The financial meltdown in Cyprus and the potential for an emergency tax on bank deposits has been the topic all week long. Cypriot banks remain closed and there is still no solution for the small Mediterranean country. The Cyprus story, which exploded in the news just over a week ago, sparked profit taking across the global equity markets. Yet the selling pressure in the U.S. was relatively mild. We are quickly approaching the end of the first quarter and fund managers are still in a buy-the-dip mood. It has been an extraordinary first quarter for the U.S. market and money managers are chasing performance so they can look good in your quarterly statements that go out next month.

Overall the U.S. economic data was relatively benign. The Philly Fed survey for March came in at +2.0 versus a -12.5 reading in February. Numbers above zero indicate growth. Weekly initial jobless claims were flat at 336,000 versus 334K the week before. Existing home sales for February came in at an annual pace of 4.98 million versus estimates for 5.0 million. Building permits hit an annual pace of 946,000, which is up from 904,000. Housing starts improved in February hitting an annual pace of 917,000 after dipping to 910,000 in January. Of course the big non-event for the week was the FOMC meeting where the Fed kept rates unchanged in the 0.0% to 0.25% zone. There was no change in the current QE program.

There was a lot more action in overseas economics. The Eurozone ZEW economic sentiment survey came in at 33.4, which was significant below expectations. Another bearish sign was French and German PMI data. French manufacturing PMI hit 43.9 and the services PMI came in at 41.9. Both of these were below estimates. German manufacturing PMI declined to 48.9 and the services index dipped to 51.6. Again, both were below estimates. Numbers above 50.0 indicate growth and expansion and below that level indicate contraction. All four readings retreated lower.

Looking to Asia the Chinese HSBC manufacturing PMI data advanced to 51.7, which was above estimates of 51.2. It is worth noting that a few days ago Goldman Sachs issued cautious comments on the impact of inflation for the Chinese economy. Meanwhile in Japan, Mr. Kuroda was sworn in as the new Governor of the Bank of Japan. It is widely expected that Kuroda will launch significantly larger monetary easing programs. This expectation is helping fuel gains for the Japanese equity markets. The BoJ's next policy meeting is April 4th.

I'm going to try and cover the Cyprus issue as concisely as possible. This small Mediterranean country had a massive banking system that was nearly eight times the country's GDP. That's because Cypriot banks were encouraging offshore money to be deposited in Cyprus thanks to healthy interest rates and the chance to avoid taxes. Evidently Cyprus is a very popular spot for wealthy Russians to park their money and avoid taxes. Most of the problems started with Cypriot banks using these deposits to buy high-yielding Greek bonds. When the Greek economy collapsed and Greece restructured the bonds, the value of these assets were drastically reduced. Suddenly Cypriot banks had significant holes in their balance sheets.

Now jump ahead to current day and Cyprus is in desperate need of a bailout to prevent their banking system from crashing. They're part of the Eurozone so they cannot print more money. The Eurozone offered a 10 billion euro bailout but Cyprus would have to raise 5.8 billion euros of capital first. Since the country is bankrupt they couldn't raise the money. The geniuses in mainland Europe (think ECB, EU, IMF) told Cyprus to raise the money with an emergency tax (a.k.a. stability levy) on private citizens' bank deposits. The original levy called for the confiscation of 6.75% of Cypriot bank deposits up to 100,000 euros and a 9.9% cut of all deposits above 100,000 euros.

Naturally the citizens of Cyprus were not happy with this idea. The Cyprus government closed the banks to prevent a bank run. All week long we have been seeing pictures of long lines at ATMs as Cypriot citizens try to carry on with their day to day lives. Many local Cyprus merchants have stopped taking credit cards and demand cash (euros) only. The fear is that if Cyprus were to suddenly leave the euro and try and launch their own currency over the weekend, the new currency would be significantly devalued against the euro.

There was supposed to be a vote by the Cyprus parliament on this "stability levy" on Monday, March 18th. It was delayed to Tuesday where the levy was voted down. Cyprus still needed to raise the 5.8 billion euros to qualify for the 10 billion euro bailout money provided by the Eurozone. Currently the European Central Bank (ECB) is providing emergency funding to Cyprus banks but just announced they will cut this emergency funding as of March 25th if the country can't reach some sort of bailout deal. The Cyprus finance minister went to Russia with hat in hand asking for a loan. It was believed that Russia might be interested in helping Cyprus if Russia could get a deal on some newly discovered natural gas fields off the southern coast of Cyprus. The Russian negotiations did not produce any agreement. Cypriot banks remain closed. Cypriot citizens are protesting in the streets. The island's government still has to raise money and/or renegotiate a new deal with the troika or leave the euro altogether and start with a new currency.

If that was not bad enough this idea to "tax" (a.k.a. steal) bank deposits to raise emergency funds is starting to spread. A German economist suggested a 15% financial asset tax on Italian bank accounts so Italy can cut their debt to GDP percentage to more healthy levels. Spain said they were considering a tax on bank deposits. Honestly? Has the world gone nuts? If these governments actually steal money from their citizens' bank accounts, how in the world are they going to stop a massive bank run in their countries? Money will be pulled out of these countries so fast it will cripple their already struggling economies. Of course regulators will try and pass capital controls to prevent money from leaving the country. Consumer and business confidence levels are likely to plummet in any country considering such a "tax".

