Money continues to flow into the U.S. stock market. The most recent data showed that equity funds saw weekly inflows of $20 billion, the fastest pace since June 2008. A dovish Fed Chairman Bernanke also helped keep the rally alive with his testimony before congress this past week. Traders are ignoring the rash of high-profile earnings and revenue misses and continue to buy stocks. The major indices are now up four weeks in a row. From the June 24th low the S&P 500 is up +7.5% and the small cap Russell 2000 index ($RUT) is up more than +10%. The NASDAQ 100 index managed its longest winning streak ever of 14 days in a row. The S&P 500, the $RUT, the Dow Industrials, and the Dow Jones Transportation Average all ended the week at new all-time closing highs. For the first time in history the value of the S&P 500 has exceeded $15 trillion (with a T). The volatility index (VIX) has collapsed during the same four weeks suggesting a serious lack of fear in this market.

We are in the middle of Q2 earnings season. There have been several earnings and revenue misses. The most recent big name misses were Coca-Cola (KO), Google (GOOG), and Microsoft (MSFT). Almost 20% of the S&P 500 components have already reported their Q2 results. About 70% have beaten Wall Street's profit estimates but that's only because analysts have significantly revised their estimates lower. At the beginning of the second quarter Wall Street was expecting +4.1% earnings growth. By the time earnings season actually started those estimates had fallen to +1.5% growth. Most of that growth is coming from the banking sector. If you exclude bank earnings then profits are expected to fall -2.7%. Revenues are also slowing down significantly. Once again everyone is pointing to the second half of the year for a rebound.

Economic data last week was mixed but the latest headlines took a backseat to the Federal Reserve Chairman's testimony before congress midweek. Mr. Bernanke reiterated the Fed's official stance that their current QE3 program would be data dependent. If the U.S. economy improved then the Fed would start to reduce asset purchases. However, if the economy got worse they are prepared to raise asset purchases. The main message was that the Fed would remain accommodative for the foreseeable future. Stocks rejoiced and continued to march higher.

We did see some improvement in the regional surveys. The Philly Fed survey surged to 19.8 when economists were only expecting a move to 8. Numbers above zero are bullish for the economy. The New York Empire State survey rose to 9.4, which was above estimates of 7.8. The industrial production numbers for June rose +0.3%.

There does seem to be a disconnect between homebuilder sentiment and actual homebuilding. The latest NAHB housing market (expectations) index showed that homebuilder confidence rose to 57, which was significantly better than expected and marked its biggest two-month rally in over 20 years. Yet housing starts actually fell almost -10% and building permits also contracted. If homebuilding slows down too much it's going to be a drag on the already slowing U.S. GDP growth. It's possible that homebuilders are trying to avoid overbuilding, especially with the sudden increase in mortgage rates. The pace of weekly mortgage applications fell -2.6%. This was the fifth weekly decline and marked the ninth decline out of the last ten weeks.

June's retail sales figures were a disappointment. Economists were expecting +0.8% growth but the headline number only hit +0.4%. If you exclude automobiles and gasoline sales then June retail sales only rose +0.15%. That's the slowest gain in almost six months. Another troubling sign was the slowdown in restaurant spending. Food-service sales plunged -1.2% in June. That's the biggest drop in over five years. The Wall Street Journal noted that the sudden decrease in restaurant and bar sales could be a signal that the U.S. consumer is growing cautious. A big part of the problem is rising gasoline prices. The average price at the pump is currently $3.67 a gallon and it's expected to rise toward $3.80 a gallon. According to Deutsche Bank, every one-cent rise in the price of gasoline reduces U.S. consumer spending by $1 billion.

In other news the Chinese Q2 GDP estimate came in at +7.5% growth. At least that's the official government numbers. Plenty of analyst believe the real number is a lot lower. Even at +7.5%, which was in-line with estimates, it is China's slowest pace of growth since early 2009. China will make headlines again this week with the upcoming HSBC PMI number, which has been falling in recent months and suggesting the country is slowing down a lot faster than official government numbers.

Back home in the U.S. the city of Detroit set a new record as the largest city to file for bankruptcy with over $18 billion in debt. Sadly this is likely a harbinger of things to come. Several large U.S. cities are on the path toward bankruptcy with Baltimore, Chicago, Houston, Los Angeles, Miami, Oakland, Philadelphia, and Scranton all likely contenders for the next major city to go under.

Major Indices:

The S&P 500 index managed a +0.7% gain for the week. That marks four weekly gains in a row. The large-cap index is up almost 120 points from its June 24th close and up +8.4% from its intraday low on June 24th. The index is currently at an all-time historic high and looks poised to test the 1700 level, which could be round-number, psychological resistance.

