Geopolitical event risk may have faded but market risk is increasing.

We avoided a disaster in the French elections and the Fed meeting was completely ignored. The budget crisis passed calmly and the earnings cycle has been outstanding. However, we are now headed into the summer doldrums with the markets at their highs. What could possibly go wrong?

The Dow closed at a three-week low on Friday and triggered a MACD sell signal. The Russell 3000, the broadest of the major market indexes, also triggered a MACD sell signal on Friday after making a new high on Wednesday by only 0.14 of a point. The prior high was March 1st.

We are moving into the dangerous period as the Q1 earnings cycle ends. With more than 450 S&P stocks already reported, there are very few earnings events left that can be a catalyst for the market. Investors will be left to make decisions based on charts and calendars rather than earnings and headlines.

This is the beginning of the "Sell in May and go away" period and the start of the worst six months of the year. Obviously, the market does not always go down in the summer but it is weak more often than not. This summer could be different because of the strong earnings expectations for the next three quarters but there may be a political roadblock in our path.

The Trump agenda is in trouble. The expectations for tax reform, deregulation, infrastructure spending and healthcare reform have propelled the markets higher since the day after the election. Now all of those items are in trouble. The recent Comey termination has significantly clouded the outlook. Senators are now doubtful they can get anything related to healthcare out of committee before the August recess in the House. That is only 39 working days away. That puts healthcare in the Nov/Dec time frame for the real battle after the competing bills are merged in the conference committee. The odds are good there will not be a successful result and a reform bill will not be signed in 2017. Healthcare has to come before tax reform. The scenario above suggests tax reform will slip into 2018 when everyone is worried about mid-term elections.

Once investors realize the revised timeframe for these events, they will lose their optimism. Investors wanting to sell now but waiting for tax reform will realize if they don't sell they are risking a market crash over the next 12 months as the agenda falls apart. The odds of the market declining this summer are rising. Strong earnings expectations are the only thing that could prevent a market disaster.

If we use the Russell 3000 as the best indicator of the actual market, we see the index has flat lined for the last three weeks but the MACD and RSI are turning bearish. Support is about 1,414 and a decline below 1,410 targets 1,380.

The same chart on the Dow shows the index closing at a three week low, but not the intraday lows. Intraday, the Dow dipped under 20,800 on Thursday, also a three-week low. The Dow is already suffering from post earnings depression since 26 of the 30 components have already reported. If the Dow continues lower below 20,800 again, it should easily test 20,500.

The S&P is trying to hold over 2,380 but struggling. The chart is not as bearish as the Dow because the trend is still sideways. A move under 2,380 negates that.

If we only had the Nasdaq indexes to look at, the market picture would be entirely different. The Nasdaq is bullish but overextended. It is due for a 2-3 day dip that scares everyone out of their positions and allows patient investors into new positions. The Nasdaq big cap techs have been holding up the broader market because they are all S&P components as well and they are offsetting the weakness in the broader index.

The small cap indexes are breaking down. Both the Russell 2000 and the S&P-600 closed at three-week lows on Friday. Resistance held and sellers gained some conviction.

The earnings cycle is coming to a close as you can tell from the number of unrecognizable symbols in the table below. However there are three Dow components reporting this week. Home Depot is likely to be the best report with Cisco the worst report. Wal-Mart probably matched estimates. I hope I am wrong and they all beat by a mile and the Dow recovers. While I am wishing I would also like to win Lotto.

The economic calendar is headlined by the Philly Fed Manufacturing Survey on Thursday and the new home construction on Tuesday. The rest of the reports are filler.

I recommending being cautious about adding long positions this week until we see which way the market is going. The S&P cannot remain sideways forever and the Dow and Nasdaq cannot continue to diverge. Eventually one will follow the other.

We need a real bout of profit taking to wake up traders. The complacency is at multi-decade highs with the VIX at multi-decade lows. It looks like everyone just assumes the market will continue higher regardless of the circumstances. The sharp dip at the open on Thursday was immediately bought but not with enough conviction to return to positive territory and then Friday was negative as well.

Over the weekend, Russia said it had agreed with OPEC to maintain its production cuts through March 2018. While there have been no formal announcements from OPEC that would seem to suggest that everyone else will do the same. Oil prices spiked to $48.75 and that lifted the S&P futures to +3.50. It will be interesting to see if that gain holds until the open.

Jim Brown

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