Investors suffered withdrawal symptoms as the euphoria evaporated.

There was nothing fun about last week's decline. However, despite the nearly 1,100 point decline on the Dow we only lost two weeks of gains. The Dow is still up 3.2% for the year and the Nasdaq 4.9%. For a normal year that would be a good January. While I expect to see some lower lows in February, that is just my opinion and no guarantee of direction.

For several weeks I have been predicting declines in the first full week of February through option expiration. The rising interest rates simply accelerated that decline by one week.

Actually, it was the excessive euphoria that caused the decline. The interest rates may have gotten the blame but the market was out of control and needed to rest.

I am reprinting these two charts from last week with the RSI on the Dow and S&P at record levels and the charts accelerating into a vertical ramp. Liz Ann Sonders from Schwab pointed out that the S&P was the most overbought since 1904. That is pretty extreme. Nobody looking at the charts below should be surprised that profit taking appeared.

It should also be no surprise that the A/D charts all showed a significant reversal. This is now a following indicator and we need to watch them for signs of an uptick. There will be a rebound and that will give us a little hook on the end of this current down slope. The key point to watch is whether there is another decline that creates a lower low after we get that rebound.

I had been profiling the spread between the 100-day average and the S&P. Last weekend the S&P was 236 points or 9.1% above the average and that has corrected to only 130 points or 4.9% as of Friday's close. This was accomplished by the -110 point decline in the index and the 6-point rise in the average. This is still a much wider than normal spread but it did bring it back into a somewhat normal range.

The RSI has gone from a 22 year high at 86.69 back to 46.08 and almost an oversold level. I discussed last week that RSI oversold/overbought levels tended to not have an immediate impact on the market but in this case, it was dramatic.

It is time to shift from how high can the indexes go to how low could they go. The S&P has multiple lines of converging support just below 2,700 at 2,685. That corresponds with the Bank of America target at 2,686 or a 6.4% decline. I would look for a rebound at the 50-day at 2,715 "IF" we do not get a rebound on Monday.

There will likely be some forced margin selling at the open on Monday and some panic selling from some investors who were not watching the market on Friday. You can imagine their surprise when they arrived home from work and turned on the news to hear the Dow posted the fifth biggest point loss in history. They are probably pacing off their nervous energy all weekend waiting for the market to open on Monday.

The Bullish Percent Index on the S&P declined from 83.2% to 77.8%. That is still elevated but definitely off the near record highs.

The percentage of S&P stocks over their 50-day average fell from 84.2% to 60.4%. That is a monster decline in only five days. The percentage over their 200-day average declined from 82.8% to 76.0%. The longer-term average is always a lot lower and a material change in that chart requires a longer time period.

The Dow is approaching uptrend support at 25,250 with the 50-day average at 25,016. I would be happy with a rebound from either level. That would be a nearly perfect dip to buy and strong support from which to launch the next rally. However, I would expect a lower high and additional selling in February once the earnings cycle is over.

The Nasdaq Composite is nearing the 30-day average where it has bounced the last five times there was some profit taking. However, the average itself is elevated and it may not hold. That is the 7,203 level. On a technical basis, the uptrend support at 7,065 and the 50-day at 7,067 would provide a much stronger base for a rebound. The Nasdaq had gone nearly vertical over the first three weeks of January and there is still a lot of profit to be captured.

The percentage of Nasdaq stocks over their 50-day average took a steep dive from 73.0% to 49.3%. The tech stocks definitely took a beating.

The Semiconductor Index fell -4.6% for the week and was a big factor in dragging the Nasdaq lower. Where the chips go, the Nasdaq will follow.

The small caps continue to underperform the large caps and the Russell 2000 never made the rocket ride spike to super high levels. The Russell chart looks like a normal chart with regular bouts of profit taking. The index closed just 2 points under what should be support at 1,500 and that would be the level to watch on Monday.

Conventional wisdom suggests a decline Monday morning and then a potential rebound later in the day. That assumes the decline last week was a normal garden-variety dip from extremely overbought conditions. In reality we really do not know what caused investors to sell.

What we do know is there are a large number of investors of all types and sizes that have been waiting for a dip to buy. The dip arrived and now it is the moment of truth. Do they go all in or do they run to the safety of cash because the evil market has shaken their convictions? We should know by noon on Monday.

Enter passively and exit aggressively!

Jim Brown

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