The Russell 2000 remains the weakest index. Support at 1,400 failed and the current target is 1355-1345. Note the severity of the decline in the indicators. The Russell is in full decline and the 1-point rebound on Friday was miniscule given the strong two-week loss. This is damaging to market sentiment and it will be worse if the index closes below 1,345.

The broad market Russell 3000 Index is in breakdown mode. The major support at 1,460 broke and the index closed well under the 50-day average. The next obvious support is the 1,425 level from early July. The indicators are negative and there could be trouble ahead.

Here is a different look at the same index. I drew uptrend support lines from multiple points and the index has broken both lines. This shows that the severity of the decline is different from those last three dips.

Nobody can accurately call the market direction on a short-term basis simply because there are too many factors that influence direction. You have technical, fundamental, seasonal, political, geopolitical, Federal Reserve, random stock news and random news events. Every factor may line up perfectly on Sunday evening and Monday morning sees a completely opposite reaction because of some combination of headlines.

We can only see what the charts tell us and then deal with reality when it occurs. The reality this week is that the August decline may have started and regardless of how eager traders are to buy the dip, there may be more volume from sellers restructuring portfolios ahead of the typical October bottom, buying opportunity. The potential is very high for a significant volatility event surrounding the budget and debt ceiling battles at the end of September. Portfolio managers are probably not willing to hold on to positions until the outcome because it is a cutthroat business. Profits are not profits until the positions are closed. Fund managers that do not outperform their peers will find themselves looking for another job. Nobody ever gets fired for taking profits.

Unless you are a short-term trader, the risks of holding long-term positions over the next 8 weeks are very high. If you have them, hold them but I would not add any new ones until we see a buying opportunity.

There is always another day to trade if you have money in your account.

Enter passively and exit aggressively!

Jim Brown

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