The next trading day is the first day of 2018 and it is likely to be volatile.

If the last 30 minutes on Friday is any indication of how the year will begin on Monday, it could be an exciting ride. I am not going to repeat all the points I made in the marke commentary section but the odds are good that we will see some bearish volatility next week. Whether it starts on Tuesday or later in the week is unknown. The first day of January can be positive as fund managers put those yearend retirement contributions to work. However, if the futures are moving sharply lower in the premarket they are under no obligation to dump that money into the market.

Volume should continue to be light on Monday but it should accelerate quickly as the week progresses. There should be no shortage of headlines as a result of the tax reform and its impact on companies. With earnings starting in just over two weeks, we could see some additional guidance warnings similar to those from Goldman Sachs, Amgen, Bank of America and Citi.

I covered the potential market movement in my Option Investor commentary so I am going to dive right into the charts today.

The A/D line on the S&P peaked on Thursday even though the index itself was still trading sideways and hit 2,692 on Friday morning. Advancers hit 308 on Thursday with decliners at 142. That was the highest number of advancers since the 362 on December 15th when the index broke out of a weeklong consolidation pattern.

Obviously, the key here will be what happens next week. If we get a breakdown in market breadth this is where it will show up first.

The chart is showing a textbook failure at support after a two-week period of consolidation. The obvious target here is 2,650. The MACD and RSI have both turned bearish. Initial support is now 2,650 with secondary support at 2,625.

The Dow A/D is a carbon copy of the S&P A/D chart with a sharp decline after a high on Thursday. This should not be a surprise given the market action. The MACD turned negative on the 21st even though the Dow was still trying to fight resistance. That last surge could have been a climax peak for this cycle.

Unlike the S&P, Nasdaq and Russell 2000, the Dow did not close at a two-week low on Friday. It was very close with a close right on support at 24,720. If the 24,700 level breaks it should target 24,100 and a -3% decline from the high. However, that would break out of the regression channel and that would be another bearish point for traders to ponder.

The Nasdaq A/D line continues to be weak. The Nasdaq has not been able to establish a positive trend of advancers over decliners since early October. The tech sector is likely going to be the leader to the downside if the market turns bearish in January.

The Nasdaq is the weakest of the big cap indexes. The index has been declining since the new high on December 18th. That intraday spike above 7,000 could have been a telltale sign of a climax top. The Friday close was right on prior resistance at 6,900 and a further decline targets 6,735 with a possible pause at 6,800. The thin blue line of uptrend support is not likely to hold on a break below 6,900. Note the MACD and RSI have turned bearish.

The small cap A/D line is also weak. They have been treading water for the last month just trying to stay afloat. I would not be surprised to see a dip back below 2,700 soon.

The S&P-600 small cap index was a little choppier than the Russell. The Russell actually made a new closing high on Thursday by 0.0013 points. Despite the weak A/D chart the Russell was holding right at strong resistance at 1,550 for the last two weeks. A breakout could have energized the broader market.

The broadest index of tradable stocks, the Russell 3000, came within half a point of a new high close on Thursday. This would suggest the broader market is not as weak as the Nasdaq chart would indicate. All the major indexes were flirting with new highs. We just needed a few more days of trading before 2018 to make it happen.

The High Yield ETF has recovered from the prior week's dip. This is positive for the overall market. Had the BYG continued lower below the black S&P line, it would have been bearish. The S&P follows the HYG.

The semiconductor sector continues to be a drag on the Nasdaq. The Nasdaq in black tends to follow the $SOX in blue. If the chips continue to be weak, the Nasdaq will not be able to pull out of its dive. When the calendar turns over to 2018, stocks like Nvidia could see heavy selling and that would be bearish for the entire tech sector.

The FANG stocks are still roughly in correlation but Netflix is the only one with a positive uptick from last week. The other three are in decline ahead of 2018. Netflix will more than likely follow once January begins.

The odds are in favor of at least a minor market decline next week. I have said in other commentaries that I expect any decline to be short, sharp and shallow. I sincerely hope the marker is listening but I doubt it cares what i believe. The Q4 earnings cycle, which starts on the 16th, is going to be bullish for the market. That means there are only about ten trading days for portfolio managers to sell stocks and buy new ones before the earnings cycle begins.

I would not be surprised to see most managers hold on to a majority of their positions rather than do a complete restructure to game the stocks with the highest tax benefits. That would me a greater potential for a quick rebound but it would also setup the chance for a bigger decline in May. In trader terms, May is very long term so they will not be worried about it next week.

Enter passively and exit aggressively!

Jim Brown

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