Market breadth took a significant turn for the worse on Friday. I reported on breadth several times over the last couple of weeks and remarked how breadth was shrinking and the market was being led higher by a smaller number of big cap stocks. Those few leaders finally ran into trouble and the declines in the smaller stocks were too broad for the big caps to support.

On Friday the small cap decliners overwhelmed advancers by 496 to 25 or roughly 20:1. I do not recall ever seeing that large of an imbalance before but that does not mean it did not happen. Thursday's short squeeze was 4:1 in favor of advancers. Given the significant imbalance I would have expected a bigger drop on the chart. The magnitude of the swing in Dec/Jan has thrown off the scale on the chart, which means Friday's decline is under represented.

Small caps are supposed to lead the broader market higher and lower. On Friday they seized the lead and declined nearly -4%. This is a bad omen for next week but as you know it is still possible for the market to reverse with a monster short squeeze like it did on Thursday. The end of the Muller investigation could have a positive impact on the market if there were no findings of wrong doing by the president. As of Saturday evening, there has not been any release of the data.

Last week I speculated there was a potential for a head and shoulders pattern to form at 2,872. The high for the week was 2,860 but these patterns do not have to be exact and 12 points is close enough. If that H&S pattern completes the target would be somewhere in the 2,600 range.

The A/D line on the S&P was much better than the small caps at 6:1 in favor of decliners. That was not as large an imbalance as the 8:1 imbalance in favor of advancers on Thursday. These are huge numbers. 2:1 or 3:1 is the norm and sometimes 4:1 but the imbalance over the last two days has been huge.

While the A/D line on the S&P did not show a major decline the percentage of S&P stocks over their 50-day average has fallen from 92% to 62.8%. That is a material decline and again shows that only a few stocks were leading the market higher while the rest were sagging.

The Nasdaq A/D line declined only slightly despite all the big caps turning negative on Friday. The Nasdaq chart could be interpreted as a H&S but it is not as pronounced as the S&P. I would not call it that and I am only showing the pattern as a comparison.

The volatility in the FANG stocks is increasing with major declines on Friday. Analysts are calling them very overbought.

The Dow pattern is showing strong resistance with two tops at 26,616 and 26,951. The nearly 600 point hit from the Boeing decline kept the Dow from testing those upper levels and could continue holding it back. For me this is a bearish chart. Even if the Dow does continue higher to test those levels it has been damaged by the Boeing drop. It no longer has Boeing adding 50-70 points a week as we saw in the prior six weeks.

The Russell 2000 is also a bearish chart with a clear failure at critical resistance of 1,600. The shorter-term daily charts simply show the struggle under 1,600 and the pending retest of 1,500. The actual failure at resistance was 4-weeks ago.

The Volatility Index has gained 4 points over the last week. This is still not in the buy zone at 20 but it represents a danger zone for holders of long equity positions. A good rule of thumb is to buy at 20 or above and sell at 11 or below. Since the VIX can remain at both extremes for a long time that is a long-term rule.

I am cautious on the market until Brexit passes and a trade agreement is reached with China. Those problems would not be so important if we were expecting 15% earnings growth in Q1. Investors would ignore those events. With growth expected to decline -1.7% there is no margin for error. Every headline counts. Be patient. There is always another opportunity to buy.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email