The big cap indexes stumbled on Tue/Wed but recovered to surge to new highs once again.
The Nasdaq dropped -110 points intraday on Wednesday followed by a minor decline on Thursday. That was followed by an explosive move higher on Friday with a 95-point gain. The uncertainty from the middle of the week was just enough to draw the shorts back into the market so they could be squeezed again on Friday.
Despite the big gains, the internals were not overly positive. On the Nasdaq there were 1,700 advancers to 1,123 decliners. Advancing volume of 1.33 billion shares were well over the 567 million shares of declining volume. However, investors always want to see 2:1 or 3:1 advancers to decliners and 5:1 or even as much as 10:1 advancing volume over declining. We were a long way from those metrics.
The gains were strong but that was due mostly to the big cap techs posting big gains ahead of their earnings next week. On the Nasdaq the generals were leading the charge but a lot of the soldiers were AWOL.
The trend is our friend and it appears the trend will continue higher for another week.
For our purposes in examining the major indexes, there was no material change. The A/D line on the S&P closed at a new high because the internals on the S&P were a blowout. The advancers of 409 on Friday swamped decliners of 92. This 4:1 ratio suggests the rally still has legs.
However, the S&P is clearly in euphoric mode as evidenced by the weekly chart. The gains continue to accelerate and the RSI at 88.54 is at a record high. That does not mean the market is going to crash next week but it does suggest there will be a reversion to the historic norms at some point in the future. There is no way an experienced investor can look at this chart and not see a potential correction in the coming months.
The A/D line on the Dow is also at a record high and there is no weakness in sight. However, there are 10 Dow components reporting this week and eventually the post earnings depression cycle will appear.
The RSI on the Dow at 92.03 is at a record high. Note that there have not been any material hiccups on the Dow trajectory since the election in November 2016. There was a minor pause in March/April but then a steady acceleration of gains for the next 10 months.
A record high RSI is an extreme warning signal. This chart is starting to look like a dot.com chart from the year 2000 where gravity was temporarily suspended. It did eventually return and it was very painful.
The Nasdaq A/D was a little choppy because of that midweek plunge. The trend remains higher but it did not close at a new high.
The RSI on the Nasdaq is the third highest in history. In April of 1986 the RSI hit 91.21 and the record high but the index continued higher until late June when a -17% correction appeared. The RSI began to weaken starting on April 20th as the rally turned choppy but the index did not fall until late June.
The second highest reading of 89.21 was July 9th, 1995. The index continued higher until Sept 3rd, when it fell -10.7% over three weeks and then traded sideways until mid January.
The fourth highest RSI was December 26th, 1999. The Nasdaq continued higher after a choppy January to peak on March 5th, 2000 before falling for the next two years.
We obviously do not know what will happen as the RSI peaks again but we have a clue from looking back over the last 45 years at the prior highs.
The RSI tends to peak several weeks before the market rolls over. Light selling appears and the generals probably continue to hold the market up while the foundations erode. What has not happened was an immediate market sell off after a peak. There was a period of time and we could track the deterioration in the RSI as the market internals deteriorated.
Obviously, past performance is no guarantee of future results but the research is not telling us the market is going to crash next week. Nothing prevents it from happening but there is no immediate cause and effect.
I have been forecasting a rough patch for the market in February after the majority of S&P earnings are over. That could begin the first full week of the month and more than likely before expiration Friday. I believe investors will take some profits off the table and then reload into different stocks for the Q1 earnings cycle that begins in April. After the Q1 earnings, I expect the market to weaken again and we could have a rough summer before rebounding again in Q3/Q4.
The small cap stocks have been the weakest index. They are moving higher but at a significantly slower pace. This is a market warning of sorts. The small cap stocks are supposed to lead the market both up and down. They are not leading and should the Russell roll over that could be the early warning signal of a broader market decline.
This is a time for investors to capitalize on the existing euphoria. In a strongly bullish market, the last several weeks tend to be euphoric and that is exactly what we are seeing now. Investors can capture significant gains but they should be constantly wary of the market internals and signs that the buyers may be losing conviction.
There may not be any warning if the market suddenly changes course. We never know what might trigger a reversal. The dip buyers will rush in thinking it is just another dip. If you are going to buy a dip, wait for signs of a rebound. Let someone else step in front of the train and try to halt the slide. If they are successful, there will be plenty of time to buy the rebound.
Enter passively and exit aggressively!
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