I can sum up last week with one word - broken.

That pretty much summarizes just about everything. We can apply this adjective to all the major stock markets in the U.S., Asia, Europe, the politics in Washington D.C. and the EU's attempts to stave off the debt contagion. We just experienced the worst one-week drop in the U.S. market in over two years. The S&P 500 fell -7.1%. The NASDAQ composite lost -8.1%. The small cap Russell 2000 index plunged -10.3%. Since the recent highs in late July or early August the German DAX index is down -15%. The English FTSE is off -11.5%. The Japanese NIKKEI is down -9.4% and the Hong Kong Hang Seng is off -10%. In just the last two weeks the S&P 500 have given up -10.7%. All of these markets have broken significant support. The big four U.S. indices have all broken their long-term up trends from the 2009 lows. To top it off the volume on this sell-off was absolutely massive!

I'm going to try and cover a lot of ground quickly here. It seems like ages ago we were waiting for the U.S. to pass a debt ceiling extension yet that was only last weekend. In just a week we've seen a number of bearish headlines. The ISM manufacturing and ISM services indices both came in lower than expected. Personal Income spending for June dropped unexpectedly. Retailers' July same-store sales were unimpressive. The PMI manufacturing data in China and most of Europe all declined and lends more credence to the global slowdown concerns.

On the positive side we did see a better than expected ADP employment report at +114K jobs. More importantly the U.S. government's non-farm payroll (jobs) report also came in better than estimated at +117,000 new jobs. The whisper number for a lot of traders was zero new jobs or even negative numbers. Congressional and senate leaders finally agreed on a debt ceiling deal and it was signed into law on Tuesday. Markets rallied on the expectation of a deal Monday morning but stocks quickly reversed lower. Tuesday ended up being one of the worst one-day drops in a year but we didn't know what Thursday held in store for us.

There were rumors all week long that the U.S. could lose its triple-A credit rating. Granted that's not a surprise. There has been speculation that we might lose this rating for months. Unfortunately the actual "deal" in Washington on Tuesday was not as aggressive in its spending cuts as the credit agencies liked. Moody's and Fitch said they would let us keep our AAA rating for now but kept us on creditwatch negative for a possible downgrade. No word yet on Tuesday from S&P on the U.S. rating. Meanwhile Europe was experiencing their own little meltdown. Concerns over Italy and Spain began to accelerate. The markets ended up plunging on Thursday with the worst one-day drop in almost three years thanks to a -500 point decline in the DJIA, a -5% drop in the NASDAQ Composite and a -4.7% drop in the S&P 500.

Safe havens like gold and treasuries were naturally in rally mode. Gold hit $1,640 an ounce on Tuesday. It hit $1,675 intraday on Wednesday and tagged $1,685 on Thursday before succumbing to the market-wide sell-off. The U.S. bond market was also surging higher. The very debt that investors were worried could get downgraded was being bought. The yield on the ten-year note fell from 2.8% a week ago to 2.4% intraday on Friday. I know most of us do not trade bonds but that is a BIG move. The U.S. two-year note saw its yield fall to an all-time record low of 0.25%. Money managers were looking for safety in anything and they would rather park it in the 2-year note with almost no yield than risk it in the market. Bonds did see a reversal lower intraday on Friday after reaching overbought levels.

The U.S. markets gapped open higher on Friday morning thanks to the better than expected jobs report. Unfortunately the rumors over a U.S. credit downgrade were getting hotter. Many blame these downgrade worries for the -400 point loss from Friday morning to the Friday lows in the Dow Industrials. Then news broke after the European markets closed that the ECB would consider buying bonds from the struggling countries of Italy and Spain. Buying bonds is a form of quantitative easing. England has been doing it. The U.S. did it with the QE2 program. Analysts saw this move by the ECB as a significant step to cooling the EU debt default fears. Granted the ECB said they "might" choose to take this step if the two countries agreed to new, very strict reforms but it was enough to spark a market rebound. The DJIA reversed its losses to recouped its 400 point decline. Yes, that's two 400-point swings in one day.

The big intraday bounce was starting to look and feel like a capitulation bottom in the stock market. Then after the U.S. markets closed on Friday the news outlets broke the story that Standard & Poor's had actually downgraded the U.S. credit rating for the first time in history. More on that later.

Friday saw the S&P 500 sink to 1168 before bouncing on the ECB news. This is an intraday breakdown under what should have been support near 1175 and the late November lows. The big intraday bounce looks like a potential bottom. Unfortunately, we do not know how the market will react to the U.S. credit downgrade news. I would expect some knee-jerk selling on Monday morning. Where we bounce is the question.

If you're a short-term trader then a dip to the 1150 level on the S&P 500 index would look like a bullish entry point. If the 1150 level breaks then we're talking a drop toward the 1100 area. A close under the 1090 mark would put us in a new bear-market (a.k.a. more than 20% off the highs).

We've mentioned the bearish head-and-shoulders on the S&P 500 before. The breakdown this past week definitely puts that pattern in play. The H&S pattern is forecasting a bearish target of 1130 over the next few months. At the current speed we could be there in a week. Broken support at 1250 is now new resistance. One thing to remember about bear markets is that they tend to see very sharp and fast rebounds that run out of gas and form new lower highs. I am concerned we could be seeing a new lower highs and lower lows pattern.

