A look at the markets by the Small Cap Network

Dont be scared by short term reversals they are healthy in any growing market!

We will have a monster micro-cap pick out soon stay tuned

August 21, 2012 9:28am PDT

Dear SmallCap Network Members,

There we go. Finally, the S&P. the DOW  and the NDX  are all testing their April highs today, however, theNASDAQ Composite  is still lagging shortly behind. At least the COMP  has made up some ground on the other indexes in recent days. One or two more good days for the COMP  and it will have followed suit.

If youve been following along, we have been anticipating this test of the highs  after the NDX  andCOMP  managed to break above their key resistance levels from early July. It has taken a little time, but were finally there. Ive included a chart overlay here of the NDX  (green), DOW  (blue) and the S&P  (red) showing you all three indexes have moved in tandem and are now either testing their highs or have just slightly broken above them. Although the NASDAQ Composite. the Russell 2000  and the rest of the small cap world still havent taken charge of the recent rally, theres no arguing the strength displayed by large caps ever since the major indexes hit bottom in early June.

Whats worth noting is the run-up of late has been stealth like with no visible catalyst on the surface, other than a slightly better than expected earnings season across the board. Theres a lesson learned here. When the media makes every attempt to distract investors with lagging economic data or speculative economic concerns, stocks will always trade based on earnings. Theres been no recent chatter of the Feds anticipated QE3 plan, Europe hasnt improved nor have the economic numbers from right here in our own backyard. However, while concerns over 2 nd  quarter earnings plagued the underlying fundamentals of the markets earlier in the summer, it has become evident the markets have once again gotten brave.

Basically, the markets prepared for the worst going into the summer and the worst didnt end up happening. A classic example that stocks trade well in advance of whats going to take place  down the road. One point I havent heard expressed much of late is that ever since global economies have been tied to the hip, the U.S. economy has been the leading indicator for things to come. So, with the economic collapse of 08 here at home, is the weakness over the last few years in Europe, China and the rest of the BRIC nations the last shoe to drop and an indication that the worst is finally over? Possibly. Remember, stocks trade in advance of whats going to take place months from now. Any positive signs coming out of Europe that their economies have finally hit bottom could become a huge catalyst for stocks here at home and abroad. Additionally, with all of the worries plaguing the rest of the world, the U.S. markets just may be the safest place to be .

Now, the big question once again becomes, where to from here? Were actually at a very pivotal point in the market  now. Either the major indexes are going to grind higher in a very orderly non-volatile manner, or were going to start seeing some resistance around current levels. Weve mentioned the possibility of a range bound market going into the elections season, but even that remains to be seen. Then again, so has a nice new leg up going into the back half of the year. Remember, Wall Street doesnt like uncertainty. And, not knowing who our President is going to be is about as uncertain as uncertain can get.

For as long as weve been following the markets, weve seen just about everything and for us to tell you we know exactly whats going to happen from here would only be challenging your intelligence. Until we get some sort of technical confirmation that this market wants to move higher or back off and retest some key support levels now, its anyones guess. I will say the risk reward of challenging a breakout is probably much better than getting long call options at current levels.

Theres an old myth in the markets that once a stock or an index tests a new high and breaks above it, that its the holy grail signal to get long for another strong new leg up. Does it happen? Sure, but more often than not buyers get exhausted on new highs and the index or stock in question becomes subject to weakness.

Heres a couple of key signals to keep an eye on going forward. Should the major indexes continue to show a quiet, slow and orderly move up, thats going to be very bullish in our opinion. Should the markets start to reveal an abnormally high level of volatility over the next few days, thats likely going to be bearish for stocks. Should we see a sharp move lower only to be met with a fierce reversal to the upside, thats going to be the biggest bullish indicator well see suggesting the markets are going to want to move higher. However, even if we get a sharp move lower that isnt met by a big reversal, its not necessarily going to mean this market is going to break down.

We have said this before and will say it again. For now and likely in the months leading up to the election, we believe the worst is over for stocks. If for some reason this market goes range bound and gravitates back to its June lows, I for one wouldnt necessarily be running for the hills as much as Id view it as a buying opportunity. Should the June low get taken out, which could take months, I seriously think a takeout of that low would be the ultimate buy signal.

I know thats very contrarian to what most would think, but I do have a key level to the downside that I think would be met with a tremendous amount of support should we get there. Theres no reason in sharing that level at this point because were a long ways away from that. Conversely, should this market breakout convincingly, the move could be parabolic because there isnt a whole lot of logical resistance levels we can spot in the near-term if the markets start to go crazy to the upside.

For now, lets see how this market reacts to its test of these highs because thats going to tell us quite a bit as to what this market wants to do over the next couple of weeks. In a perfect world, we get a sharp short-term move lower, which gets erased by a sharp reversal to the upside. That would likely cause a fierce and very playable move to the upside. Show me the money Jerry.

Warmest Regards,

SmallCap Network