Stocks posted another losing week marking the end of August, one of the worst months this year for equities. Better than expected economic data renewed fears that the Federal Reserve would begin tapering their QE program in September. The threat of the Fed reducing their QE program has sparked a major sell-off in emerging markets and their currencies with India's rupee leading the way lower. Taper fears were almost overshadowed by geopolitical risks which helped push crude oil toward $110 a barrel as the U.S. moved closer to a strike on Syrian President Assad's regime. The rise in oil came just in time for the Labor Day holiday in the U.S. where more than 34 million Americans were expected to travel for the long weekend, with most of them driving to their destination. At the end of the week the S&P 500 had lost -1.8%. The NASDAQ was down -1.8% and the Russell 2000 index lost -2.6%. Transports were hit hard by rising oil prices and the Dow Jones Transportation average lost -3.5%.

Most of the economic data this past week was actually positive. The Richmond Fed manufacturing index bounced from -6 to +14, when economists were only expecting a bounce back to zero. The Chicago PMI inched higher from 51.6 in July to 53.0 in August. Consumers were feeling better. The Conference Board's Consumer Confidence index rose from an upwardly revised 81.0 in July to 81.5 in August. The final reading on the University of Michigan consumer sentiment survey for August was adjust from 80.0 to 82.1. Meanwhile the weekly initial jobless claims continue to drift lower, falling -6,000 to 331,000. The four-week moving average has declined to its lowest levels in almost six years.

chart of initial jobless claims:

The latest estimate on U.S. Q2 GDP growth was a surprise. The first estimate was +1.67% growth. That number was revised higher to +2.5% growth. Unfortunately, almost the entire change was due to a significant revision in net exports. There are already concerns that this trend in net exports might reverse in the third quarter. The sharp improvement in the headline number is still positive for investor sentiment.

Housing data was mixed. The Case-Shiller home price index rose +12% year over year for the June reading. Yet pending home sales for July dropped -1.3%, which was worse than expected and shows an acceleration from June's -0.4%. This slowdown could be a reflection of rising interest rates with the average 30-year mortgage rate now at 4.8%. Rising rates continue to impact mortgage applications. The MBA weekly mortgage index lost -2.5%. That is the 14th decline out of the last sixteen weeks for the index.

Syria

Syria was one of the biggest stories last week and will remain a potential market moving event going forward. Worries that the U.S. might launch a strike at Syrian President Assad's military plagued the markets all week long. Over the last two and a half years the civil war in Syria has killed more than 100,000 people and created two million of refugees. Suddenly the U.S. and its allies are up in arms because of reports that Assad used chemical weapons to kill more than 1,400 people.

It might seem odd that Assad can kill tens of thousands with bullets, rockets, and tanks but as soon as chemical weapons are involved we are supposed to care. That's because the civilized world expects wars to follow rules and try to make warfare a little less barbaric. Too often chemical weapons end up killing innocent civilians. Unfortunately, Assad is fighting for his survival and will likely do whatever it takes to stay alive. The bad news is that Assad has one of the largest stock piles of chemical weapons in the Middle East.

Believe it or not but there is the question of if chemical weapons were actually used and who used them. U.N. inspectors claim that chemical weapons were used but they won't say by which side and they still need a week or two to verify their findings. Meanwhile there are rumors floating around that it was the rebels who used chemical weapons. One has to wonder, Assad is fighting nine different rebel groups (most of them linked to Al-Qaeda) and he was winning the fight. Why would Assad risk involving the U.S. if he's winning? The idea has been proposed that the rebels did it for the sole purpose to get the Americans involved.

Why does the stock market care about the Syrian civil war and if the U.S. gets involved? Syria does not produce a lot of oil. Yet oil prices have been rising as tensions in the area heat up. It's because Syria could be the fuse that ignites a much larger regional conflict. We have to look at some of the players. Syria's two main allies are Russia and Iran. Russia has a naval base in Syria and Syria buys a lot of military arms from Russia. Iran supports Syria because Assad and the minority sect that rules the country is Shiite Muslim while the rebels are Sunni Muslims (Iran is mostly Shiite). The Shiites and Sunnis have been killing each other for over 1,000 years. Saudi Arabia is Sunni and they're supporting the rebels. The U.S. is allied with the Saudis, which is why the U.S. is providing weapons to the rebels, which is twisted since most of the rebels are linked to the terrorist group Al-Qaeda, which was responsible for the 9-11 attack on the U.S.

