After Friday's short squeeze and new highs on small cap indexes, the bulls may be warming up for s September to remember.

The big cap indexes failed to make new highs on Friday but S&P small and midcap indexes were in breakout mode. Volume was higher than expected for the last three days and dip buyers were very active.

The Dow made a four-week low on Thursday so it was unable to reverse to a new high on Friday. The index was up +125 at the open only to decline to +25 at 1:30 and then reverse again to close with a 72-point gain. While that was positive, it remains well below the historic high at 18,636. The Dow is the best example of a big cap index. It is struggling to remain in the two-month consolidation range while the smaller cap stocks are making new highs.

The big cap stocks are hampered by issues in China and Europe and global currency conversion issues. The small caps stocks are not as globally oriented so the impact from those forces is limited.

Historically, Q4 is bullish for small cap stocks. Portfolio managers can get more bang for their bucks in the small caps. In times of market stress they favor the highly liquid large caps where there is some level of security in case they have to exit quickly. When the market has a positive bias, as it does today, the small caps are the preferred stocks.

The Russell 2000 made a new 52-week high but is still well below the historic high at 1,295. The Russell is the broadest small cap index and the only requirement for entry is their market cap. That means there are a lot of relatively uninvestable companies in the index. The S&P small cap indexes are populated by invitation only after a team from S&P have reviewed the stocks and handpicked them out of a group. This means the indexes have higher quality components.

Russell 2000 Small Cap Index

S&P-600 Small Cap Index

S&P-400 Midcap Index

The rally in the smaller cap stocks ahead of a normally volatile period for the market suggests we are going to see more gains. Portfolio managers would not be buying small caps if they perceived any danger on the horizon. Unfortunately, in order to load up on small cap stocks they will need to unload some large caps in the weeks ahead. That will depress the Dow and S&P and those indexes are normally seen as "the" market.

The S&P has not been as weak as the Dow but it is a tight race. The S&P is sticking to the 2,175 price magnet and has solid resistance at 2,193. Support at 2,150 is now critical and a breakdown there could disrupt the entire market.

The market has not had a major decline since January. The two day dip after the Brexit vote was a headline move rather than a market correction. We are way overdue for a 3-5% decline to equalize the market pressures and allow new investors a buying opportunity. While I do not see any invent on the horizon that could cause a mini correction, it is the events you do not see that are the most dangerous. Also, the market does not need an event to cause a decline. Sometimes the various unseen factors suddenly align at the same time and a trap door opens beneath the market.

The FOMC meeting on Sept 20th could be a hurdle. If the Fed decides to hike rates regardless of the data, the market would react negatively.

The economic calendar for next week is benign with the possible exception of the Fed Beige Book on Wednesday. The earnings cycle is over but there are still a few companies reporting. Hewlett Packard on Wednesday could be important for the tech sector. Everything else is just filler.

I continue to recommend keeping your stop losses tight and plan to reestablish any stopped positions on any September dip. Market lows for the last six months of the year tend to happen in Sept/Oct. I would also maintain a shopping list of stocks you would like to own on a market drop. Many investors are too concentrated on dumping positions in a sudden market decline. They should let their stop losses handle that task while they enter buy orders at bargain basement prices for new stocks they would like to own. We never know when the market will hit a sudden air pocket so it helps to have your shopping list already prepared and you should revise it at least once a week.

Jim Brown

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