Bear trap. Bullish reversal. Short squeeze. Bear-market rally. Whatever you want to call it, the action in stocks last week was pretty volatile. The major indices reversed from a significant breakdown under support and new 52-week lows to close positive on the week. The S&P 500 rebounded from 1074 at Tuesday's low to 1171 by Friday morning. That's a +9% bounce in less than a week. The small cap Russell 2000 index bounced from 601 on Tuesday to almost 676 on Friday morning (+12.4%). There are plenty of stocks that are up more than +10% from their Tuesday lows. Yet in spite of the rebound the trend is still a bearish one of lower lows and lower highs.

Bob Pisani, on CNBC, said this was the first time the stock market had closed positive two weeks in a row in the last three months. Investors digested a number of lackluster economic reports. Friday's jobs report was better than expected. Yet the focus remains on Europe. Europe is driving this market. It's no surprise that investors were doing a little profit taking on Friday after Moody's and Fitch issued new credit downgrades. More on that in a bit. Sadly, in other news, this past week co-founder of Apple Inc. (AAPL), Steve Jobs, passed away. Many consider him a true icon and technology visionary who changed the world.

Stocks stumbled out of the Q4 gate with Monday's decline and breakdown. It felt like a bear market with stocks ignoring good news and bankruptcy rumors swirling. Monday's rumor target was American Airlines (AMR) and shares fell -33% on rumors the company was going to file for bankruptcy protection. AMR denied the story. The U.S. ISM data for September was better than expected at 51.6 when economists were expecting a drop from 50.6 to 50.5. Numbers above 50.0 indicate growth and you can see how close we are to dipping into negative territory. Meanwhile PMI economic numbers from France and Germany were bearish.

Tuesday is when the magic happened. Or should I saw short squeeze. Officially the S&P 500 fell into bear market territory with a drop under 1,090 on Tuesday. Federal Reserve Chairman Ben Bernanke's comments to the Joint Economic Committee on that the Fed was still ready to take necessary action to strengthen the economy had very little impact on stocks. Finally, late in the day stocks were firmly in the red when the story broke that Europe was planning to recapitalize their major banks to protect them from a Greek debt default. The euro reversed higher and the dollar plunged on this news. The S&P 500 had been rolling over and was headed back toward its Tuesday morning lows. When this story broke the short covering began in earnest. This index rallied from 1080 to 1125 in less than an hour (+4%).

Wednesday and Thursday saw the oversold bounce in stocks continue. The U.S. ISM services data came in better than expected at 53.0. The retail sector's September same-store sales data was generally better than expected, which suggested the U.S. consumer is still hanging in there. Meanwhile in Europe the rush to prop up the financial system continued. The Governor of the Bank of England, Sir Mervyn King, made headlines with his statement that the region was facing its worst financial crisis since the 1930s if not the worst crisis ever. The BoE announced they were increasing their 200 billion pound quantitative easing program to 275 billion pounds. Across the channel the European Central Bank (ECB) left interest rates unchanged.

The tone of trading changed a bit on Friday. Investors were naturally worried about headline risk over the weekend. Friday morning Moody's downgraded several British and Portuguese banks. Yet here in the U.S. the news was positive with a better than expected nonfarm payroll (jobs) report. The rally on the jobs data didn't last and investors began to sell into strength. After a massive bounce from Tuesday's lows traders wanted to lock in gains before the weekend. The selling intensified on Friday afternoon after Fitch downgraded credit ratings for the countries of Italy and Spain. Financial stocks led the decline with the BKX banking index down -4.3% on Friday.

Overall the pivotal event for the week was an awakening in the Eurozone that their banks did need to be recapitalized and that a Greek default was virtually unavoidable. At least that was the general theme and a concerted effort by the major EU players on saving the banks fueled the stock market gains. Now we just need to see some follow through on these bank recapitalization plans.

Europe & Greece

Looking a little bit deeper into Europe and Greece we are definitely seeing some movement by regulators. We've talked about it before. Europe seems to be having their Lehman Brothers style of meltdown where the banks don't trust each other and the definitely not lending to each other. One of the big headlines for the week was Dexia, a large Dutch bank. Both Belgium and France came together to bailout Dexia for the second time in three years to prevent the financial giant from collapsing.

We have seen two different stress tests on the European banks in the last couple of years. Both times the results came back positive with passing grades with no concerns that the banks need to recapitalize. Almost no one believed these tests were accurate but the party line was, "EU banks are fine. There is no need to worry." The markets knew better. Finally we're hearing EU leaders admit that yes, there is a problem. As you already know, the first step to solving the problem is admitting you have one. We have been writing about finance minister meetings and summits on solving the EU debt crisis for months. Yet this past week it seems the stock market finally believes European leaders will actually do something about it. At least that's the tone or the message equity investors are hearing.