At this point, it doesn't matter how the Cyprus issue is solved. The EU's suggestion to confiscate the savings of citizens has cast grave doubts about the safety of deposit insurance. If citizens don't believe their money is safe then the banks are going to suffer for it. If people don't trust the banks then business activity is going to fall. Significant sections of the EU are already in recession (or worse) and this confidence-shaking fiasco is going to compound their problems. Many people are already pointing to this blunder as the final blow that will eventually unravel the Eurozone.

Major Indices:

In spite of all the headlines the S&P 500 index held up pretty well. The big cap index only lost -0.2% for the week. The index found short-term support near 1540 and once again looks poised to rally and hit new all-time highs. Of course that may depend on how the Cyprus issue plays out. At the moment the U.S. markets are trying to ignore the issues in Europe.

The numbers to watch are 1565, which is the old closing high and 1576, which is the intraday high. Given the trend of higher lows it seems like a new closing high could happen pretty soon. Yet the S&P 500 is still in danger of a massive triple-top pattern. Assuming Cyprus doesn't completely meltdown this week I would not be surprised to see the S&P 500 index rally into the $1570-1580 zone - just in time to mark the end of the first quarter.

Don't let new highs fool you. The Q1 earnings season is just around the corner and disappointing earnings results could endanger the rally.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

Monthly chart of the S&P 500 index:

The NASDAQ composite spent the week churning sideways inside the 3200-32.60 range. It closed with a -0.1% dip for the week. Overall the index held up relatively well considering the weakness in the semiconductor sector. The NASDAQ's largest component, AAPL, looks like it's ready to rally, which would certainly improve investor sentiment.

Weekly chart of the NASDAQ Composite index:

Out of the major U.S. indices the small cap Russell 2000 index delivered the worst performance with a -0.6% decline. Yet even this was minor considering the $RUT's gains for the year (+11.4%). If stocks continue to weaken then the $RUT might find some short-term support near 920 and near its 40 or 50-dma. Below that would be potential support near the 900 mark. On the other hand, if this rally were to continue, then a breakout to new highs could signal a run toward the 990-1,000 level for the $RUT. That's assuming the Q1 earnings season doesn't short circuit the rally.

chart of the Russell 2000 index

Economic Data & Event Calendar

The situation in Cyprus is likely to overshadow any economic reports this week. We will get new updates on consumer confidence and consumer sentiment. Fed Chairman Bernanke will speak on monetary policy on Tuesday. The third Q4 GDP estimate comes out on Thursday. The market will close on Good Friday to celebrate Easter.

You may notice that I have removed the U.S. budget resolution as an event. The republicans and the democrats have agreed to a funding solution that keeps the U.S. government going through September of this year. The next big fight will be the debt ceiling issue in May.

Economic and Event Calendar

- Monday, March 25 -
Potential vote on Cyprus Bailout Plan
German consumer confidence

- Tuesday, March 26 -
Federal Reserve Chairman Bernanke speaks
Durable Goods Orders
Case-Shiller 20-city home price index
Consumer Confidence
New Home Sales
Richmond Fed manufacturing survey

- Wednesday, March 27 -
Pending Home Sales
Eurozone industrial production

- Thursday, March 28 -
Weekly Initial Jobless Claims
U.S. Q4 GDP (3rd) Estimate
Chicago PMI

- Friday, March 29 -
U.S. market closed for Good Friday
Personal Income & Spending
University of Michigan Sentiment index

Additional Events to be aware of:

May 18th - U.S. debt ceiling deadline

The Week Ahead:

Looking ahead this week will see a tug-of-war between bearish headlines from the Cyprus situation and window dressing for the quarter end on Thursday. Momentum still favors the bulls. What worries me is Q1 earnings season. We have already seen several major earnings disappointments and or earnings warnings from the likes of Caterpillar (CAT), AK Steel (AKS), Steel Dynamics (STLD), Federal Express (FDX), and Oracle (ORCL). So far the market has been able to shrug off these negative headlines. Yet these warnings do not bode well for Q1 results.

Right now analysts are only expecting Q1 earnings growth of +0.58%. That's right, less than 1% growth. There is a growing chance that Q1 earnings could come in negative. That would prompt a big round of negative earnings revisions since Wall Street is way too optimistic for the rest of 2013. Currently analysts have set Q2 earnings growth estimates at +7%, Q3 at +10%, and Q4 at +15.6%. That's quite a jump from +0.5% growth in Q1.

The combination of a potentially disastrous Q1 earnings season with the S&P 500 at multi-year (almost all-time) highs and the likelihood of a bearish reversal at resistance to create a triple top pattern seems rather ominous. Investors have plenty of reasons to be cautious here. The stock market might also be considered overbought. Nearly 85% of the S&P 500 are trading above their simple 200-dma. History has proven that when this reading gets above the 80% level the market is nearing a top and a correction is almost imminent (give or take a few weeks).

Can the U.S. market (S&P 500) rally to new highs in the next several days? Absolutely, it can. Are we close to a pivotal market event with Q1 earnings season? Yes, we are. Could we see the market top in the next two to four weeks? Absolutely! If you're an investor, why buy stocks (or LEAPS options) now with the market at new highs and near resistance, when we have a pretty good chance of seeing a better, lower entry point a few weeks from now?

James