Weekly chart of the S&P 500 index:

Daily chart of the S&P 500 index:

The NASDAQ composite's breakdown under 2600 creates the sell signal for its bearish head-and-shoulders pattern. This pattern is forecasting a drop toward the 2325 level. We can look for broken support near 2600 to be new resistance.

Daily chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite:

The small cap Russell 2000 index was hammered for a -10% loss in just one week. This index is down -17.3% from its April highs. A -20% move would signal a new bear market. If the $RUT closes under support near 700 it could be a significant warning signal for the rest of the market.

Daily chart of the Russell 2000

Weekly chart of the Russell 2000

No chart for the SOX semiconductor index tonight. It has broken below its long-term up trend. Broken support in the 375-380 area should be new resistance.

I do want to point out the -9.4% drop in the Dow Jones Transportation index last week. At the lows on Friday this index was down more than 1,000 points from its all-time high in July. The transports essentially hit -19% and bounced. If stocks do not recover soon we could see the $TRAN testing support near prior resistance at the 4500 level.

Weekly chart of the Transportation index:

The economic calendar this week is a little light. The FOMC meeting on Tuesday is the biggest event. Wall Street will be laser-focused on what Ben Bernanke has to say following the U.S. credit downgrade. Of course the reaction to the downgrade is not on the calendar but Monday morning will be pretty interesting. Other highlights for the week will be the wholesale inventories, retail sales, and the Michigan sentiment reading.

- Tuesday, August 9 -
FOMC MEETING

- Wednesday, August 10 -
Wholesale Inventories

- Thursday, August 11 -
Weekly Initial Jobless Claims
U.S. Trade Balance numbers

- Friday, August 12 -
Michigan Sentiment for August
Retail Sales for July
Business Inventories

Last week I wrote about the prospect for a downgrade to the U.S. credit rating. Here's an excerpt of what I said:

"There are plenty of analysts who will argue that the market has already factored in a downgrade to a double-A rating. If there is a downgrade there might be a temporary knee-jerk reaction but overall it's already baked into the stock market. Yet a downgrade has not been baked into the economy. If the U.S. loses the triple-A rating it will cause interest rates to rise across the country. Everyone from consumers to corporations to local and state governments would all see their interest rates rise. We could also see a wave of credit downgrades for any institutions that depend on the U.S. government. Rising interest rates could slow spending, slow investment, and slow hiring."

Here we are a week later with a downgrade by S&P and I don't have anything new to add. If you have a fixed rate interest rate on your house or car then you're fine. Going forward rates "should" rise but that's not a guarantee. Just look at how fast the yields on the 10-year note have been dropping, which puts downward pressure on rates.

I have said it before. Money managers both here in the U.S. and overseas have to put their money somewhere. Many of these fund managers cannot just sit there in cash. If they are pulling money out of equities then the U.S. bond market is still the safest spot for it. The U.S. bond market is the deepest, most liquid market of its kind. It is massively bigger than our stock market and it's 10 to 20 times larger than its nearest rivals. The U.S. bond market is the place to park your money. That's exactly what money managers are doing. The yield on the short-term U.S. note is at 0.01% and hit 0.005% intraday on Friday. I mentioned earlier that the two-year note saw its yield fall to 0.25% for the first time in history because so many investors are buying it as a safe haven investment.

Last week I wrote:

"What really concerns me, assuming we do get a debt ceiling extension passed, is that the market still faces a storm of uncertainty. The U.S. economy seems to be slowing drastically and the situation in Europe is not improving in spite of all the bailout attempts...

... and you can bet U.S. investors will see the volatility in our stock market. "

Some analysts might argue that the better than expected jobs data on Friday throws cold water on the economic slowdown in the U.S. but I don't agree. Yes, we were happy to see the stronger numbers. However, one report does not reverse the virtual parade of negative economic numbers over the past several weeks. Furthermore we need about +150,000 new jobs a month just to keep pace with the population growth, new graduates, and immigration. So +117,000 jobs does not cut it.

What happens in Europe this week could be the pivotal event for our markets. Will the ECB actually commit to its own QE program for Italy and Spain? If we get some sort of resolution, even temporary, it would be helpful. Meanwhile here at home the Fed comments on Tuesday could give the markets a push one way or the other. No one really expects QE3 but there has certainly been a lot of talk about the possibility of more stimulus of some kind in the U.S.

The last few weeks, in my market commentary, I have been cautioning readers that stocks might be a lot lower "four to six weeks from now". Well here we are, a lot lower, just a lot sooner than I expected. Right now there is no way to know if the sell-off is done. While we would love to see a "V" shaped bottom to this correction it doesn't always happen so cleanly. Some would argue that bottoms are a process for the stock market. At the moment we do not know how the U.S. markets will react to the S&P downgrade. I do expect some selling on Monday morning but we don't know if Monday will be a bottom or will it merely initiate a new leg lower.

- James