Have you ever eaten Chinese food only to be hungry again a couple hours later? Investors are suffering from the same problem. They get a dose of news about the Chinese trade process and it fills them up for a couple hours but they are almost immediately hungry for another serving.

Unfortunately, there is a lot of news flowing and not all of it is positive. The prior week the market tanked temporarily on news we were a long way from an agreement and there would be no meeting between Trump and Xi. Last week the market exploded higher on news the talks were progressing and negotiators would return to Washington this week for further talks. Furthermore, Trump and Xi agreed to meet at the end to sign a memorandum of understanding once an agreement was reached. Trump even said he was willing to postpone the March 1st tariff increase if there was measurable progress in the talks.

Using the recent trend, it would suggest there will be another round of negative news this week. The president is fond of the carrot and stick approach. The prior week was a stick week, last week was a carrot week and this coming week could be another dose of the stick involving a new round of threats.

With the markets closing in on strong resistance from two months ago it is going to take another carrot week to lift us over those levels. Futures on Sunday evening were positive but only barely. Futures on Monday evening are slightly negative. There are no indications of direction. The Asian markets are mixed with minor gains and losses.

On Monday President Trump is threatening military involvement in Venezuela if an orderly transition of power cannot be made. While the conditions in Venezuela are horrific, the market will not be happy with a military incursion because Venezuela is supported by China, Russia, Iran and Syria, four of our favorite countries. Russia and China could respond because of their extensive investments in the country. They will not want to lose billions of dollars in debts and facilities. Venezuela owes China more than $20 billion in oil backed loans. Russia was using the country as a military base in South America to project power closer to the USA.

Markets like to climb a wall of worry so they may get their chance this week.

Analysts are puzzled as to why the market keeps rising. The Dow, Nasdaq and Russell have been up for 8 consecutive weeks. Another streak that is not getting as much attention is the 11 consecutive weeks of outflows from equity funds. Bank of America said $83 billion has flowed out of equities over the last 11 weeks. These two facts seem to contradict each other. How can the markets rally for 8 weeks if there have been outflows for 11 weeks?

The market cap of the US equity market is $34 trillion. The $83 billion in outflows is only 0.00237% of the total market cap. This is the proverbial drop in the bucket. This does not mean $83 billion is not material because the vast majority of the US market cap never changes hands. Those stocks sit in investor accounts for years or even decades at a time without being traded. Average daily trading volume is about $350 billion. The $83 billion in outflows over the last 11 weeks equates to about $1.5 billion a day. Compared to the $350 billion average daily volume, it is insignificant. This is another example of people worrying about a headline that is immaterial in the bigger picture. It sounds like a big number, but it isn't once you do the math.

What is important is the resistance at 2,815 on the S&P. This level repelled rallies three times since October and we are getting close again. The S&P has rallied 429 points since the December 26th low at 2,346. There have been three periods of decent retracement along the way, but this rebound is very overbought given the length of the rebound and the weak fundamentals in economics and earnings. Nobody will be more excited if we break through that 2,815 level but I remain skeptical until it happens.

We do know that these high-profile resistance targets act like tractor beams when the index gets close so the odds are good, we will test it. It is the results after the test that are important. Do we push through or fail again? Also, since this level is such a high-profile event the bears are likely to be setting up their shorts once we pass 2,800.

The Dow benefitted from the rotation into industrial stocks and stocks that will benefit from a Chinese trade agreement. Boeing continues to be a leader whenever the China talk turns positive. The index closed over the first line resistance at 25,817 with the next target at 26,191. The giant round number in our future is 27,000. If we get through that resistance from November, the 27,000 level is going to be the instant target.

The Nasdaq Composite closed just barely over the 200-day at 7,465 and a move over 7,500 should set up a sprint to 8,000 and the highs from October. The decline in the FANG stocks held the index back on Friday.

The Russell 2000 closed 3 points over correction territory with the second-best percentage gain at 1.56% of all the major indexes. The small caps reacted much stronger than expected on the positive news from China. They should not be impacted as much from the tariffs other than cost of goods and raw materials. The small caps are mostly domestically focused companies and do very little business in Asia.

We have a light calendar for next week with the FOMC minutes the highlight. The Philly Fed Manufacturing Survey and the Existing Home Sales are the next most important.

Chinese trade negotiators will travel again to Washington this week in hopes of getting closer to a final deal before the March 1st trade deadline. The meeting days have not been published.

The Q4 earnings cycle is 80% over with 394 S&P companies having already reported. Q4 earnings growth is now projected at 16.4% with 6.0% revenue growth. Some 69.5% of companies have beaten estimates and 61.7% beat on revenue. For Q1 there have been 56 guidance warnings and 23 guidance upgrades. The are 51 S&P companies reporting this week. The forward PE has risen to 16.3%. The Q1 earnings forecast has declined to -0.5%. Energy is the biggest drag with a projected decline of -13.6% and healthcare is the strongest sector with a +6.2% forecast.

The earnings calendar is shrinking. Dow component Walmart will report on Tuesday. Agilent, CVS, Dominoes Pizza and Hewlett Packard Enterprise should be the most watched for the rest of the week.

With the government shutdown out of the way and Chinese negotiators coming to Washington to play nice once again, there is little in the headlines to roil the market. The market does best when it is climbing a wall of worry and we seem to be entering a calm period. However, the last two weeks of February are normally the weakest as post earnings depression weighs on the market. With the major indexes nearing their prior highs on weak earnings projections ahead of a weak period on the calendar, what could possibly go wrong? Obviously, quite a bit but investors appear to be drunk on the potential for a trade agreement. The hangover could be painful.

Enter passively and exit aggressively!

Jim Brown

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