Introduction

First, we want to thank our readers for their patience over the last few weeks as we wrapped up our summer travel. We will be back in the office this week and returning to our normal publishing cadence.

The market continues to grind sideways, frustrating both bulls and bears alike. Bears remain convinced a major top is in place, while bulls are waiting for the indexes to finally break free of their multi-week consolidation and resume the primary uptrend. Instead, both sides have been forced to endure relentless rotational chop.

These are often the most difficult market environments to trade. Add in the violent sector rotations we've witnessed over the past month and it becomes a recipe for unnecessary losses. There is a reason many traders reduce activity during the summer months and let the algorithms battle it out. Thin liquidity can exaggerate every move, conviction fades quickly, and overtrading becomes an expensive habit. Sometimes the best trade is simply doing less.

That said, the rotational theme we've discussed extensively over the last month remains firmly intact. It increasingly resembles a game of hot potato, with capital rapidly rotating from one leadership group to the next as investors chase the latest narrative, only to abandon it just as quickly for the next shiny object.

Much of that rotation has been funded by the market's unquestioned leader: semiconductors. Despite the recent cooling, the semiconductor ETF (SMH) is still up roughly 70% year to date—more than three times the return of the next-best major segment of the market, small caps. Leadership of that magnitude was never likely to persist uninterrupted, and as capital rotates away from the market's biggest winners, it has created both opportunity and a meaningful roadblock for the broader indexes.

At last week's low, the semiconductor ETF (SMH) had corrected roughly 15% from its highs. That is certainly a meaningful pullback, but hardly the kind of decline that changes the longer-term thesis, despite what many of the doomsday headlines would suggest.

Recall our view from a few weeks ago. When the SMH printed a weekly DeMark Combo 13 sell signal, we suggested the group was likely putting in an intermediate-term top and entering a corrective phase during Q3. This outcome should not have come as a surprise. In fact, the previous weekly Combo 13 sell signal in February produced an almost identical decline of roughly 15% over a six-week period.

The correction, therefore, is behaving well within historical expectations. More importantly, the February pullback did not mark the end of semiconductor leadership—it merely reset an overcrowded trade before the uptrend resumed. At this stage, we see little evidence that the current correction represents anything materially different.

We also suggested in our 7/5 report that the rotation into lagging sectors could begin to reverse as earnings season approached. Thus far, that thesis is playing out as expected.

Technology has led the rebound this week, with energy close behind, while many of the recent rotation winners have begun to lose momentum.

That marks an almost complete reversal from the rotational action we witnessed over the prior two weeks, when we first advocated rotating into lagging sectors and stocks. As we suggested, that trade now appears to be unwinding as earnings season approaches and capital rotates back toward technology leadership.

So, what does it all mean? In truth, the market still appears to be searching for its next durable leadership theme. Choppy, rotational environments are designed to wear out both bulls and bears, and so far, Q3 has done exactly that.

The biggest surprise has been the resurgence of the Magnificent Seven. While we argued that the group could rebound into earnings season, we did not anticipate this degree of outperformance.

Since bottoming on June 25, the Mag 7 Index has rallied roughly 10%, while the S&P 500 excluding the Mag 7 has been essentially flat—a remarkable 1,000 basis points of relative outperformance. Software, another group we've highlighted as a potential source of alpha during this leadership transition, has gained roughly 9% over the same period. Meanwhile, the semiconductor ETF (SMH) has declined approximately 4%.

The message from the tape is becoming increasingly clear: growth capital is rotating back toward the largest technology franchises, while semiconductor leadership has paused following an exceptional run. Whether that rotation has staying power now rests largely on earnings season. If results and guidance validate the renewed enthusiasm, leadership could broaden within technology. If not, another rotation may be just around the corner.

Stay tuned.

From a purely technical perspective, the Mag 7 appears poised to retest its all-time highs after completing an inverse head-and-shoulders bottoming pattern. The measured move projects to levels above the prior highs, suggesting the pattern remains constructive rather than cautionary. Simply put, there is very little about this setup that looks bearish.

Of course, all of this could become secondary if the renewed tensions with Iran escalate. As always, how the market closes the week will be far more important than how it opens. Headlines can dictate the short-term reaction, but the weekly close will tell us how investors ultimately choose to price the risk.

This week also marks the unofficial start of earnings season, with the major financial institutions kicking off. According to Bloomberg Intelligence, S&P 500 profits are projected to increase roughly 24% year-over-year in the second quarter—one of the strongest readings outside of post-recession recoveries. The real question, however, is whether corporate America can continue delivering against the backdrop of persistent inflation, renewed strength in energy prices, and the possibility that interest rates remain higher for longer.

The setup is far from straightforward. Consensus earnings estimates have steadily moved higher into reporting season, raising the bar for companies to impress. In markets like this, "good" often isn't good enough—anything short of exceptional results or guidance can be met with swift selling. At the same time, forward estimates have become more conservative, reflecting growing macro uncertainty. If management teams can exceed those lowered expectations while maintaining confidence in the outlook, earnings could provide the catalyst needed to push the major indexes to new highs.

Fasten your seat belts. It could be a bumpy ride.

Let's see what the charts are telling us.