The Italian bond market jolted the global markets on Wednesday. It was another volatile week for stocks. After staring into the abyss on Wednesday it seems that Europe is slowing backing away from the edge. Both Italy and Greece are replacing old leaders with new ones bent on stronger austerity measures to prevent an EU meltdown. At least that's what they want you to believe. It was a quiet week for economic data but the consumer sentiment report was positive. Meanwhile stocks did benefit from a couple of positive corporate headlines thanks to CSCO and CAT.

It was another week of European headlines dominating the news and stock market action. Stocks were surging on Tuesday only to see gains vanish with Wednesday's big decline, which was the biggest one-day drop for the market in about three months. Financial stocks were hammered with a -5% loss as investors reacted to news that yields on Italy's 10-year bonds had risen over 7%. The 7% level is key psychological level for the market. It was at this level that Portugal, Greece, and Ireland all asked for a bailout. Unfortunately Italy is too big for a bailout as the EU's third largest economy and one of its largest debtors with $2.6 trillion in sovereign debt.

Thankfully news that Italian Prime Minister Berlusconi would resign helped calm the markets. News that Italy's Senate had approved stronger austerity reforms to comply with EU demands also fueled investor sentiment. The next step is for Italy's lower house to approve the reform, which should occur this weekend. Meanwhile in Greece the government has replaced Prime Minister Papandreou with Lucas Papdemos as their new interim leader.

Back home in the U.S. we got positive news from tech giant Cisco Systems (CSCO) who reported stronger than expected earnings. Dow-component Caterpillar (CAT) said its backlog of orders had risen +40% and that sales for the quarter were the best in its history. Another big positive for stocks was the Michigan consumer sentiment report out Friday morning. Economists had been expecting a rise from 60.9 to 61.3 in November. Yet Friday's report showed a surge to 64.2. Analysts like to think that consumer sentiment provides insight on consumer spending. Rising sentiment should suggest stronger consumer spending, which accounts for about 70% of the U.S. economy.

The stock market's two-day bounce on Thursday and Friday is encouraging but I am somewhat concerned that Friday's rally is misleading. The U.S. bond market was closed for the Veteran's day holiday and volume in the equity markets was pretty low. This throws doubt on Friday's widespread rally.

Major Indices:

Take a moment to study the S&P 500 index. You can see that it has been consolidating sideways over the last couple of weeks with a neutral pattern of lower highs and highs lows. Traditionally these "pennant" formations are neutral but more often than not the prevailing trend continues. That's good news since the prior trend here was up. We should see the S&P 500 breakout of this pattern this week.

If the bulls can keep the rally going then their next obstacle is resistance in the 1285-1300 zone. Beyond that we're looking at major resistance near 1350.

Daily chart of the S&P 500 index:

The action in the NASDAQ is a bit more volatile with a plunge from 2727 on Wednesday to 2600 on Thursday morning. The 2600 level continues to hold as support. Pretty soon that level will also gain additional support from the rising 50-dma. Unfortunately you could argue that Wednesday is a new lower high. Traders could buy dips near 2600 or wait for a breakout past resistance.

Daily chart of the NASDAQ Composite index:

The small cap Russell 2000 index also has a neutral pattern of lower highs and higher lows. Once again the prevailing trend should have the edge here. Yet I'm not sure how far the small caps can rally. The simple 200-dma is near the June lows near 775, which could prove to be tough resistance. Seasonally this should be a bullish time of year for small caps (November through January). If this index can breakout it could signal a significant move higher for the wider market.

Daily chart of the Russell 2000 index

We are starting to see economic data pick up again after a relatively quiet week. The big reports will be the national PPI and CPI data. Plus the Philly Fed on Thursday could be a market mover.

- Tuesday, November 15 -
Producer Price Index (PPI)
Retail Sales for October
New York Empire Manufacturing Survey

- Wednesday, November 16 -
Consumer Price Index (CPI)
Industrial Production & Capacity Utilization

- Thursday, November 17 -
Weekly Initial Jobless Claims
Housing Starts & Building Permits
Philly Fed survey

The Week Ahead:

I'd like to think that after Greece and Italy replace their Prime Ministers with new leaders focused on austerity that we will see the pace of headlines out of Europe cool off. It's possible the markets will give these new leaders some time to put their house in order before we see another crisis. Then again that could be wishful thinking. One of the more disturbing bits of analysis I read this weekend stated that austerity has never been successful in saving a country that is buckling under a massive debt load. Time and time again governments have tried but every time austerity produced recessions, higher unemployment, lower tax revenues and eventually they needed to go into bankruptcy and restructure their debt. This does not bode well for Europe, especially for Greece and Italy.

Unfortunately, this means the crisis in Europe is not over yet. It may not be over for years to come. The situation is growing dire enough that the stronger countries, like Germany, are pondering what if scenarios that essentially boil down to a divided Europe where the EU might only consist of the stronger, more fiscally responsible countries.

On a short-term basis I am hoping we get a break from the parade of EU headlines. Of course these headlines might just get replaced with headlines from Washington about the "super committee" that is supposed to be finding a way to slash $1.2 trillion in spending by the November 23rd deadline. At the moment there is little consensus among committee members and this could prove to be a stumbling block for U.S. markets.

I am still cautiously bullish on stocks but you can see that the major indices are stuck in a sideways range. The problem is that we do not know which headline is going to be the one that knocks the market one way or the other out of that neutral pattern. If we are lucky it will be a positive headline on stronger economic data in the U.S. that determines market direction.

- James