A massive winter storm is blanketing much of the northeastern U.S. with snow but it failed to freeze investor sentiment for stocks. The S&P 500 index and the NASDAQ composite have extended their gains to six weeks in a row. The small cap Russell 2000 index and the Dow Jones Transportation Average have both hit new all-time highs (again). Momentum definitely seems to be in favor of the bulls. Meanwhile both the U.S. dollar and the U.S. bond market managed a little oversold bounce from their February 1st lows.

There were a number of economic reports, much of it overseas, this past week. In the U.S. the December factory orders rose +1.8%, which was below estimates for a +2.3% gain. Services count for nearly 80% of the U.S. economy and the ISM services index rose to a better than expected 55.2. Readings above 50.0 indicate growth. The ISM service index's employment component produced a reading at 57.5, its highest level in seven years. The weekly initial jobless claims came in at 366,000 versus 371,000 the week before. Meanwhile the U.S. trade gap narrowed to $38.5 billion in December thanks to a decline in oil imports and a rise in our exports.

There was a lot of activity in Europe. The Eurozone said their December retail sales fell -0.8%, which was worse than expected. The Eurozone services PMI data for the group improved to 48.6, which was slightly ahead of expectations but still in contraction territory (under the 50.0 mark). On a positive note EU leaders did agree to a budget deal. After a marathon length 25 1/2 hour negotiation they finally reached agreement on their next seven-year budget. Elsewhere the EU's largest economy, Germany, was showing improvement. German factory orders improved. The German government said exports in 2012 rose +3.4% to a record 1.1 trillion euros.

There were also a number of headlines out of Asia. Japan said their machinery orders rose for the third month in a row. Singapore saw their pace of manufacturing turn positive. India's HSBC services PMI hit 57.5, which was better than expected. It looks like China is poised to lead the world's economic rebound. Chinese imports rose +28.8% in January while their exports rose +25%. China also saw their HSBC services PMI rise to 54.0 in January, up from 51.7 the prior month. The country's crude oil consumption rose +4.9% in 2012.

Major Indices:

The S&P 500 was starting to act like it was forming a top with the choppy sideways action in the 1490-1515 zone. Technically Friday's rally to a new high (and a new 5-year high at that) is a bullish breakout. Friday's gain all came within the first 30 minutes of trading and the S&P 500 spent the rest of the day in a narrow range.

Stocks and indices tend to get frothy at tops and bottoms as buyers and sellers battle it out. Thus the recent choppiness was starting to look like a top. Yet if the index can keep this new strength alive then we could see the S&P 500 make a run at its all-time high in the 1560 area. I wouldn't get too excited just yet. I've been warning readers that the 1520 level could be overhead resistance and the index remains below this level for now. Plus, on the weekly chart below you can see how the index has stalled at a major trend line of highs. Now after a six-week rally the S&P 500 is overbought, overextended, and overdue for a correction lower. When that correction does show up I am expecting a dip back toward the 1480-1470 zone.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ composite has continued to rally without any help from AAPL but GOOG has broken out to a new all-time high above $785 a share. The NASDAQ index has finally rallied to what should be resistance at its 2012 highs near 3200. If the index does correct lower from here I would expect a pullback toward the 3100 level. A failure at 3200 would also spark concerns over a potential bearish double top pattern. If the NASDAQ manages a breakout past 3200 then it could spark some short covering. After a six-week rally, the NASDAQ is due for some profit taking.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index added a +0.2% gain for the week thanks to Friday's rally. This also marks a new all-time high. For 2013 the $RUT is already up +7.5%. Even more impressive is the +20% gain from its November lows. The trend is up and momentum favors the bulls yet eventually the $RUT will see a correction. It's overbought and way overextended. I've placed some Fibonacci retracement tools on the daily chart below to produce some "what if" targets if the $RUT were to correct lower from the 920 level. It looks like a correction into the 880-860 area would be a good bet. The old all-time high near 870 could offer some support.

chart of the Russell 2000 index

Economic Data & Event Calendar

We could have a relatively quiet week for economic data. Retail sales for January might disappoint on Wednesday. The Eurozone GDP estimate also comes out on Wednesday. The Chinese begin their Lunar New Year on February 10th and the Chinese markets will be closed all week long. Feb. 10th marks the beginning of the "year of the snake". President Obama will make his state of the union address on Tuesday night. The Q4 earnings season is winding down.