Syria has threatened that if the U.S. attacks them then Syria will strike at Israel. Syria also threatened to retaliate against its neighbors who are interfering in the conflict. That could include several countries like Jordan, Turkey, Saudi Arabia. Iran has also threatened to attack Israel if the U.S. gets involved. Israel has promised to protect itself and respond in kind. These are likely empty threats by both Syria and Iran. If either country were to attack Israel it would provoke a much stronger response from the U.S. If Syria were to attack Turkey, a member of NATO, it would provoke a response from all of NATO. At the same time Russia has been consistently warning the U.S. to not get involved and Russia has been sending more warships to the Mediterranean. The last thing we want is an armed conflict with Russia.

President Obama has felt compelled to act because of his promise to punish Syria if they cross the "red line" of using chemical weapons. Secretary of State John Kerry delivered a stern speech on Friday, while the stock market was open, that set the tone for an imminent strike on Syria. Yet President Obama is quickly losing support for any military action. The United Kingdom has been supportive of the U.S. and Prime Minister David Cameron had been seen as a U.S. ally on a strike against Syria. Yet the British people do not support any military action and the British Parliament just voted no against Cameron's resolution for action against Syria. That was a painful blow to Obama's aggressive stance. The U.N. security council has already said no to any military action because Russia has vetoed it. Rhetoric was starting to rise that any unilateral action by the U.S. would actually be illegal based on international law. NATO doesn't want to get involved either with its secretary general in a recent interview stating that, "NATO will have no role in any military action in Syria."

The situation isn't much better for President Obama at home. Over 200 congressman and senators have already voiced their disagreement with military action in Syria. A recent poll suggests that only 9% of Americans would approve of any action. Obama had boxed himself into a corner with his rhetoric about how the U.S. would act if Syria crossed the line. If it's proven that Syria did use weapons, then Obama does need to act. Otherwise failure to strike might embolden countries like Iran and N. Korea. Prime Minister Cameron's failure to get a positive vote in Britain might have provided Obama a way out. This Saturday President Obama spoke from the White House and said that he had already decided to strike at Syria but would wait and present the issue to congress to be debated and approved when they return to Washington. That was a surprise but probably one of the smartest moves Obama has made in office. If congress votes no then he can blame congress for America's failure to act and it gets him off the hook for his "red line" comments. This also gives Obama time to work behind the scenes. There is a G20 Leader's summit coming up in Russia in just a few days (Sept. 5-6th). Obama will be face to face with leaders from all over the world including Russia, Britain, France, Germany, China, and Saudi Arabia.

Europe

Turning back to economic news, it was another week of generally positive news out of Europe. The Eurozone retail PMI inched higher from 49.5 to 50.3. Numbers above 50.0 indicate growth. Germany's Ifo business climate index rose from 106.2 to 107.5 in spite of a -1.4% month over month drop in German retail sales. Greece remains simmering in the background. The country did confess that yes they will need a third bailout. Greece could become a bigger issue for the markets as we get closer to the German elections in late September.

Major Indices:

The mid-August bounce in the S&P 500 failed and now the index has broken down below its simple 100-dma. This index did manage to bounce near 1628 a few times this past week. This short-term support seems to coincide with a trend line crossing the June low (see daily chart below). The S&P 500 is now down three out of the last four weeks and the intermediate trend (down) is testing its longer-term up trend.

