The new year 2013 is off to a strong start for Wall Street. The major U.S. indices are soaring thanks to news of a fiscal cliff deal in Washington. On January 2nd, word of an agreement between the democrats and republicans pushed the Dow Industrials to a +308-point rally. The NASDAQ composite soared almost 93 points and the S&P 500 gained +2.5% the same day. By the end of the week the small cap Russell 2000 index had broken out to a new all-time, record high. The Dow Jones transportation average is not that far behind, only 84 points from a new record high. Gold and silver tumbled on a rally in the dollar. Oil posted its fourth weekly gain in a row. The bond market reversed sharply lower.

A few highlights of the fiscal cliff deal revealed that individuals earnings less than $400,000 a year will not see their income taxes go up. Those making more than $400K will. Yet any employee will see their payroll taxes rise as the tax holiday was allowed to expire. Your payroll taxes will rise from 4.2% to 6.2%. The $109 billion in defense spending cuts has been delayed for two months giving politicians more time to negotiate (probably about the debt ceiling, but more on that later). The economic data last week was focused on employment but the ISM data was better than expected. The national ISM index rose from 49.5 to 50.7 in December. Readings over 50.0 indicate growth and expansion. Meanwhile the ADP employment change report showed private sector jobs gaining +215,000. On Friday the non-farm payroll (jobs) report came in at +155,000. Economists were only expecting +143K. The prior month (November) was revised higher from +146K to +161K. The unemployment rate was unchanged at 7.8%. Overall it was relatively positive, showing slow and steady growth.

The "steady" part of U.S. job growth is a bit surprising. Felix Salmon, at Reuters, published an interesting piece on the jobs report's lack of volatility. According to the BLS, who produces the monthly report, they claim that their own numbers could be off by 100,000 workers at least 10% of the time. Yet we haven't see that sort of volatility in the monthly numbers. Here's a link to the article but be careful, it might fuel your inner conspiracy theorist. (link to Felix's article: click here.) Another event this past week was the FOMC minutes from the latest meeting. Market participants were surprised to read that some of the fed governors are starting to think the Federal Reserve should slow or stop their QE programs in late 2013. That's a lot sooner than we've all been led to believe and the U.S. dollar rallied on the news while U.S. bonds sank. The strength in the dollar helped push precious metals lower.

The action in the U.S. bond market is starting to look like a potential top. Yields on the ten-year note have been hovering in the 1.55 to 1.90% range for months but this past week they broke out higher (on bond weakness). If the rally in the bond market is actually over the all that money could start flowing back into equities. However, I think it might be too early to call a top in bonds. When yields spiked back in March 2012 they were probably thinking it was a top as well. This is definitely an area that investors will want to keep an eye on. I am posting a monthly chart of the 10-year yield to offer you some perspective.

Monthly chart of the 10-yr U.S. bond yield:


Major Indices:

Bingo! U.S. stocks reversed sharply higher on news of the fiscal cliff deal. I'm sure a lot of it was short covering. The S&P 500 delivered a +4.5% gain in just four days (market was closed on Tuesday). Now the index is nearing potential resistance at its 2012 highs in the 1470 area. A breakout past 1470 could push the S&P 500 to levels not seen since late 2007. On a short-term basis the index is overbought and probably needs to pullback some or consolidate sideways to digest these gains.

The 1440 and 1420 levels should now be new support. If the S&P 500 is able to keep the rally alive then the next major resistance level (past 1470-1475) is round-number, psychological resistance at the 1500 mark.

chart of the S&P 500 index:

Monthly chart of the S&P 500 index:

The tech-heavy NASDAQ composite soared +4.7% for the four-day week. Most of that was on the gap open higher from Tuesday morning. Last week I cautioned readers that 3050 and 3100 were likely resistance. There is a chance that the NASDAQ tries to fill the gap before moving higher. Or the NASDAQ could churn sideways as it tries to digest these gains and investors wait for corporate earnings news to fuel the next move.

We can look for potential support at 3050, 3000, and 2950. The next level of significant resistance is probably the 2012 highs near 3200. A breakout past 3200 would mean new multi-year highs. I'm including a monthly chart of the NASDAQ to provide some perspective.

chart of the NASDAQ Composite index:

Monthly chart of the NASDAQ Composite index:

The small cap Russell 2000 index was the big winner for the week with a +5.6% gain. It has also broken out past resistance to close at new all-time, record highs. The $RUT is definitely short-term overbought but it can always grow more overbought. Broken resistance near 870 might offer a little bit of support but if the market corrects I would expect a bigger pullback in the $RUT.

If the rally continues then the next level of likely resistance should be the 900 level. Once past 900 the 1,000 level could act like a magnet. I want to warn you that if the Q1 earnings season isn't very good then a lot of these gains could vanish.

