The S&P 500 had rallied +2.3% the first three days of the week. Then it gave most of it back with a slide that started on Thursday (thanks to Google) and then accelerated lower on Friday. Disappointing earnings results and guidance from a handful of high-profile names has sapped investors enthusiasm for stocks. The drop on Friday (-1.7% for the S&P 500) was the worst one-day drop since late June. It was also the 25th anniversary of Wall Street's Black Monday. That's when the Dow Jones Industrial Average fell 23% in one day on October 19th, 1987, scarring a generation of investors in the process.

This past week was the first full week of Q3 earnings results. It's also the first quarter in three years where corporate profits are negative (year over year). We'll talk about earnings in a moment. There were a number of headlines from overseas. In Europe the German ZEW survey saw its current conditions component fall to its lowest level since June 2010. Meanwhile investors were very disappointed that the recent EU summit failed to come up with some sort of solution for Spain. On Tuesday there was hope that Spain might actually ask for a bailout but there was no follow through. Spain definitely needs some financial aid but they are unwilling to accept the strings attached to any new EU bailout. EU leaders did make progress on agreeing to a new banking oversight scheme. The plan calls for new EU-wide banking regulation to be submitted by the end of 2012 and then eventually approved and implemented by the end of 2013.

Meanwhile across the Pacific ocean China was making headlines. The latest Chinese Q3 GDP estimate came in at +7.4% growth. That sounds good compared to the U.S's +1.3% growth rate. Yet for China, at +7.4%, it was the slowest level of growth since Q1 2009. It was also the seventh consecutive quarter of slowing growth. On a positive note China saw both its retail sales numbers and industrial production figures come in better than expected. Plus, China's consumer price index fell to +1.9%.

It was a busy week for economic data in the U.S. The September retail sales number came in at +1.1%, which was better than the prior months upwardly revised +1.2% and the +0.7% estimate for September. The Consumer Price Index (CPI) for September hit +0.6%, which was slightly above expectations but the core CPI only rose +0.1%. The New York Empire State manufacturing survey for October improved to -6.2. A month ago this came in at -10.4 but economists were expecting an improvement to -4.0. Readings above zero indicate growth while under zero it suggests economic contraction. On a more positive note the Philly Fed survey improved to 5.7 for October compared to the prior month's reading at -1.9. Analysts had been expecting an improvement to 1.0. The employment component of the survey plunged to -10.7, the lowest reading since late 2009.

Housing data was the big positive surprise this week. Both building permits and housing starts came in better than expected for September. Permits rose from an 801,000 annual pace a month ago to 894,000 in September. Housing starts improved from an annual pace of 758,000 to 872,000. This surge in housing starts was the biggest improvement since July 2008. Unfortunately, the existing home sales numbers failed to impress. The National Association of Realtors said existing home sales for September slipped -1.7% to a seasonally adjusted 4.75 million pace. NAR did report that nationwide inventories have fallen to a more normal level of 5.9 months of inventory. This is the lowest inventory reading since March 2006. Declining inventory levels helped fuel a +11.3% jump in the median price of a home, now at $183,900.

We are in the middle of Q3 earnings season. Thus far it's been rather disappointing. A string of earnings or revenue misses from big names like General Electric (GE), McDonald's (MCD), Microsoft (MSFT), Intel (INTC), Intl. Business Machines (IBM), and Google (GOOG) have all played their part in the market's bearish reversal lower this past week. Thus far 117 companies in the S&P 500 index have reported their Q3 results and the average earnings growth is down -4.0% from a year ago. That's twice as bad as the recent Wall Street estimates of -2.1% earnings growth.

Major Indices:

Stocks rallied the first three days of the week but the S&P 500 rolled over once it hit the 1462-1465 area. The index has seen a sharp drop back toward recent support near 1430 and its rising 50-dma. A breakdown here (under the October 12th low of 1425) would forecast a drop to the next support level at 1400. If the 1400 level breaks then we're probably looking at a drop to 1380 or the simple 200-dma (currently at 1374).

If you're feeling optimistic then you could argue the S&P 500 might be building a bull-flag pattern but a close under 1420 would definitely look negative and break the pattern.

chart of the S&P 500 index:

Disappointing earnings reports from the likes of Intel (INTC) and Google (GOOG) have weighed heavily on the NASDAQ. The composite underperformed the other major indices with a -2.1% drop on Friday. I cautioned readers that the next likely support level could be the 3,000 mark. Currently the NASDAQ is down about -6% from its September highs. You could argue it's a bit oversold here so there is a good chance the NASDAQ might bounce off the 3,000 mark. You'll notice that the index has a bearish trend of lower highs and lower lows.

