The third quarter stock market rebound continues. After shaking off what looked like a bearish failed rally pattern a week ago the major U.S. averages surged to new one-month highs following M&A news in the biotech sector, a dividend increase from General Electric (GE), and another round of positive earnings reports. The S&P 500 index is up +3.5% for the week and up over +9% from its July intraday lows. The NASDAQ composite is up +4.2% for the week and up +10% from its July lows. The Dow Jones Industrial Average is up +3.2% for the week and +7.9% from its July lows.

Just a few days ago the market was slipping lower on Federal Reserve Chairman Ben Bernanke's semiannual testimony before Congress. His words that the Fed's economic outlook for the U.S. was "unusually uncertain" fueled the decline on Wednesday. Losses proved to be short lived. A week of better than expected earnings results from the likes of Apple (AAPL), Microsoft (MSFT), United Parcel Service (UPS), Caterpillar (CAT), American Express (AXP), Verizon (VZ) and Ford Motor Co. (F) all helped boost investors confidence that the U.S. economy may not be as weak as the recent economic reports have been suggesting. Thus far about 85% of the 149 S&P 500 component companies that have reported their Q2 earnings have managed to beat Wall Street's earnings estimates.

Market gains were accelerated on Friday after General Electric raised their quarterly cash dividend by 20% from 10 cents to 12 cents and restarted their stock buyback program. Both events are seen as a vote of confidence on GE's business and the state of the economy. The dividend is payable on October 25th to shareholders of record on September 20th. There was also big news in the biotech sector. The Wall Street Journal broke the story that French drug maker Sanofi-Aventis, the world's fourth largest drug manufacturer, was in talks to buy Genzyme Corp. (GENZ). Shares of GENZ immediately spiked from $54 to over $62 a share and closed with a +15.4% gain.

Investor confidence has also gotten a boost from strong gains overseas. Speculation that the Chinese government might ease their fiscal policies in the second half of this year has fueled the rally in China. The Hong Kong Hang Seng index is up +2.8% for the week. The Chinese Shanghai index is up +6.1% on the week. Keep an eye on the Shanghai index, which is nearing potential resistance in the 2600 area. Meanwhile the bounce continues in the European markets as well. The German DAX index is forming a bullish pattern of higher lows. The English FTSE index has rallied back toward resistance near the 5400 level. A breakout over 5400 would certainly be a bullish development.

Powering the strength in Europe this past week has been strong economic data and speculation that the stress test of EU banks would yield positive results. The United Kingdom reported a +1.1% increase in its GDP for the second quarter. Economists were only expecting an improvement from +0.3% in the first quarter to +0.6%. In Germany the IFO institute reported that their business climate (confidence) index, which surveys 7,000 managers, rose to its highest reading since July 2007 at 106.2. Economists were actually expecting a drop from 101.8 to 101.5. Euro zone industrial orders data also came in better than expected. Together these headlines overshadowed a report that ratings agency Moody's has put the nation of Hungary under review for a possible credit downgrade. Talks between the government of Hungary and the IMF have broken down and Moody is concerned about the country's budget deficits.

Of course one of the biggest stories on Friday was the release of the stress tests results for 91 major EU banks. If you read the headlines then you know that only 7 of the 91 banks failed. The tests were billed as a success in offering new transparency for the financial system, which is supposed to build investor confidence. The stress test report said EU banks need to raise about 3.5 billion euros in capital (about $4.5 billion).

The market has been anticipating these results for weeks and the testing process has been widely criticized for its lack of details. Well now we are finally starting to get some details and you can bet analysts will spend the weekend digging deeper into these numbers. A good question to ask is why do EU banks only need to raise 3.5 billion euros in capital? Just a few days ago the best minds on Wall Street were estimating that the EU banks would need to raise 60-90 billion euros worth of capital.

Another question to ask is why did only 7 banks out of 91 banks fail? Of these seven, one was a Greek bank, one was a German bank, and the rest were Spanish banks. All were expected to fail so there was no surprise. When the U.S. did their stress tests many months ago 10 of 19 banks needed to raise capital (approximately $75 billion worth). The markets are also left wondering why this stress test did not test for a worst case scenario (a.k.a. sovereign debt default) when odds of Greece defaulting are so high. The EU banking regulators who ran this test did not force banks to count sovereign debt on their trading balance sheets. Instead of having to mark-to-market these securities, which would have been a big discount from their face value, the banks were allowed to count the assets at full value because they were holding them to maturity. It certainly seems like this test was not strict enough to offer the market any real clarity or confidence.

