Is the stock market rally running out of steam? Or did stocks just pause to catch their breath before the next leg higher? Politicians continued to wrangle over extending the Bush tax cuts but finally agreed on a compromise that President Obama signed into law. Yet this positive news failed to kick stocks higher. Instead investors remained cautious amid deteriorating views on the European credit crisis.

Ireland's debt rating was downgraded by Moody's on Friday but Ireland has already agreed to a bailout package from the IMF/EU. This downgrade news didn't have much affect except to reinforce the idea that the rating agencies remain one step behind the markets. The ratings agencies could be trying to fix that as Moody's put the country of Spain on review for a possible downgrade. Meanwhile Standard & Poor's put the country of Belgium on their credit watch for a potential downgrade. Out of the PIIGS countries that have encumbered the EU with worries over a potential sovereign default the one everyone is afraid of is Spain since it has the biggest economy.

On a much more positive note the flow of economic data in the U.S. continues to improve. In contrast to its name the Conference Board's index of Leading Economic Indicators seem like they lag the economy and the markets but this data is improving nonetheless. This past week showed the LEI rising +1.1 points in November. The LEI are now projecting a +3.0% growth rate for the U.S. GDP in Q4. Speaking of GDP this coming week will see the third and final estimate for the U.S. Q3 GDP numbers.

This week will be a holiday shortened week thanks to Christmas with the markets closed on Friday. Most of the economic data will come out on Wednesday, Dec. 22nd and Thursday, Dec. 23rd. On Wednesday economists expect the third estimate for our Q3 GDP to rise from +2.5% to +2.7%. We'll also hear the November existing home sales data on Wednesday. Thursday's economic data releases include: personal income and spending, durable goods orders, new home sales, weekly jobless claims, and the final December reading on the University of Michigan consumer sentiment.

The S&P 500 has been struggling with resistance in the 1245-1246 area. Traders bought the dip when the S&P slipped toward its rising 10-dma. Should the market roll over we can watch for support near 1220. If that level breaks then the 1200 level. Optimistically the index is still headed higher and the next level of potential resistance is the 1260 area.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The tech-heavy NASDAQ doesn't look that much different than the S&P 500. Stocks have been consolidating sideways and the NASDAQ composite bounced from its first test of the rising 10-dma. The NASDAQ did manage to tag a new three-year high on Friday at 2651. If this trend higher continues the next level of significant overhead resistance is the 2725. However, that's 75+ points higher. I'm sure we'll see the NASDAQ pause a couple of times between here and there. If by chance the NASDAQ starts to correct lower then we can watch for support near 2550 or the rising 50-dma.

FYI: The NASDAQ-100 re-ranking occurs this Monday (Dec. 20th) before the opening bell. These seven stocks are being removed from the NASDAQ-100 index: CTAS, DISH, FWLT, HOLX, JBHT, LOGI, and PDCO. These seven stocks are being added to the NDX: AKAM, CTRP, DLTR, FFIV, MU, NFLX, and WFMI.

Daily chart of the NASDAQ Composite index:

I like to keep an eye on the SOX semiconductor index since the chip stocks are so influential for the technology sector. Currently the SOX seems to be correcting a little bit but the overall trend is still higher. Eventually this group will breakdown from its narrow, bullish channel but until it does the path of least resistance is up!

Weekly chart of the SOX semiconductor index:

I remain very encouraged by the strength inside the small cap stocks. Instead of correcting lower the group delivered a much more bullish choice to just consolidate sideways. There is short-term resistance at 780 and short-term support in the 765 area. Should the market actually see a correction then broken resistance near 740 would be key support and a great place to look for new bullish entry points.

Daily chart of the Russell 2000 index:

Weekly chart of the Russell 2000 index:

Essentially little has changed from a week ago. We are in a seasonally bullish time period for stocks. Investor sentiment is improving thanks to a steady stream of improving economic data. As the outlook for 2011 improves it should drag stock prices higher. The next real test will be Q4 earnings season, which will begin in about three weeks. Investors will be focused on corporate America's outlook as businesses look ahead into next year.

While I would love to wait to buy a dip right now we may not actually see any significant dips between now and yearend. If you forced me to predict the future I see stocks inching higher or at the very least drifting sideways into the end of 2010. Depending on which index you look at we're sitting at two or three year highs. Fund managers would love to keep stocks at these levels so their yearend statements look healthy. We only have nine trading days left in the year and volume will probably be light as people focus on their holiday vacation instead of the markets.

There is always the risk of the unexpected. Fears that China will raise interest rates have faded this past week but it's still an issue. North Korea is still threatening war with South Korea. The situation for the struggling EU countries is not improving but so far the markets seem to be willing to let the euro zone and the IMF tackle these issues one country at a time. Investors will continue to focus on the U.S. dollar as the Federal Reserve tries to keep interest rates down with the QE2 program.

This is a LEAPS option trading newsletter. Our time frame is several months or more for most of our trades. While I would dearly love to wait for a correction back to support as our next entry point we are starting to see a few breakout possibilities. Hopefully if we're patient there is a good chance the market could see some profit taking following the onset of earnings season in the middle of January. We will certainly be watching any multi-day sell-off as a possible entry point to initiate new long-term bullish trades. Overall our outlook for 2011 has improved tremendously from six months ago and we look forward to the opportunities that next year will present.

From our family to yours, we wish you a very merry Christmas and happy holidays!

- James