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Pre-holiday fake-out, or are the lows in?

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Stocks rallied on more light trading volume led by a jump in the price of oil and energy stocks. The Dow gained 258-points, or 1.0%. The beaten down Russell 2000 small cap index gained 1.15%, but our S-fund (+0.73%) hasn't been keeping up with the Russell as it generally does. The Transports were also big winners on the day jumping 1.77%. The S&P 500 and Nasdaq both had more modest to moderate gains. The dollar rallied yesterday, which weighed on the I-fund.

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The price of oil, and energy stocks in general, helped lift stocks yesterday. The energy sector has been a major drag on the stock market and yesterday's action saw it, and a few other lagging sectors, lead on the upside which brings to mind the holiday reversal phenomenon. I've talked about it often so I won't go too into it, but quickly - there is a tendency for stocks to move in the opposite direction to the larger trend right before a major holiday weekend. That larger trend then tends to resume shortly after the holiday weekend. We'll see.

The fact that bonds rallied so much this month could be setting up a late August / early September positive bias as money managers rebalance their portfolio's stocks to bonds ratio. A basic example would be if a money manager's investment prospectus says they keep 70% of their assets in stocks, and 30% in bonds, and bonds rally 10% while stocks fall 10%, in order to keep that 70/30 ratio for the next month, they have to sell bonds and buy stocks.

The trading volume is normally light this time of year and when we see a 250+ point rally in the Dow, it could be as a result of the rebalancing by just a few large money managing firms.

The point is, the move up or down, depending on how a month is getting rebalanced, may not be a true indication of which way the market wants to go. When you combine that with those pre-holiday reversal tendencies, the short-term moves can get confusing. You can see false breakouts or breakdowns that were - not so much artificially manufactured because they are real trades - but the supply and demand that caused it may not be the same after the holiday or a few days into a new month.

I don't know if that's what's happening now. It feels like it a bit, but light volume, pre-holiday trading is not usually the best judge of what is going on in the market.

That makes short-term analysis, particularly technical analysis, and things like investor sentiment, get skewed. That's why trading volume gets light because, not only are folks on vacation, but many professional traders don't like to trade in environments like this. For at reason, barring any major events, I'll make today and Friday's commentary quick because the charts may not be telling the true story. As a matter of fact, they could be faking us out.

Per "Some financial markets will be closed on Monday, September 2 in observance of the Labor Day holiday. The Thrift Savings Plan will also be closed. Transactions that would have been processed Monday night (September 2) will be processed Tuesday night (September 3), at Tuesday's closing share prices."

The S&P 500 (C-fund) remains in that large red bear flag and the recent back and forth action may have created a small bear flag (blue) within the larger one. The moving averages have been key levels of support and resistance lately, and it's the 100-day EMA providing resistance now, while the 200-day EMA has held firmly as support all month.

The S-fund had a good day but remains below some key resistance. The 200-day EMA has been broken for a few days (and 4 straight closes), but what is fairly new is that yesterday's rally failed at an attempt to get back above the 200-day simple moving average - something I don't normally track unless it's getting in the way. That may be something to watch going forward.

The Dow Transportation Index had a big day but it is still just gyrating within that falling flag formation, which is below the 50 and 200-day EMAs. Meanwhile the 9700 level held again at yesterday's lows.

Here's the catalyst for the rally in stocks yesterday as the Energy sector led on the upside on Wednesday. The chart isn't as impressive as the headlines made it sound, although $56 is holding again.

AGG (F-fund / bonds) was mostly flat on the day after an early rally reversed. The blue rising channel seems to be the new trend, but if we see any of that rebalancing by money mangers in the coming days, it could threaten the top of the old channel (red), which has been holding as support for the last week.

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Thanks for reading. We'll see you back here tomorrow.

Tom Crowley

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