The real test will be Monday. The results of this EU bank stress tests were released after the close of trading in Europe. Monday will be the first time Europe can trade on this news. Investors will be watching the inter-bank lending rates. The EU banking system has been struggling because none of the European banks trust each other so they don't want to lend to each other. Instead they have been borrowing from the ECB. If EU banks actually believe the results from this stress tests then inter-bank rates should go down. Yes, Monday could be a very interesting session.

While I'm on the topic of foreign countries it is worth noting that both Brazil and Canada raised their interest rates this past week thanks to the strength of their economies. This could put some pressure on the dollar. Actually, if the markets believe in the EU stress test results then the euro should rally. One analyst firm has raised their target on the euro to $1.30 but that isn't so far away with the euro closing near $1.287 on Friday. More importantly if the euro continues to rally then the dollar will continue to slide. Dollar weakness should fuel commodity strength. Gold has been underperforming lately. Oil has started to drift higher. The real winner this past week was copper. A couple of weeks ago (July 10th) in the LEAPStrader watch list I suggested readers watch copper for a breakout. Copper has continued to rally and broke out over resistance with a +8.7% rally for the week. Copper inventories have fallen for approximately five months in a row. That hasn't happened since 2004, before the housing market peaked. Falling inventories suggest demand for copper is picking up, which is a bullish sign for the global economy.

Technically this past week has reversed some of the short-term indicators into more bullish postures but the S&P 500 is still testing resistance near 1100 and still has additional resistance at its 200-dma and the June highs near 1130.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ is showing a little more strength with a bullish breakout above its 50-dma and 200-dma in the last few days. I still want to warn you that the NASDAQ is trading with a bearish trend of lower highs and lower lows. The bearish signal of the 50-dma crossing under the 200-dma is not going to reverse any time soon. Short-term the NASDAQ trend is up but there is plenty of resistance near the 2300 area.

Daily chart of the NASDAQ index:

More aggressive traders may want to check out the small caps. The small cap Russell 2000 has produced a bullish breakout over its 50-dma and 200-dma. On a short-term basis the $RUT looks poised to rally higher but there appears to be significant resistance in the 670-675 zone. I would be cautious here.

Daily chart of the Russell 2000 index:

I am willing to admit I was surprised by the market's strength this past week. The recent string of positive earnings reports has painted a brighter picture of the economy. However, while most companies are managing to beat earnings estimates, we are seeing more miss the revenue number. That suggests business may be tougher then they're letting on and they made the numbers with cost cutting. Furthermore, all of the challenges facing the U.S. and Europe have not changed. Europe's debt crisis remains unsolved. The U.S. is still facing stubbornly high unemployment and a deteriorating housing market. Investors will be keenly focused on the back-to-school shopping season to gauge the strength of the U.S. consumer but back-to-school doesn't start for another couple of weeks.

I would be very cautious when it comes to launching new long-term LEAPS positions. This seems to be more of a short-term traders market. Stock mutual funds have continued to see outflows while money is moving into bond funds. This is a pattern that hasn't changed for months. So if money is moving out of stock funds what would be driving the market higher? The answer might be short covering and short-term traders. Most investors are still confused. Earnings results are coming in better than expected and we're hearing lots of bullish guidance and comments about the economy. Yet the actual economic data over the past few weeks is clearly showing a slowdown in the economy. What should investors pay more attention to... the economic data or the earnings numbers? Neither are infallible and both are subject to interpretation.

Before I go I need to mention North Korea. A few weeks ago North Korea was making a lot of noise about the potential for war. The saber rattling cooled off but now N. Korea is making headlines again. The U.S. plans to perform military exercises with the South Korean navy with up to 20 ships and 200 aircraft. N. Korea doesn't appreciate this show of force and is threatening a "nuclear deterrence" should the U.S. and S. Korea proceed with these exercises. Essentially this is a wild card for our weekend. If something serious occurs it could quickly derail the markets.

~ James Brown