Don't forget that Valentine's Day is this Thursday.

Economic and Event Calendar

- Monday, February 11 -
Chinese markets are closed all week for Lunar New Year holiday

- Tuesday, February 12 -
President Obama's State of the Union Address

- Wednesday, February 13 -
MBA mortgage index
Retail Sales for January
Import/Export prices
Business Inventories (for December)
Eurozone industrial production
Eurozone GDP estimate

- Thursday, February 14 -
Weekly Initial Jobless Claims
G-20 meeting
(Valentine's Day)

- Friday, February 15 -
New York Empire State manufacturing survey
University of Michigan Consumer Sentiment

Additional Events to be aware of:

Feb. 18th - U.S. markets closed for President's Day
Mar. 1st - U.S. sequestration deadline

The Week Ahead:

Looking ahead the market does face a number of challenges. Bull markets do tend to climb the "wall of worry". One issue that could threaten the U.S. is a slowdown in consumer spending. The payroll tax holiday expired December 31st, 2012. Thus most employees have a slightly smaller paycheck this year and it could be impacting their discretionary spending. Another issue that could be curbing consumer spending is fuel prices. Gas prices at the pump have risen 21 days in a row and according to AAA the average gas price is now at $3.555 a gallon. Gas has not been this high in over three months. Unfortunately it looks poised to keep climbing.

The market also faces a potential storm on the horizon with the sequestration battle in Washington. If you recall part of the fiscal cliff was the sequestration issue (across the board cuts in spending for both defense and entitlements). Right now the deadline for sequestration cuts to take effect is March 1st, 2013. If those cuts are allowed it will push the U.S. economy into recession and could severely impact employment. The most recent Q4 GDP estimate came in at -0.1%. While that is likely to be revised higher you can see that the U.S. economy is hovering right at zero percent growth. Estimates have suggesting the spending cuts could take -1% or more off the U.S. GDP. Plus, the Bipartisan Policy Center (BPC) estimates a minimum of 1.0 million jobs lost due to sequestration cuts. The Congressional Budget Office (CBO) puts their estimate at 1.4 million jobs lost.

If that wasn't bad enough there is a growing geopolitical risk that could impact the markets. Israel has threatened to unilaterally strike at Iran's nuclear facilities for years. The next meeting between Iran and the International Atomic Energy Agency (IAEA) is on February 13th. No one expects Iran to comply with the IAEA but this meeting could bring Iran's nuclear ambitions back to the forefront.

Another hotspot issue that's even more threatening are the rising tensions in Asia. The North Korean leadership is getting more belligerent and they're planning a new nuclear weapons test. That has increased tensions with the South Koreans, who have told soldiers to be ready for any signs of aggression.

Meanwhile tensions are rising between China and Japan. The two countries are arguing over a handful of uninhabited islands. The Japanese call these islands the Senkaku. The Chinese call them Diaoyu. The Chinese claim they owned them until the Japanese took control in the late 1800s. Then in the late 1960s it was discovered that the area might have significant oil deposits. Immediately there was renewed disagreement over who owned them. This time the trouble started back in September last year when Japan "nationalized" the three islands they didn't already control.

Both countries have warships in the area. This past week a story surfaced that Chinese ships turned on their fire control radar and targeted Japanese navy ships. Fire control radar is what you would use to calculate how to aim your guns and missiles from your ship to your target. Basically this was the equivalent of the Chinese military drawing their gun and pointing it at the Japanese. Thankfully no one pulled the trigger. The Chinese government denies this event. If shooting between these two major Asian powers does breakout it could have a very negative impact on the global markets.

Looking back to the market, the trend is still undeniably up, but equities remain very overbought and due for a correction. Long-term the rotation out of bonds will be bullish for stocks but that will not prevent the stock market from seeing a normal healthy correction. Personally I would hesitate to launch new long-term bullish positions now when we might see a much better entry point two or three weeks down the road at lower levels.

James