It's also no surprise that Fitch downgraded Italy's and Spain's credit ratings. The question is why did they take so long. We've talked about the sovereign credit downgrades before. They're nothing new and we will likely see more as this drama unfolds. Fitch is keeping both on credit watch negative for the possibility of new downgrades in the future (again, no surprise here). One event that could really cause some market volatility would be a credit downgrade for France or Germany. These are the two biggest economic engines for the EU. They're also assuming the biggest responsibility for any bailout funds. A credit downgrade for either of these two would definitely raise concerns across the region. Speaking of which many analysts are expecting Europe to see a recession (or two) in the next several months and for some of the struggling countries, it could be borderline depression level business activity thanks to all the austerity measures.

German chancellor Angela Merkel and French President Sarkozy met together in Berlin for their eight summit in less than two years. These two are trying come together and present a united front before EU leaders meet on October 13th and the G20 meets later this month. If you recall Germany is taking a harder stance on Greece and would rather let them default but France, whose banks own a lot of Greek debt, wants to save Greece somehow. Their meeting was Sunday. The headlines on Sunday night said Merkel and Sarkozy have agreed to an end of October deadline for some sort of "comprehensive" rescue plan to stabilize the Eurozone (source: Financial Times). These two leaders did not offer a lot of details. The lack of details could send stocks lower on Monday, but Merkel was quoted saying, "We are determined to do whatever is necessary for the recapitalization of our banks". If market participants choose to focus on the "whatever it takes" comment, then stocks could rally.

It is worth remembering that EU leaders are meeting on October 13th to decide if they will release the next tranche of bailout funds to Greece (about 8 billion euros). Without this loan it was expected that Greece would be bankrupt by October 17th but now it looks like Greece can make it a few more weeks and wouldn't run out of money until mid November. There is still a growing speculation that Greece will default within the next year and probably before the end of this year. Some are expecting Greece could default in the next four or five weeks. It could be a race. Will the new €440 billion ESFS fund get approved by all the Eurozone members before Greece defaults? Will it matter? Some analysts are suggesting that the EU will need €2 trillion in rescue funds before this sovereign debt debacle is all over.

Jobs Report:

Before we talk about the major indices let's go over the jobs report quickly. Economists were expecting the headline job number to be +60,000 in September. The nonfarm payroll report came in at +103,000. That's 43K better than expected, right? Unfortunately we have to delete about 45,000 jobs from striking Verizon employees going back to work. Thus September's report was pretty much in line with expectations. Private payrolls rose +137,000 but the government continues to cut jobs. The real surprise on Friday was the revisions to the prior jobs report. We were expecting the August jobs report, which came in at zero, to be revised lower. Instead the August report was revised higher to +57,000. July's was revised higher from +85K to +127K. The U.S. really needs a minimum of +150,000 a month just to breakeven with our population growth. We're not there yet but the trend seems to be improving, which should ease some of the recession fears for the U.S.

Major Indices:

The S&P 500 dipped into bear-market territory under the 1,090 level only to reverse higher. I've said it before. Bear-market rallies tend to be very fast and sharp. These bear-market rallies seduce investors back into the market only to roll over again. It is certainly possible that last week was the bottom but I'm not convinced. The big bounce stalled at the trendline of lower highs. The larger trend is still down. I don't think we'll know if the market has bottomed yet until we see a couple of weeks of Q3 earnings. Plus, we'll need to see more from Europe and how well they accomplish their plans to recapitalize the banks. If Europe stumbles in their rescue plans then equities can easily reverse lower.

The S&P 500 has short-term resistance in the 1180 area near its simple 50-dma. Beyond that there is resistance near 1200 and then near 1230. If stocks do pull back we can probably look for short-term, temporary support near 1120 and 1100 again.

Bear Flag pattern on the S&P 500 index:

The NASDAQ composite broke down under its August lows on Tuesday morning but rallied off the 2300 level. The rebound carried back to 2500 and its 50-dma before finally seeing some profit taking. Is this just an oversold bounce and bear market rally? Or has the NASDAQ seen a bullish double bottom in the 2350-2300 zone? We really won't know these answers on Monday. Short-term the NASDAQ looks poised for more profit taking.

Looking at an intraday chart you can see a mini double bottom near 2300 on Tuesday and a short-term double top near 2500 on Friday. A normal 38.2% Fibonacci retracement would mean a dip back to 2430. On a short-term basis I would wait for a new bounce in the 2430-2400 region before considering new bullish positions. Bigger picture you can still argue the trend is down. If the NASDAQ does roll over the bear-flag pattern is still in play. The flag pattern would suggest a multi-week drop toward the 2100 area. This would line up with the weekly chart's support near 2100.

