Market streaks do not last forever. Five weeks of consecutive gains is forever in market timing.

The major indexes completed their fifth consecutive weekly gain and have moved from overbought to extremely overbought despite the slow start to the week. You may remember that the first two days of the week were very choppy with sharp declines at the open that were followed by some low volume dip buying that lifted the indexes back to the flat line.

Monday was the lowest volume day of the year and Friday was the third highest volume day of the year. That was due to the quadruple witching option expiration and some rebalancing in the S&P 500.

After the Fed decision on Wednesday the "all clear" signal was obvious and anyone currently short in expectations of a hawkish Fed was forced to cover. The Dow and S&P surged to finish the week with a +388 point gain on the Dow and +27 on the S&P. Obviously the performance difference between those two indexes was significant. Despite a +2.2% gain in the biotech index on Friday it closed the week with nearly a -3% loss. That decline in biotech stocks continued to weigh on the S&P and the Nasdaq. This allowed the Dow to surge ahead in performance.

The Dow has rebounded farther than the S&P and that means the Dow will hit critical resistance first and there is plenty of resistance waiting. It is extremely unlikely the Dow will just cruise through that highlighted area of resistance without seeing some significant profit taking. That represents serious congestion and as you can see by the chart it has been with us for most of last year around the 18,000 level.

We may be approaching the end of the current rally. If you compare it to the August/September decline in the chart below, the double bottoms are almost identical. The S&P rebounded +245 points from the September low at 1,871 to the November high of 2,116 or roughly a 13.1% rebound. Since the February low of 1,810 the S&P has rebounded +239 points or +13.2%. The September rebound took 36 days. The current rebound has taken 37 days.

Obviously, there is no rule that says one rebound has to follow the same script as a prior rebound but the S&P is only one good day away from downtrend resistance at 2,065 and then a steady stream of strong horizontal resistance at 2080, 2105, 2115, 2132, etc.

The identical patterns of the two rebounds are so easy to see that even a novice investor should recognize the similarity and become cautious. This is how tops are formed.

Obviously, I am expecting some rocky periods ahead. Market volatility normally increases at tops and bottoms. This comes from lots of indecision on the part of traders. Some believe the rally will continue while others are taking the opportunity to unload a lot of their positions into the eager hands of those expecting higher highs. The market direction depends on which side has the most conviction.

Because this is an election year there is an even bigger thunderstorm headed for the market this summer. As the primary winners shift to become general election candidates the real battle will appear and the mudslinging will reach a fever pitch. This typically depresses investor sentiment until they have a good idea about which candidate will win. If the race boils down to Trump and Clinton the market will favor Clinton. The devil you know is easier to deal with than the devil you don't know. At this point Trump is a wildcard and most economists believe his election will cause a recession because of his trade policies. Fortunately, just saying "I am going to impose a tariff on China" does not make it so. It would require legislative approval to turn his wishes into a law and while that is the safety valve on his election he would still be a negative impact on the economy.

I do not want this to be about whom I favor for election. Personally, I favor neither candidate but that is not the point. The point is that the storm clouds will gather ahead of the conclusion of the primary campaigns this summer. As the general election campaigning begins they will worsen depending on the candidates chosen.

The Q1 earnings cycle is also going to be market negative. On Friday, FactSet predicted Q1 S&P earnings will decline -8.4% and it will be the first time since 2008/2009 that earnings have declined for four consecutive quarters. On December 31st, the estimate for Q1 was for earnings growth of +0.3%. So far of the 118 S&P companies that have issued guidance for Q1, 78% or 92 companies have lowered guidance. Only 26 companies have issued positive guidance. For Q4, with 99% of companies reporting, 69% beaten earnings estimates and only 48% beat revenue estimates. Revenue growth estimates for Q1 have fallen from +2.6% to a decline of -0.8% since January 1st.

Q1 profit margins are expected to drop to 9.3% and the lowest since the 8.9% margin in Q4-2012. Analysts have cut earnings estimates by an average of 9% since December 31st. That is almost double the ten-year average of -5.3%. Estimated earnings from the financial sector have fallen from growth of +1.6% to -6.7% decline. The technology sector estimates have fallen from +0.4% growth to a -7.2% decline. Earnings are declining at the fastest rate since 2009.

Our only hope there is that the bar will have been set so low that every company will beat those lowered estimates. We have seen it many times in the past when the estimates become so ugly that any beat becomes an instant ray of hope. With the dollar falling we could see a lack of negative guidance because of the strong dollar. That would be th first quarter in a long time that companies did not warn on currency problems.

We do not know what is going to happen over the next six weeks. What we do know is the indexes should have a significant challenge moving through those resistance bands.

Typically when the market has rebounded 10-15% from seriously oversold conditions we see a 3-5% decline from the highs before a new rally begins. That would equate to a 60-100 point drop on the S&P. With the first major resistance at 2,075 that suggests a drop back to 2,000 if we saw a normal corrective process.

I would love to see all the "normal" trends trashed and the S&P make a new high before the Sell in May cycle but we do have to consider the historical trends and their potential to disrupt the markets.

We have been running without any stop losses in the portfolio since we were blown out of most of our positions in Jan/Feb. As the S&P moves closer to 2,075 I am going to put some stop losses back into effect in hopes of capturing some profits when/if the market rolls over.

I am also anticipating adding some index ETF shorts in the next week or two. We can use them as hedges or just another profit opportunity.

The economic calendar is devoid of any real market moving events but there are a lot or reports. If the tide has turned and they begin to come in better than expected it could support the market. With the Fed already on hold, any negative reports could have a negative impact on the market. Bad news could really be bad news in this cycle.

The market is closed on Friday for Good Friday and historically the market is bullish going into the Easter weekend.

Jim Brown

Send Jim an email