Stocks might see a short-term bounce from current levels but I am expecting the S&P 500 to test the 1600 level before September is over. Actually given all the potential land mines for the market in September we could see the S&P 500 drop toward its June lows and/or its simple 200-dma in the 1560 area.

chart of the S&P 500 index:

The NASDAQ composite has not seen that much profit taking. It too is down three out of the last four weeks but the NASDAQ is only off -2.7% from its early August highs. There does appear to be short-term support in the 3575 area. If that level breaks then I would expect the NASDAQ to correct lower toward the 3500 mark and potential technical support at the rising 100-dma.

chart of the NASDAQ Composite index:

Profit taking in the small cap Russell 2000 was worse with a -2.6% drop for the week. The index failed near prior support at 1040 and now the $RUT looks poised to test the 1,000 level and its 100-dma soon. I would expect another short-term bounce at 1,000. There is no guarantee the index will hold this level. A breakdown below 1,000 and its 100-dma could portend a drop toward the 950 level and its simple 200-dma.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

It's a brand new month and that means lots of economic data reports. China starts us off on Sunday with the latest HSBC China manufacturing PMI data. The U.S. markets are closed on Monday for holiday. Then we'll see the ISM index and the Fed's Beige book report later in the week. The market's focus will likely be on Friday's jobs report since a strong jobs number will likely assure that the Fed will begin tapering their QE program in September.

We will also get the latest interest rate decisions out of Japan and the EU. ECB President Draghi will hold a press conference after the ECB's decision is released.

We are a week away from U.S. lawmakers returning to Washington on September 9th. Previously they were due to debate the U.S. debt ceiling and budget issue but now they will likely debate the Syrian conflict issue first.

Economic and Event Calendar

- Monday, September 02 -
Eurozone PMI data
U.S. market closed for Labor Day
China's non-manufacturing PMI

- Tuesday, September 03 -
ISM index
Construction spending data

- Wednesday, September 04 -
MBA mortgage index
auto and truck sales data
Federal Reserve Beige Book Report
Eurozone services PMI
Bank of Japan's interest rate decision

- Thursday, September 05 -
Weekly Initial Jobless Claims
ADP Employment Change report
factory orders
ISM services
European Central Bank (ECB) interest rate decision
ECB President Mario Draghi press conference
G-20 Leadership summit begins in Russia

- Friday, September 06 -
unemployment rate
Non-farm payrolls (jobs) report for August

Additional Events to be aware of:

Sept. 9th - Congress returns to Washington.
Sept. 18th - FOMC meeting & Bernanke press conference
Sept. 22nd - German elections
September - U.S. debt ceiling deadline

The Week Ahead:

As we look ahead to next week we could see stocks bounce on Tuesday in reaction to President Obama delaying any military action on Syria. The Syria question could be delayed three or four weeks as we wait for the U.N. inspectors to verify their findings on chemical weapons and give the U.S. congress a chance to debate and vote on the issue. Delaying the Syria question is probably good for stocks but it also means it could remain a black cloud hovering over the market's head.

We could see the market throw another "taper tantrum" in September. I am surprised that market participants do not have whiplash from the back and forth on is the taper happening or not. It seems like every other week the mood changes from it's on to it's off. Currently it looks like the taper is back "on" for September. The chatter among Wall Street analysts this past week seemed to suggest that the Federal Reserve is looking for any excuse they can to begin tapering in September.

Long-term the taper is positive because it means the Fed believes that U.S. growth is strong enough to continue without additional stimulus. Yet short-term it's going to cause volatility. Plus there are always unintended consequences. Without going into too much detail, the America's multiple QE programs were a boon for emerging markets. Now that the Fed is poised to scale back its QE program we're seeing money rush out of emerging markets. Currencies for many of these already weak economies are crumbling, which only exacerbates their problems. According to PIMCO's Mohamed El-Erian, the U.S. could face a negative feedback loop where U.S. companies struggle to find growth in these emerging markets.

I want to reinforce the idea that the next few weeks could be very volatile. The Syria issue, the jobs report, the potential for the Federal Reserve to begin tapering (likely at the September 18th FOMC meeting), and the U.S. debt ceiling and budget debate are all potential land mines for the stock market. I would hesitate to launch new long-term bullish positions now when we might see a much better entry point come October.

James