The U.S. stock market started the third quarter on an up note. Momentum faded and equities experienced a rocky week thanks to some troubling headlines out of Europe. Believe it or not but after last week's choppiness and widespread declines the S&P 500 index is still less than one percent from its all-time high set on July 3rd - just five trading days ago.

Market Statistics:

Stocks just delivered their worst weekly performance in three months. The small cap Russell 2000 index led the way with a -3.99% plunge. The NASDAQ composite fell -1.6% for the week. Both the Dow Industrials and the large cap S&P 500 managed to pare their weekly losses to less than 1%.

Tuesday and Thursday were pretty ugly considering the low-volatility environment. Yet traders are still in a buy-the-dip mood. The main stories fueling the market weakness was disappointing economic data out of Asia and Europe. Plus, a shocking revelation out of Portugal that resurrected all the worries about a financial meltdown in Europe but we'll talk more about that in a minute.

Money was searching for safety and U.S. bonds rallied. The yield on the 10-year note pierced 2.5% on Thursday and closed at 2.52% on Friday. Gold was also in rally mode and the GLD broke out to three-month highs. Gold is currently up six weeks in a row, which makes it the best streak since August 2011. Gold prices are up +6% in the last six weeks and up +10.9% for the year. Meanwhile gold miners are really outperforming. The GDX gold miner ETF is also up six weeks in a row. It has been a very volatile year for the GDX but it's currently up +29% year to date.

Weekly chart of the Gold Miner ETF (GDX)

In contrast oil is down sharply. West Texas intermediate crude oil futures fell -2% to close at $100.83 a barrel. Oil is now down 9 out of the last 10 days and just marked its fourth weekly loss in a row. The International Energy Agency said Iraqi oil production fell -260,000 barrels a day last week but the difference was made up by other OPEC nations. Fighting continues in Iraq but the headlines are not making front page news so its impact is not having an effect on investor sentiment.

Economic Data

It was a quiet week for economic data in the United States. The only real event was the FOMC minutes from the June meeting. The message the market got from the minutes was that the Fed is likely to end its current QE program and reduce the stimulus by the last $15 billion in October. You could choose to interpret that as confidence that the U.S. economy is improving. Analyst are now looking beyond the end of QE and speculating on when the Federal Reserve will start to raise rates again.

Bloomberg noted some good news in consumer sentiment hitting the highest levels in six years. The Bloomberg Consumer Comfort Index rose +1.2 to 37.6 the week ending July 6th. The component that measures consumer outlook on the U.S. economy reached levels not seen since January 2008.

With little economic news in the U.S. the markets looked overseas and what they saw was disappointing. Germany said their industrial production fell -1.8% for the month. That's down from a -0.3% reading the month before. Italy reported a -1.2% drop in their industrial production and Great Britain saw a -0.7% drop.

Japanese machinery orders plunged -19.5% for the month, which doesn't bode well. China said their exports rose +7.2% in June. That looks like good news but economists were expecting a +10% gain. Meanwhile Germany said their exports actually dropped -1.1% in May. That was worse than the -0.4% estimate.

The real story of the week was in Portugal. With a GDP of $212.5 billion and a population of less than 11 million people, Portugal is not a very big player on the world stage. Yet the European banking system is so interconnected that if Portugal were to see a dramatic failure the shockwave could affect the entire region. Espirito Santo International failed to make a short-term debt payment. ESI happens to own Espirito Santo Financial Group SA and Banco Espirito Santo. Suddenly the creditworthiness of both financial companies were in question. The two stocks plunged -9% and -14%, respectively, before the exchanges halted trading.

This news fueled a serious case of nervousness for the European financial system and European banks were hammered lowered. The Portuguese stock market fell -4.2% on Thursday while the country's bond yields soared. Portugal's central bank was trying to soothe investors' fears on Friday and the major European indices (Germany, France, and Britain) all bounced.

American banking giant Wells Fargo & Co (WFC) was making headlines on Friday. The company reported Q2 earnings before the opening bell. Wall Street was looking for a profit of $1.01 per share with revenues in the $20.7-20.8 billion range. WFC met expectations with a profit of $1.01 on revenues of $21.1 billion. Net income was $5.7 billion. That's up from $5.5 billion a year ago.

