The last day of 2012 ended on an up note. Stocks have been down for several days as investors worried the U.S. would go plunging over the fiscal cliff. Yet now, here at the very last moment, it seems that politicians in both the House and the Senate are finally finding compromise. There has been a flurry of activity in Washington. The market rallied this morning on positive comments that a deal was close to getting done.

Looking back at the economic data last week, most of the news was positive but investors didn't care since the market's focus was on the cliff. Housing data was better than expected. The pending home sales index rose +1.7% in November to 106.4. This is a new two-year high. The November new home sales figures hit an annualized rate of 377,000, which is up from October's 361K. Over the last twelve months home sales are up +9.8%. The Case-Shiller 20-city home price index rallied +4.3% in October, up from a +3.0% gain the month before.

The Chicago ISM index, previously known as the PMI, showed an improvement from 50.4 to 51.6 in December. Readings above 50 indicate growth and expansion. At 51.6 this is the highest reading since August. Meanwhile one of the only bearish data point last week was the consumer confidence reading. The latest consumer confidence reading fell from 71.5 in November to 65.1 in December, which was significantly worse than expected.

Of course the real story last week and today remains the fiscal cliff negotiations in Washington. Last week we saw market volatility pick up as stocks ricocheted from one news headline to the next. Late Friday afternoon we saw stocks accelerate lower in a rush on disappointing news that the fiscal cliff talks were still at a stalemate.

The situation seems to have changed over the weekend. Now that we're down to the last few hours before the deadline expires on January 1st we're hearing that the House and the Senate are working together to patch over some of the biggest holes in the fiscal cliff. This morning it was widely reported that President Obama claimed a deal to avoid a tax hike on middle class Americans was "in sight". The latest story is that both sides seem to have agreed on a $400,000 income threshold as the key level. Those making more than $400K a year will see their taxes go up. Washington is also trying to solve a problem with the Alternative Minimum Tax (or AMT) that is projected to hit up to 25 million Americans if Washington doesn't do something about it. Another tax issue is the payroll tax holiday. At the moment it does not look like the payroll tax holiday will survive. About 160 million U.S. workers only pay 4.2% in payroll taxes. That is set to go up to 6.2% on January 1st.

Another story that made headlines over the weekend was the Dairy "cliff". The latest U.S. farm bill expired back in October. The farming industry is riddled with a convoluted web of federal subsidies and guidelines that impact how farmers manage their business and how much you and I pay for products in the story. Currently the average cost for a gallon of milk is about $3.65. Yet now that the last farm bill expired all the programs that affected the dairy industry would revert back to some arcane formula set 50 plus years ago that would lift the cost of milk to about $7.00 a gallon. You can probably imagine the urgency in Washington to do something before such an American staple as milk were to suddenly double overnight. Instead of tackling such a complicated issue like updating the farm bill the democrats and republicans have agreed on a one-year extension for the milk provision in the 2008 farm bill.

Major Indices:

Last week the S&P 500 index gave up -1.9% but for the year the S&P 500 was still up +11.5% (as of Friday's closing bell). The index has corrected lower toward round-number, psychological support at the 1400 level. This morning (Monday) the S&P 500 briefly dipped below this support level (1398) and then immediately reversed higher.

I don't see any changes from my prior comments on the S&P 500. The main levels to watch are still support at 1400 and most likely support at 1380 and 1350. It's possible the 200-dma near 1390 could offer support. On the upside the S&P 500 faces potential resistance near 1420 and the 1440-1450 area. A breakout past 1450 could signal a run towards the 2012 highs near 1470.

chart of the S&P 500 index:

The NASDAQ composite index fell -2.0% last week with a pullback toward support near the 2950 level. For the year the NASDAQ is up +13.6% as of Friday's closing bell. The market's big rally on Monday is pushing the NASDAQ up through resistance near its 200-dma and the 3,000 level. The main levels to watch remain unchanged. There should be support near 2950, 2900, and 2850. Overhead the most likely areas to look for resistance are 3050 and 3100. If the NASDAQ can close above 3100 we have a pretty good shot at seeing it rally toward is 2012 highs near 3200.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index ($RUT) plunged five days in a row on fiscal cliff fears. The $RUT fell -1.8% last week. Yet it managed to recoup all of those losses with a +2.0% rebound on Monday. Strength in the small cap Russell is a good sign for the health of the broader market. If a cliff deal gets done we could see the $RUT rally toward its all time highs near 870.

chart of the Russell 2000 index

It's the first of the month again and that means a lot of economic data. With the markets closed on Tuesday everything is going to be crammed into the last three days of the week. The reports to watch are the ISM on Wednesday, the ADP Employment change report on Thursday, and the non-farm payrolls (jobs) report on Friday. Economists are expecting +143,000 new jobs in December.

Economic and Event Calendar

- Monday, December 31 -
Last day before the fiscal cliff deadline!

- Tuesday, January 01 -
U.S. markets closed for New Year's Day

- Wednesday, January 02 -
ISM index
construction spending
auto and truck sales
Eurozone PMI data

- Thursday, January 03 -
Weekly Initial Jobless Claims
ADP Employment change report

- Friday, January 04 -
non-farm payrolls (jobs) report for December
unemployment rate
Factory Orders
ISM Services index

Additional Events to be aware of:

Jan 10th, 2013 - ECB interest rate decision

The Week Ahead:

Looking ahead it is still all about the fiscal cliff. The market rallied sharply on Monday thanks to positive news about progress towards a deal. Yet no deal has been completed and we only have a few hours to go before the deadline passes. It is possible that some sort of short-term deal or extension gets done. Technically we could actually go over the cliff and then see our legislators pass a bill that would retroactively stop that from happening.

Another twist on the negotiations could be the U.S. debt ceiling issue. The U.S. is scheduled to hit its debt ceiling on Monday (today). That means the U.S. has essentially hit its limit on the country's credit card. The U.S. Treasury will have to rely on accounting tricks to avoid the U.S. from not paying its bills. This could be a major factor in getting some sort of deal done.

Everything comes down to "the deal". Do we get a deal or not? What kind of deal will it be? Will it be a short-term fix or a bigger compromise? On Friday option trading guru and former market maker Jon Najarian surprised many by confessing that he was completely out of the markets. The potential volatility over the fiscal deal made it too dangerous to trade. I am paraphrasing. Jon actually said, "For the first time in 31 years in the market, I am completely out of everything. I see no reason to stick with longs and no reason to get short either." He may have a point. If a "deal" does get done then the market could rally sharply or we could see a sell the news reaction instead. The problem is that we don't know the details of any deal yet. If congresses rushes to pass some sort of deal to avoid disaster the quality of the deal will be questioned. Najarian is expecting the first two or three weeks of January to be weak and hopes to get back into the market on this weakness after some of the dust from any fiscal cliff deal settles.

Bigger picture 2013 will remain hostage to Washington. PIMCO's co-CEO Mohamed El-Erian was quoted on Monday saying that the "dysfunction and polarization" of our politics in Washington would be a major drag on the U.S. economy. El-Erian expects more of the "new normal" with a very slow-growth economy and constant highly unemployment.

Short-term, the big bounce on Monday is encouraging but these gains could all be erased just as quick if there isn't a deal by Wednesday morning. It may be safer for investors to just take a step back, away from the market for a few days to wait for this fiscal cliff deal business to shake out before committing new capital.

Happy New Year!

James