Daily chart of the NASDAQ Composite index:

The small cap stocks continue to be very volatile. The Russell 2000 index experienced a big breakdown last Monday. Tuesday's turnaround produced a bullish engulfing candlestick reversal pattern. Unfortunately Friday's session produced a bearish engulfing candlestick reversal pattern. From Tuesday's low to Friday's high the $RUT rallied about 75 points or (+12%). The $RUT remains in bear-market territory, down -24% from its 2011 highs. I would remain pretty cautious on the small caps until we see the $RUT close above its 50-dma.

Daily chart of the Russell 2000 index

Intraday chart of the Russell 2000 index

The headlines in Europe continue to fuel volatility in the banking stocks. The sector hit new two-year lows early last week. Then when stocks reversed the financials experienced a big bounce yet it stalled at resistance. It certainly looks like a bear-market rally. Nimble traders could use this action as a new entry point for short-term bearish positions and just put a stop loss above last week's high. You can see the trend on the XLF and BKX charts below.

Intraday chart of the XLF financial ETF:

Intraday chart of the BKX banking index:

We're also keeping an eye on the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation average. The DJIA witnessed a huge bounce from 10,400 to 11,200. Unfortunately for the bulls the 11,200 area is both resistance at the top of its bearish channel and its technical resistance near the 50-dma (not shown on the chart below). The Dow Transports are showing a similar trend of lower highs and lower lows.

Intraday chart of the Dow Jones Industrials

Intraday chart of the Dow Jones Transportation Index

Looking at the economic calendar we have a quiet week. The bond market is closed on Monday for Columbus Day. Monday will also be the first day of trading for the Chinese markets after a weeklong holiday. The FOMC minutes from the last meeting come out on Tuesday. The 13th is an EU meeting on Greece. Then on Friday we'll see import/export prices, business inventories, and the first look at October's Michigan Sentiment numbers.

The biggest event, other than the EU meeting, is probably the beginning of Q3 earnings. Dow-component Alcoa (AA) starts the season with their report on Tuesday. The big reports this week are J.P.Morgan Chase (JPM) and Google (GOOG) on Thursday.

- Monday, October 10 -
Bond market closed for holiday.
Equity markets are open

- Tuesday, October 11 -
FOMC minutes
AA's earnings

- Thursday, October 13 -
Weekly Initial Jobless Claims
EU meeting on Greece
JPM and GOOG report Q3 earnings

- Friday, October 14 -
Business inventories for August
Import/Export prices for September
Michigan Sentiment for October

The beginning of Q3 earnings this coming week will be a nice distraction from the market's focus on Europe. Unfortunately, as we witnessed with most of the economic data, the news does not matter unless it's about Europe. This will still be a pivotal earnings report. Investors want to know if business slowed down in the third quarter and what corporate execs are seeing as they look forward to the fourth quarter and 2012. Currently the bullish camp is arguing that stocks are cheap on a valuation basis. We need to see strong earnings to support that idea otherwise stocks are going to get even cheaper if investors sell the news.

I remain very cautious on the stock market. The S&P 500 did hit bear market territory and bounce. The rebound does have the characteristics of a typical bear-market rally. The larger trend is still negative with lower lows and lower highs. The focus in Europe to recapitalize the banks is very encouraging but it should have been done a couple of years ago. This process was messy in the U.S. How much worse is saving the banks going to be with the various EuroZone members all squabbling over the details?

There are analysts that believe last week will be the lows for the year and that bigger picture we're looking at a bullish entry point. Traditionally the fourth quarter is normally a bullish time for stocks. If corporate earnings guidance is positive then it could keep the rally alive. However there are plenty of analysts and traders who strongly believe we will either retest the lows or make new lows before the end of the year. There are concerns that Wall Street's Q3 earnings estimates are still too high, which sets up for a disappointment.

The drama over Greece is not over yet but we definitely seem to be getting closer to an "end" whatever that might be. Although I suspect the default is still a few weeks away. When that happens we should expect a knee jerk reaction lower in stocks and a spike in the bond market. The euro will drop and the dollar will rally. The question will be, given all the preparation in anticipation of a default, how quickly will investors buy the Greece-default dip? We can't answer that today because we don't know yet the ripple effects of such an event.

Looking back at the headlines for the week the most powerful one was not Europe's plans to recapitalize their banks. It was the death of Steve Jobs. The man was far from perfect but he did have some keen insights into both business and life. The New York Times published this as part of their tribute to Jobs:

"Steve [Jobs] made choices," Dr. Ornish said. "I once asked him if he was glad that he had kids, and he said, 'It's 10,000 times better than anything I've ever done.' "

My thoughts are don't forget why you're working so hard. Make sure you take time to enjoy your family and friends. When we are on our death bed, we are not going to wish we had worked more. We're going to wish we had more positive memories of those important to us. We are going to want to look back and remember a life well lived.

- James