Shares of WFC were down every day last week and gapped down on Friday morning as traders sold the earnings news. Analysts are a little concerned about WFC's net interest margin. A year ago WFC's net interest margin was 3.40%. The first quarter it was 3.20%. Last quarter this fell to 3.15%. WFC is one of the biggest mortgage lenders in the country. The bank said its mortgage originations hit $47 billion in the second quarter. That's down from $112 billion a year ago but up from $36 billion in the first quarter.

Weekly chart of the Wells Fargo (WFC)





Major Indices:

The S&P 500 lost -0.9% for the week. The index pierced short-term support near 1960 and its 20-dma on Thursday. On a short-term basis the index looks like it wants to rally. Yet looking at the weekly chart you can see how over extended the index really is. The S&P 500 has gone more than 1,000 days without a -10% correction. In a normal market it would see a correction about once or twice a year.

I don't see any changes from my prior comments on the S&P 500. If the 1960 level fails then there might be support at 1940 and 1920. The real level to watch is most likely the 1900 area, which would coincide with the bottom of its long-term bullish channel on the weekly chart.

chart of the S&P 500 index:

Intraday chart of the S&P 500 index

The NASDAQ composite posted a -1.6% loss for the week. The good news is that this index managed to bounce near its prior highs. There is no guarantee that "support" near 4370 is going to hold.

If the NASDAQ breaks down below the March peak then 4300 is the next likely level of support. A really ugly drop could pull the NASDAQ down to its long-term trend line of higher lows on the weekly chart.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index

Right now there is a lot of focus on the small cap Russell 2000 index. This index just delivered its worst weekly performance in two years with a -4% plunge. The $RUT has clearly reversed at resistance near its March highs. This is starting to look like a bearish double top. One of the fast money guys on CNBC called it an "epic" double top.

There is still potential support in the 1140-1150 zone. Below that the 1080-1100 area is probably decent support. The six-week up trend from the May lows is clearly broken.

The current sell-off in the $RUT has 39% of the Russell 2000 stocks trading in bear market territory.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index

This week will see an increase in economic reports. We'll get two Fed surveys with the New York and Philadelphia reports. Plus, the wholesale look at inflation in the PPI.

The pace of Q2 earnings announcements will pick up speed.

Economic and Event Calendar

- Monday, July 14 -
Q2 earnings season announcements pick up speed.
Citigroup (C) reports earnings

- Tuesday, July 15 -
New York Empire State manufacturing data
Retail sales for June
Import/Export prices
JPM, GS, INTC, and JNJ reports earnings

- Wednesday, July 16 -
Producer Price Index (PPI)
U.S. Industrial Production data
Federal Reserve's Beige Book
BAC and EBAY report earnings

- Thursday, July 17 -
Weekly Initial Jobless Claims
Housing Starts & Building Permits
Philadelphia Federal Reserve survey
MS, IBM, and GOOG report earnings

- Friday, July 18 -
University of Michigan Consumer Sentiment
G20 Meetings
GE, HON, and KSU report earnings

Looking ahead the market still faces potential geopolitical risks. The situation in Israel is slowly escalating. Hamas terrorists fired over 800 rockets and more than 60 mortars into Israel last week. The Israelis responded with airstrikes that hit more than 1,000 targets. On Friday Israeli commandos traded fire with Hamas fighters but it does not appear to be part of a full scale invasion. Israel has not ruled anything out and continues to build up its forces on the Gaza border. Israeli Prime Minster Netanyahu said he has spoken with several world leaders in the past week including U.S. President Obama and several European leaders. If the Israeli army does march into Gaza it might be negative for investor sentiment.

The situation in Ukraine is not improving either. On Friday the pro-Russian rebels killed almost two dozen Ukraine forces. This time they were using "heavy" weapons including what appear to be Russian rockets. Ukraine President Petro Poroshenko had declared that, "For every life of one of our soldiers, the militants will pay with dozens and hundreds of theirs." U.S. Vice President Biden spoke with Poroshenko on Saturday saying the U.S. would continue to pressure Russia to do more to stop the violence and remind them of the consequences if they do not. There will be an EU summit in the July 16-18 time frame and one of the main topics will be Russia and if the country has done enough to counter the rebels that Ukraine claims are being supplied by the Russians.

With the exception of the small cap Russell 2000 index the U.S. market seems to be hovering near its highs. Investors are waiting for more data and earnings results from the Q2 earnings season. The real focus will be guidance.

James