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Small caps soaring, rest of the market is following

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Stocks got off to a relative slow start on Wednesday, but momentum built with the help of another big rally in small caps. By the close the Dow gained 228-point and surpassed the 27,000 level again, and the S&P 500 closed back above 3000 again for the first time since July. Trading volume was on the light side as we approach the old highs, next week's potential rate cut, and some seasonal headwinds.

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So who wants to sell in front of a rate cut - or at least a 89% probability of a rate cut - next week? Apparently not a lot of folks. But what happens afterward? What happens if the 11% who think there will be no cut are right? The action looks good but we always have to be on our toes.

Here's a 1-year chart of the S&P 500 and what happened after the prior FOMC meetings. Some had a rate hike (red arrows), one had a rate cut (green, and that is expected next Wednesday again), and the blue arrows were meetings where no action was taken on rates, but policy statements still impacted the markets.

It's a bit mixed but surprisingly the market didn't do all that well overall after those meetings. The S&P 500 did continue to rally for 5-6 weeks after the June rate cut before peaking.

Now if we take a look at September's seasonality chart, we see that starting about on the 17th, next Tuesday, there isn't a whole lot of green on the daily return averages and percentage of times positive through the end of the month. With the rate cut scheduled for the 18th, is the seasonality chart predicting a "sell the news" reaction?

Chart provided courtesy of

If the Fed says they are heading to 0% rates or even negative rates, as the President suggested to compete with the rest of the world, I don't think there would be much that could stop the rally. I don't think they will say that, but they may be more dovish then we expect, and that could keep the bears away.

The futures jumped on Wednesday night after President Donald Trump tweeted that he will be delaying the increased tariffs on China to Oct. 15 from Oct 1 as a “gesture of good will.”

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The S&P 500 (C-fund) rallied picking up a decent gain on the day. Small caps have been stealing the show so by comparison the S&P is lagging, but it is still having a decent month - a month that is historically a struggle for stocks. After closing above 3000, I would think that an attempt will be made to test the recent highs. How that will be embraced by investors is the question. Double tops tend to bring on some selling, but the FOMO (fear of missing out) investors may still be looking to buy any dip.

The S-fund just keeps racing higher as investors move from the old favorites to the beaten down small caps. This could be a short-term move, and rebalancing like this isn't always bullish for stocks, but if this wants to test the recent highs, it has more room to on the upside.

The longer-term 2019 chart of the S-fund index shows two things... One is that the top of the current channel (red) is well above the current levels. There is one interesting obstacle, and that the the old broken support line (blue) that is now being tested and could act as resistance. A break above that and the top of the channel would be more likely. But it has to continue higher after its recent long winning streak.

The Dow Transportation Index started out slowly yesterday and spent much of the day in negative territory, but some late buying gave it another strong day gaining 0.83%. One big positive yesterday was that the late rally broke it above the descending resistance line off the April 2019 high.

The EFA (I-fund) had a solid gain and is in the process of trying to fill that open gap near 65.50. It had already broken above its descending resistance line a few days ago.

The Volatility Index moved lower yet again so investors are getting more at ease with the action. The question is, are they getting too complacent yet? The current bull flag is looking a lot like the flag we saw before last year's big December sell-off. One difference is that the 200-day EMA held last year where this week it has broken below it. Whether that makes a difference, I don't know, but it's very interesting.

AGG (bonds) was fairly flat on the day as it found some support at the bottom of the channel that we have been watching for weeks. The 50-day EMA is also within reach as possible support.

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

Tom Crowley

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