With bullish sentiment at the second highest level this year, could we go higher?

I wrote last week about the crumbling wall of worry and how normal markets like to climb a wall of obstacles rather than speed down an open highway with no roadblocks. The indexes had a good week with the Dow gaining 407 points thanks to several big gainers.

The S&P had one big gain on Monday and then traded sideways the rest of the week just below strong resistance at 2,500. Monday was a short squeeze relief rally that a war with North Korea did not break out over the weekend. The sideways trading was fear of 2,500. This is going to be a pivotal level for the market and the index closed exactly on that level on Friday.

What that chart is telling us is that there was significant fear of that resistance at 2,500 and portfolio managers and traders were exiting longs all week as we approached that level. On the positive side, there was no material decline. Thursday was negative about 3 points but that is hardly a problem.

The key for this week would be a breakout or breakdown from that level. If we did get a decent decline, I believe it would be bought. With the bullish sentiment exploding and the major indexes setting new highs, any pullback would be a gift for the dip buyers.

The A/D line on the S&P exploded higher despite the dead stop at 2,500 on the index. This is a case of the troops moving higher but the generals being sold at that level. This is a very bullish scenario. If the A/D continues to improve, the index will break out and there will be short covering on the big caps.

I was surprised the Nasdaq Composite did not close at a new high since the Semoconductor Index closed at a 17-year high. The chip stocks lead the Nasdaq and they should have led it to a new high. However, the big cap techs were weak as a result of contamination from Apple's decline and they held the Nasdaq back slightly. If the chips continue higher, the Nasdaq will follow.

The Nasdaq came to a dead stop over the last four days at the prior intraday high at 6,460. This level is the equivalent of the 2,500 level on the S&P. The Nasdaq did not set a new high on Friday. However, all the indicators are positive including a strong A/D line. In theory, a breakout should be imminent.

The challenge for the Nasdaq is the potential weakness in Apple. If we see further declines, I would expect mixed results from the rest of the big caps as they trade in sympathy.

The A/D line on the Dow also broke out to new highs suggesting the current rally has legs. However, as you can see in the A/D chart there were plenty of hiccups along the way. The Dow has been fortunate with a rebound in energy and financials and continued strength in Boeing. The financials will be at risk this week depending on the Fed decision on Wednesday. With a 407-point gain for the week, there is also the risk of some profit taking. I would expect it to be minor given the strong bullish sentiment.

The broadest market index of tradable stocks is the Russell 3000. The index closed at a new high on Friday. I do not have an A/D chart for the R3K but I do have the broad market internals for Friday. Bear in mind this was an expiration Friday with weekend event risk. There were 4,358 advancers and 2,793 decliners. There were 477 new highs and 76 new lows. The Russell 3000 internals would mimic those numbers.

This is a broad market rally and the S&P and Nasdaq "should" break out if those numbers continue. There are never any guarantees regardless of how bullish or bearish the conditions appear to be.

This could turn out to be a September to remember as long as we do not trip over some unexpected headline or monster sell program. September is the period when portfolio managers restructure their portfolios in normal years. They may be riding the wave higher but that does not mean they will not bail the instant the wave appears to be cresting.

As investors, we need to stay long until proven wrong. Keep your stops in place but allow for some minor volatility as the market trades around these critical resistance levels.

Enter passively and exit aggressively!

Jim Brown

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