Lawmakers have fought to a stalemate and nobody is capitulating.

The fight between the two parties has reached a stalemate with each side resorting to name calling and competing hash tags. Nobody knows how long this shutdown will last because both parties have hardened their positions.

The market did not appear to be concerned on Friday with three of the top four indexes closing at record highs. However, they may be more concerned on Monday if it appears the political fight is going to be prolonged.

At this point, any decline would be a buying opportunity. Post shutdown markets normally rebound sharply. The key word there was normally.

With our markets up so strongly in 2018, there may not be a lot of gas left in the tank. I personally believe we are going to see some prolonged weakness in early February after the majority of the S&P has reported earnings. That is just my opinion and not a guarantee.

Every recent dip has been quickly bought. Money inflows are at record levels. Investors are going all in on fear of missing out or FOMO. That is not likely to change because of the shutdown in Washington. The sharp increase in earnings expectations should overrule the shutdown headlines but there could be some initial weakness. Since there have only been four shutdowns in the last 25 years this is somewhat of a rarity and many investors have not seen this before.

The S&P continues in its vertical climb and closed at a record high on Friday at 2,810. That is only 45 points from the median yearend target of 18 major analysts. That means some investors will be easing back on their bullishness as that target moves closer. To be fair there are multiple analysts with targets at 3,000 and above so there are still carrots on the proverbial stick.

For the last three weeks I would have just reused the prior A/D chart. With the market continuing to set new highs the A/D line is also setting new highs. The daily new highs from S&P stocks are running about 10:1 over new lows. On Friday, there were 107 new highs and 9 new lows. Back on Mon/Tue it was closer to 15:1. On December 9th it was 40:1 with 121 new highs to 3 new lows. There is no weakness to be seen in the market internals other than just day to day volatility.

The S&P remains very over extended and at the widest divergence from the 100-day average that I have seen with my charts dating back to 1976. Every week I mention the overbought conditions and they just become more overbought. We know that eventually the S&P will return to touch the 100-day as it did in August. It is just a matter of time.

The Dow A/D line is no different. The majority of the Dow stocks remain in a positive trend but there are 8 reporting earnings this week. We could be approaching a turning point once post earnings depression appears.

The Dow is now 10.7% above its 100-day average and well outside its prior uptrend channel. The index did not close at a new high on Friday despite the records on the Nasdaq, S&P and Russell. This could be a sign of exhaustion ahead of the Dow earnings cycle.

The Nasdaq A/D chart stumbled early in the week as the big cap tech stocks turned choppy once again. They finished the week with the index at a high but only half of the big caps were positive.

The Nasdaq was volatile early in the week but moved over those tall candles to close at a new high on Friday. The index is now 605 points or 9% over the 100-day average. There is no way anyone can look at the chart below and not see an impending decline. The Nasdaq has cycled every 2-3 weeks over the last six months and it has now gone vertical for three weeks. There is a decline in our future, probably in early February if we can get by the shutdown without a dip.

The Russell was a strong performer on Friday but it has only posted large gains on three days since early December. The index has lagged but may be preparing to lead again. The tax reform will help small businesses significantly but the shutdown could hurt sentiment. Next week should be critical with strong resistance at 1,600.

I am not going to bore you with a lot of additional charts today because I covered must of the usual suspects in the Option Investor commentary. The bottom line to the market forecast is that a short-term shutdown should not impact the markets and could actually provide a buying opportunity. A longer term shutdown complete with a couple weeks of negative headlines could be a cloud over the market that keeps it from moving higher as earnings are released.

I am looking for a prolonged period of weakness beginning in early February as guidance becomes fully priced into the market and post earnings depression begins to drag stocks lower. We will know by the February option expiration if I am right.

Enter passively and exit aggressively!

Jim Brown

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