The larger trend is up but short-term the $RUT is due for a dip.

chart of the Russell 2000 index

Monthly chart of the Russell 2000 index

I want to point out that the Dow Jones Transportation average is in breakout mode. After months of churning below resistance near the 5200 level these last few weeks have produced a bullish breakout higher. Now the $TRAN index has rallied to major resistance near its all-time highs in the 5500-5600 range. The all-time intraday high was 5627 back in 2011. The monthly line chart below shows the $TRAN's closing values so it looks like it's already breaking out. Following the transports is important because Dow Theory says we can't have a sustained market rally without cooperation by the transports. On a short-term basis the transports are overbought and due for some profit taking. On a long-term basis a strong close above 5630 would be very bullish.

Monthly chart of the Dow Transportation Average

Traders should also be aware that this big market rally has crushed the volatility index (VIX). Normally when the VIX is very low it indicates complacency and a lack of fear in the market. When traders get too comfortable it could spell trouble. This last week has seen the VIX collapse from above 22 to under 14 (-36%) and it's nearing the 2012 lows set this past summer.

I am not calling a top in the market based on the plunge in the VIX but it is a warning sign. Stocks can continue to rally and the VIX could hit new multi-year lows but the lower it goes the higher the risk of a bearish reversal. Think of it like a rubber band. The harder you stretch out a rubber band the faster and harder it snaps back. It's just one more thing to keep an eye on.

chart of the Volatility Index

The economic data slows down a bit this week. We will see new info on the Eurozone area with their PPI and retail sales. Plus China will release its inflation data and retail sales numbers. The ECB has an interest-rate meeting on January 10th. Yet the event to watch is the beginning of the Q4 earnings reporting season. Alcoa (AA) launches the Q4 earnings season on Tuesday, after the closing bell. The pace of earnings will pick up significantly the following week.

Economic and Event Calendar

- Monday, January 07 -
Eurozone Producer Price Index (PPI)

- Tuesday, January 08 -
Eurozone retail sales
Dow-component Alcoa (AA) kicks off Q4 earnings season

- Wednesday, January 09 -
Chinese inflation data
Chinese retail sales

- Thursday, January 10 -
Weekly Initial Jobless Claims
ECB interest rate decision
Wholesale inventories

- Friday, January 11 -
(nothing significant)

The Week Ahead:

I just mentioned how earnings season is about to begin. Corporate results and more specifically guidance will determine market direction for the next few weeks. There seems to be two very divergent camps right now. Some analysts believe that earnings estimates are still too high and we're going to see a number of misses. They are worried that the fourth quarter was a lot worse than expected. Worries over the fiscal cliff and how to handle rising taxes in 2013 may have stalled corporate investment and consumer spending. On the other hand there are those analysts that expect Q4 numbers to come in healthy. Essentially worries about the cliff and rising taxes may have actually pulled economic activity and spending from the first quarter and into the fourth quarter.

One issue that worries me about earnings season is where stocks are currently at. The market has already seen a significant rally. The major indices are at their highs or making new ones. Better than expected earnings numbers could already be priced in and traders could use the earnings announcement to sell the news and lock in gains. Whether or not anyone buys the post-earnings dip will likely depend on guidance. If there is an outbreak of disappointing guidance we could see the market reverse lower in a hurry.

Another issue to be aware of is the upcoming political fight in Washington over the U.S. debt ceiling. This country has already hit the debt ceiling, which means we've maxed out our credit card. Since we borrow about 40 cents of every dollar we spend, we're not going to get very far into 2013 unless we raise the limit on our credit card. Eventually our creditors are going to stop loaning us money unless we change our spending habits but that's another discussion for another time.

The deadline to solve our debt ceiling issue is in February. The media is calling it the "debt threat" so if you see that term bandied about you know what they're talking about. The debt ceiling issue was a big deal back in 2011. Lack of cooperation between politicians led to a stalemate and the U.S. went past the debt ceiling in the summer of 2011. In reaction S&P downgraded the U.S. credit rating and the stock market plunged.

Now we're hearing more analysts express concerns about the debt threat. One Bank of America analyst is forecasting a -10% to -20% drop in the stock market due to the debt ceiling issue. The "debt threat" will consume the market and the financial media for days on end. Fortunately, that's a few weeks away. Wall Street is going to focus on corporate earnings first. We'll have to wait and see if focusing on corporate earnings is a good thing or a bad thing.

The market's trend is up but some of the major indices have major resistance in front of them. Corporate earnings results, guidance and the debt threat are all potential land mines that could explode and send the market lower.

Trade cautiously.

James