When markets reach new highs one of two things happens. When the fundamentals are bullish is sparks the fear of missing out (FOMO) rally that takes us higher. When fundamentals are lackluster and the market gains are based on external factors like potential rate cuts, the new high excitement can fade quickly.

The AAII Sentiment Survey bullish sentiment has risen for four consecutive weeks and closed at 35.9% on Wednesday. While that is good, the rate of gain is slowing and it still means 64% of investors are either neutral or bearish. That means two thirds of investors are not excited about the new highs.

AAII Investment Survey

Over the last 12 months Bank of America says more than $300 billion went into fixed income bond funds and $150 billion flowed out of the equity market. Only 54% of investors are holding equities.

Given those numbers it is unbelievable that the market hit new highs last week. However, it was a narrow breadth big cap rally. The 2,000 small and midcaps stocks are declining.

The reason the market is losing traction is that the big caps are rolling over. We reached new highs on Monday and it has been all downhill the rest of the week. The A/D line is clearly in trouble having stalled and coming very close to a two-week low close.

The small cap A/D line peaked three weeks ago and is in danger of a sharp decline. There have been multiple lower highs over the last two weeks. The Russell 2000 closed at a three-week low.

The relative comparison chart between the Dow and the Russell paints a very clear picture of who is leading the market. The small caps are falling despite the new highs on the three big cap indexes.

The major indicators on the Russell have turned bearish and the index has not tested downtrend resistance since July 1st. The trend is definitely headed lower. I do not see any impending headline that could reverse the decline on the small caps. They did not move higher on the impending rate cut and are not likely to move higher when it actually happens. We are heading into the summer doldrum period and August is the worst month of the year for small caps.

The Nasdaq is also in trouble. The FAANG stocks are ALL headed south, and Netflix has imploded. This has poisoned sentiment on the rest of the pack and when you include Microsoft they account for more than 30% of the weighting on the Nasdaq 100. The Netflix disaster makes investors worried there may be another disaster coming in future tech earnings.

On the flip side the chip sector has held up relatively well. This is helping to prevent a tech crash. When Broadcom backed out of the Symantec acquisition and shares rebounded this lifted other chip stocks in the group even though they were not linked to the transaction.

On the Nasdaq, prior resistance at 8,070 and 8,109 should now be support. Next week's earnings are tech heavy and that could be a blessing or a curse depending on the results.

The VIX rebounded slightly from the prior week lows near 12. If the big caps continue their post earnings swoon the VIX will continue to rise. Note that while August is normally the worst month of the year, we did see the VIX hit 10 last August when the market spiked unexpectedly. Market cycles tend to repeat but there are never any guarantees.

I would refrain from entering new long positions until after the FOMC meeting. While it is almost guaranteed they will cut rates by 25%, more than 24% of investors are expecting a 50-point cut. Those 24% are going to be disappointed and will likely sell positions they have developed ahead of the meeting.

Enter passively and exit aggressively!

Jim Brown

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