The prior week was positively boring but conditions changed in a hurry.

I wrote last week that watching the market was like watching grass grow it was moving so slow on abnormally low volume. That changed in a hurry on Tuesday. The major indexes gapped significantly lower on the news North Korea had fired a missile over Japan. Everyone was worried there would be a military response. When the U.S. and Japan resorted to yet another strongly worded press release, investors instantly realized there was no military option. North Korea had called their bluff and gotten away with it.

Add in the positive expectations for legislative action after the Harvey disaster and suddenly investors were not worried about a government shutdown at the end of September. Markets rallied with the Nasdaq rebounding 3.3% to a record high in only 4 days.

I would be the first in line to warn that volume was very light at 5.1 billion shares on Friday after a similarly light week and that the Dow and S&P stopped exactly at strong resistance. I am not saying the market cannot continue higher. The market can move in either direction at any time to confound even the most astute market watchers. However, we are entering the most volatile month of the year and normal trading will resume late next week.

Despite the Nasdaq making a new high and the Dow and Nasdaq rebounding to prior resistance, there were some dramatic changes in the market internals. The S&P advance/decline line set a new high for this cycle. We have been watching this closely over the last month as it weakened. The new strength suggests the rally has more room to run.

Given the strength of the Nasdaq with a 3.3% rebound in 4 days, you would have expected the Nasdaq A/D line to breakout as well. However, the Nasdaq internals were very negative heading into the week and that is what allowed the short covering to lift the index so quickly. The A/D line is going vertical but it has a ways to go for a breakout. This means there was some divergence in the Nasdaq stocks. This was not a broad based rally but one led by a small subset of the population. Those laggards are either going to join the party or the generals are going to realize they are leading the charge by themselves.

Strangely, the Dow A/D line did set a new high even though the Dow index was the laggard of the big three indexes. The Dow posted minor gains the last three days with lackluster afternoon trading. Apparently, it was enough to have the majority of the Dow stocks participate at least a little.

Despite the rally, the S&P Bullish Percent Index only rebounded from 63% to 66.4%. This is the percentage of S&P stocks with a buy signal on a Point and Figure chart. This means either we have a lot of room to run OR a lot of S&P stocks are not participating. It is a reason why we should be cautious about jumping into new long positions next week.

The rebound turned the charts from bearish to bullish but there is still the problem of strong resistance at 2,480 on the S&P. Even if we do get through that level, there is extremely strong resistance at 2,500. Only a very few analysts have yearend targets at 2,500 or above. The vast majority are expecting something from 2,350 to 2,450. This means the 2,500 level could be the bell that is rung at the top of the market.

Conversely, the best six months of the year begin on November 1st. If the markets can hold at this level through the normally volatile September period, we could see all those analysts resetting their yearend targets a lot higher. This is going to be a pivotal week and September is going to be a pivotal month. How we end this month will have a lot of bearing on how we end the year.

The Dow is lagging the Nasdaq and S&P with resistance at 22,000. The historic high is 22,118 with the intraday high at 22,179. The Dow chart has a very good chance of scaring investors with a double top formation at those highs. Whether it actually turns into a market top or becomes just a stutter step on the way to higher highs, we should know soon. It will only take a couple more days of gains to put the Dow into those resistance zones, assuming it can break through 22,000.

The 207-point Nasdaq rebound from Tuesday's opening low has stretched the index into overbought territory. With decent resistance at 6,460, it will be a tough test unless the market surges out of the gate on Tuesday after the event risk fades. A Tuesday short squeeze could accomplish the task but there are still two days of weekend left and plenty of time for negative headlines. The Nasdaq chart also have the potential for a double top formation. However, if you look at the pattern from June, the same formation existed and the Nasdaq broke out. If that were to happen again in September, the short covering would be fierce.

The Russell 2000 rebounded sharply but it has a ways to go before it can retest the highs at 1,452. After 7 consecutive days of gains, it is due for a rest.

The FANG stocks grouped tightly together with the exception of Facebook. The big caps rallied over the last three days but faded on Friday afternoon. This could have been profit taking ahead of the weekend or simply a realization they had rebounded too quickly.

I am neutral for next week. Tuesday volume will be very light but normal volumes should begin to return on Wednesday. There is a light economic calendar but the House and Senate will resume their session and with only 12 days to conclude a budget, debt ceiling and hurricane relief, the headlines will be flowing fast. September is normally the most volatile month of the year but none of the seasonal trends have been followed this year.

The key points to watch this week will be the potential breakout or failure by the S&P at 2,480 and 2,500. Those levels could negate the impact of the Nasdaq on the market direction.

Enter passively and exit aggressively!

Jim Brown

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