If the 3000 level were to fail then the next level of support is probably the simple 200-dma near 2970 or the exponential 200-dma near 2950.

chart of the NASDAQ Composite index:

The small cap Russell 2000 bounced from support near 820 but failed at its trend of lower highs. Now it is testing key support near 820 again. The close under its simple 50-dma is bearish. The next level of support looks like the trend line from its October 2011 low, which just happens to coincide with its rising 200-dma (see chart).

The short-term trend is down but a close under its simple 200-dma (or the 800 level) could signal that the larger trend for the $RUT has turned bearish.

Daily chart of the Russell 2000 index

Last week the flow of Q3 earnings results turned into a downpour. This week the pace of earnings announcements will turn into a flood with hundreds of companies reporting. Outside of earnings results we could see headlines out of Europe. Spain is holding its regional elections on Sunday, October 21st. There is a Spanish bond auction on Tuesday so it will be interesting to see how bond buyers react to the election headlines. Italy will also sell debt on Friday. Meanwhile ECB President Mario Draghi meets with the German Parliament on Wednesday, which could spark headlines.

Here in the U.S. investors might be focused on the third and final presidential debate to be held on Monday night. Midweek is a two-day FOMC meeting but after the last meeting's QE-infinity program, this meeting is not expected to produce any headlines. Last but not least is an early look at U.S. GDP growth for the third quarter, which is released on Friday morning.

In corporate news, besides earnings reports, we will see the media focus on Apple's launch of the iPad mini. Plus we'll see Microsoft launching its new Windows 8 operating system and its new Surface tablet, a rival for Apple's iPad.

Economic and Event Calendar

- Monday, October 22 -
3rd U.S. presidential debate

- Tuesday, October 23 -
FOMC meeting begins two-day meeting
Eurozone Consumer Confidence
Chinese Manufacturing PMI report

- Wednesday, October 24 -
FOMC meeting ends, interest rate decision Wednesday afternoon
New Home Sales (for September)
Eurozone PMI report

- Thursday, October 25 -
Weekly Initial Jobless Claims
Durable Goods Orders (for September)
Pending Home Sales (for September)

- Friday, October 26 -
U.S. Q3 GDP estimate
University of Michigan consumer sentiment (for October)

Additional Events to be aware of:

Nov. 6th - U.S. Presidential Election

The Week Ahead:

Looking at the week ahead I am concerned that stocks will likely continue to drop or at best churn sideways. Investors are probably in a wait and see mode. Thus far earnings results have not been very inspiring. Plus, we have the presidential election in two weeks. Who wins the White House could definitely influence investor sentiment. We also have October 31st quickly approaching, which is fiscal year end for many mutual funds. This could generate window dressing (or undressing) depending how the market moves from current levels.

A couple of weeks ago analysts estimates for Q3 earnings growth had fallen to -2.1%. Right now the average corporate report is showing -4.0% growth. If this doesn't improve quickly it will definitely dampen investor appetite for stocks. A good question I read this weekend regarding earnings asked if what were are seeing is just a bump in the road for earnings growth or a sign of things to come given a slowing global economy and the fast approaching fiscal cliff for the U.S.

Speaking of the fiscal cliff, CNBC had an interesting article discussing a Bank of America analyst report on the impact of the cliff and perception of the cliff by investors. There was a survey of fund managers and the vast majority (72%) thought that investors have not yet priced in the potential impact of the fiscal cliff. Think about that for a moment. Almost three out of four fund managers do not think investors have properly considered the impact the fiscal cliff will have on corporate earnings and business and how that might be reflected in the stock market. If something were to somehow awaken investors to the risk facing the economy, the Bank of America analyst suggested that the S&P 500 could quickly fall to 1250 and likely continue down to the 1,000 level. That is a -30% haircut from current levels.

While we're talking about investor perception I should mention the AAII sentiment survey. Last week the most recent survey showed that bearish sentiment rose 5.7% to 44.5%. This is the highest reading since early June 2012. It's also the eight week in a row that bearish sentiment was above the long-term historical average of 30%. Investors surveyed are asked if they think stocks will rise or fall over the next six months. Historically 39% of investors are bullish and 30% are bearish. The most recent survey showed only 28.7% of investors are bullish. Now take into account that October normally starts the best six months of the year for stocks. There is definitely a disconnect with investors somewhere.

James