The markets moved higher last week on a strong dose of end of quarter window dressing.

Add in some big cap, small cap rotation and a blowout rally appeared. The Russell 2000 was the leader with a monster 9.9% rally from the August 21st lows. The nearly 30 point gain on Wednesday was pure short covering as resistance at 1,452 failed and portfolio managers began chasing stocks higher for their end of quarter statements. They were able to keep the Russell positive on Thr/Fri with minor gains to protect their investment from Wednesday. Next week begins a new quarter and window undressing could appear.

Monday and Tuesday could be positive as end of quarter retirement cash hits the market. After Tuesday, we may need another catalyst to keep the markets moving.

I do believe the approaching Q3 earnings will be the carrot that keeps the markets positive but early October is typically very volatile. None of the normal historical trends have worked in 2017 but that does not mean we should just ignore them in the future. We always need to be aware of the potential market moves.

With the monster gains in the Russell it should be no surprise that the A/D line for the small caps exploded to the top of the charts. Small cap volume on Wednesday was more than three times normal. It should also be obvious that this trend cannot continue. When you compare the last three weeks to the rest of the chart there is no comparison. The Russell is now very oversold and is due for a rest.

The Russell broke through the horizontal resistance at 1,452 and the uptrend resistance at 1,472. The index is flirting with the 1,500 level after consolidating for 9 months after the election. Any other time this would be an amazing show of market strength but we need to see if it can hold the gains over the next 2-3 weeks.

The Russell 2000 is two-thirds of the Russell 3000 and the larger index closed at a new high but the gains were significantly less because the large cap stocks in the R3K were undergoing some selling as portfolio managers rotated into the small caps. The R3K just barely edged over uptrend resistance on Thr/Fri but it was still a good week. The R3K shows us the breadth of the rally and suggests it may have some staying power. Note that the R3K is also flirting with 1,500. This round number resistance on this index and the R2K could be tough to cross.

To emphasize the big cap to small cap rotation theory, the Dow struggled all week while the small caps were surging. The Dow failed to close at a new high and failed to even return to resistance. The 22,500 level is looking tough given the Dow's recent weakness. Note the MACD is very close to a bearish signal.

The S&P surged on Friday to break convincingly over prior resistance at 2,508 and post an excellent end of quarter close. Given the lack of participation for the past two weeks, this was obviously end of quarter window dressing. The S&P now has resistance at 2,525. That reminds me of the 1969 Zager and Evans song, "In the Year 2525." That song gives you an idea of how old I am.

The S&P is only slightly more bullish than the Dow because it has more components to overcome the small cap rotation problem. Financials helped lift the S&P after President Trump said he had interviewed 4 candidates for replacing Janet Yellen. The candidates named would be more hawkish than Yellen and rates spiked higher on the news.

The A/D line on the S&P shows us the rally was broad based and showing no signs of weakness. This is amazing since 128 of the S&P stocks are 15% or more below their 52-week highs. On Friday there were 294 advancers and 158 decliners on the S&P with advancing volume 2:1 over declining.

The big cap tech stocks were struggling most of the week and the Nasdaq was fighting resistance at 6,460 for the last three weeks. On Friday, all the big cap techs were positive and the lack of drag allowed the Nasdaq to post a strong breakout almost to 6,500. Note the MACD was negative for the last week.

If the Nasdaq can maintain its gains it would held significantly to ease any pain of profit taking and window undressing on the Russell 2000. The Nasdaq needs to remain over that 6,460 level on any decline.

Notice how the FANG stocks lost their continuity since the July peak. They are all over the map and their correlation has dissipated. This has caused the Nasdaq to struggle up until Friday.

The correlation between the Nasdaq and the semiconductor sector is 100%. They have been in lock step the last week. As long as the chip stocks continue to rally the Nasdaq will follow.

In theory, the markets should continue higher with the Q3 earnings being the Pied Piper's magic tune that keeps stocks moving forward. Unfortunately, as Yogi Berra is credited with saying, "theory never works in practice." We will get to test that theory next week once the end of quarter retirement inflows evaporate on Wednesday.

The Q3 earnings do not begin to appear in volume until the third week in October but there are some notable stocks in week two to keep investors attention.

November 1st begins the best six month period for the markets. We just need the market to remain positive until then. The trend is our friend until it ends.

Enter passively and exit aggressively!

Jim Brown

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