I would not be surprised to see the S&P 500 index tag 1700 and then begin to correct lower. If the index does pullback I would look for possible short-term support at 1670 and 1650. Using a Fibonacci retracement tool a pullback from the 1700 level would suggest a dip toward 1650.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ's rally made a new string of 13-year highs. The NASDAQ composite index almost hit 3625 on Thursday before paring its gains. The combination of GOOG and MSFT both missing earnings on Thursday night pretty much guaranteed some profit taking on Friday. The NASDAQ gapped down on Friday but there wasn't any follow through selling.

The 3550 level could be short-term support but if the market does see a pullback I would expect the NASDAQ to fill the gap so that means a dip to the 3525 area. A traditional 38.2% Fib retracement would suggest a dip closer to 3500.

chart of the NASDAQ Composite index:

The rally in the small cap Russell 2000 index has been very strong. The index is up +1.35% for the week after another string of record highs. The $RUT is up +11% from its intraday low on Monday, June 24th. There is no denying that the $RUT is short-term overbought here. It's also worth noting that the rally has hit the upper trend line of higher highs. That might suggest the small cap index could see a pullback soon. I would look for potential support near 1020 and the 1000 level.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

We have a relatively light calendar for economic data this week. The big reports will probably be the HSBC manufacturing PMI number for China on Tuesday and the U.S. durable goods report on Thursday. The rest of the week will be highlighted by earnings reports. This will likely be the busiest week of the Q2 earnings season with more than one third of the S&P 500 components announcing. Just a few of the big names to watch for will be Apple (AAPL), Facebook (FB), Amazon.com (AMZN), McDonald's (MCD), Boeing (BA), Caterpillar (CAT), and United Technologies (UTX).

Don't be surprised to see Japan in the headlines on Monday. The country is holding its upper house elections on Sunday, July 21st.

Economic and Event Calendar

- Monday, July 22 -
existing home sales data

- Tuesday, July 23 -
HSBC manufacturing PMI data for China
Eurozone consumer confidence

- Wednesday, July 24 -
new home sales data
Eurozone PMI

- Thursday, July 25 -
Weekly Initial Jobless Claims
durable goods orders

- Friday, July 26 -
University of Michigan Consumer Sentiment

Additional Events to be aware of:

July 31st - FOMC meeting interest rate decision
September - U.S. debt ceiling deadline

The Week Ahead:

The week ahead will be all about earnings. There will be hundreds of companies reporting. Thus far the reports have been rather dismal. Yet expectations have been so low that the market has managed to keep the rally alive. For some unknown reason market participants are swallowing the line that the second half of 2013 will be better. Yet we've seen multiple analyst firms downgrade their second half U.S. GDP growth estimates in recent weeks.

Carter Worth, the chief market technician at Oppenheimer, has made some interesting observations. The current period from March 2009 through July 2013 is almost an exact copy of the S&P 500's rally from March 2003 to July 2007. According to Mr. Worth the correlation is 95.5%. I've borrowed Oppenheimer's chart below to show you. What Carter's chart doesn't show you is what happened afterwards. By the end of 2007 the market had peaked and begun a multi-month bear market that cut stocks in half.

2003-2007 vs. 2009-2013 S&P 500 index

Monthly chart of the S&P 500

Mr. Carter believes the market is overdone and has been suggesting that investors sell now. I can certainly understand his concern. All of the issues I mentioned last week are still here. The situation in Europe is unresolved and Greece and Portugal continue to flounder while Spain and Italy may not be that far behind. The Eurozone remains in a recession. China is slowing down and is not the engine of growth that many believed would save the global economy. The proxy war in Syria and violence in Egypt continues.

The U.S. economy is slowing down as well and will likely see its GDP growth slow to +1% in the second half of this year. Corporate results have been disappointing with sales likely to come in negative for the second quarter by the time earnings season is over. If that wasn't enough the U.S. housing market is facing headwinds from rising mortgage rates. Consumer spending is slowing down thanks to rising gasoline prices. Businesses are cutting back employee hours and only hiring part-time workers in preparation for Obamacare.

Every market is different. The issues that sparked the stock market reversal in late 2007 and the financial collapse of 2008 are not the same issues we face today. There is no guarantee that today's market is going to reverse. Currently the only thing that seems to matter is the Fed's QE program and that is unlikely to change any time soon.

The trend remains higher but on a short-term basis the market is overbought and due for some profit taking. Investors may want to take a step back and let the market deflate a little bit. Let's assume the S&P 500 does hit 1700. A minor -3% pullback from 1700 would mean a dip to 1650. That might be a good spot to re-evaluate market conditions and new trades.

James