The last full week of 2013 has come to an end and stocks continued their march higher. As expected volume was very light with many market participants either away on holiday or already done for the year. Unless something drastic happens in the last two days of trading 2013 is poised to deliver the stock market's best year since 1995. The Dow Industrials are up more than +25% for the year. The Dow Transportation Average and the SOX semiconductor index are both up +38% while biotechs were some of the best performing stocks in 2013 with the biotech index up +51.5% year to date. What didn't perform this year was precious metals. Gold ended a 13-year streak of gains with a -29% plunge in 2013.

Economic Data

It was a very quiet week for U.S. economic data. We saw the final December reading for the University of Michigan Consumer Sentiment data, which was unchanged at 82.5. Durable goods orders from October surged +4.5%. Next week the calendar rolls over into a new month and we'll see an increase in economic reports. Yet we will not see the next jobs report until January 10th.

Overseas Data

Economic data out of Europe was quiet. France said their GDP retreated -0.1% quarter over quarter. This negative news was slightly offset by improving consumer spending (+1.4% for the month) and a +0.5% advance in French PPI data. Looking ahead into 2014 it could be a volatile year for Europe and the Eurozone. There seems to be a growing expectation that Italy might default on its debt. Although it's worth noting that the bond markets are not pricing this in. The yield on Italy's 10-year bond is only 4.21% and significantly below its 2013 highs (4.9%). Usually the danger zone is above 7.0%. Italy will bear watching since their debt to GDP is over 125% and they have the third largest bond market in the world. Their economy is struggling. Wages in Italy are near 25-year lows and they are stuck in the longest recession since World War II.

German Chancellor Angela Merkel did win reelection in 2013, which was seen as a positive for the markets. Yet she could face a tough time corralling the rest of the Eurozone into making the necessary changes to keep the Euro experiment afloat. There are a growing number of anti-EU political movements gaining steam in Europe and these could hamper efforts to forge a tighter fiscal union among Eurozone members.

Economic data out of Asia was mostly positive last week. Japan said their housing starts surged +14.1% year over year, which was well above expectations. Japan's manufacturing PMI inched higher from 55.1 to 55.2. Numbers above 50.0 indicate growth. The country's retail sales hit a pace of +4.0% growth. This data helped keep the rally in Japan's stock market going and the NIKKEI index hit six-year highs, closing above psychological resistance at the 16,000 level.

Major Indices:

The S&P 500 index added +1.27% for the week. That lifted its year to date gains to +29.1%. It has truly been an exceptional year for stocks. On a short-term basis the index looks overbought. This past week has seen a breakout above its trend line of higher highs (see chart) but this could be temporary. I would not be surprised to see a correction back toward the 1820-1810 area. However, the calendar still favors an up trend so any pullback may be lighter and shallower than expected.

If this market rally does continue the next levels of potential resistance should be the 1860 and 1880 areas.

chart of the S&P 500 index:

The NASDAQ composite continues to soar with a +1.26% gain last week. Its 2013 gains are a staggering +37.6%. This past week has seen a string of new 13-year highs. Friday's move actually produced a small bearish engulfing candlestick reversal pattern. Combine that with its short-term overbought condition and odds favor a pullback. The next area of potential support is probably the 4,075-4,100 area. Previous dips in the NASDAQ approach the simple 30-dma, which is currently near 4,036.

You can see on the chart below that the NASDAQ is hovering at resistance on its trend line of higher highs. Yet another signal that the NASDAQ may be poised for a dip. If somehow the rally continues then the next level of resistance should be the 4200 mark.

chart of the NASDAQ Composite index:



The small cap Russell 2000 index set a string of new all-time highs last week. Although it looks like Thursday's intraday pullback from its high and Friday's decline is suggesting the rally is out of gas. The $RUT delivered a +1.28% gain last week, which pushed its year to date gains up to +36.7%.

In addition to being short-term overbought the $RUT is also hovering at its trend line of resistance (see chart). If the index sees a pullback we can watch for potential support near 1140 and the 1135 levels.

chart of the Russell 2000 index



Economic Data & Event Calendar

It should be a relatively quiet week for economic data. The biggest report in the U.S. is probably the national ISM index on Thursday. Typically we would see the jobs report on the first Friday of the month but this January we won't get the jobs numbers until January 10th.

Don't forget that the market is closed on January 1st, 2014 for New Year's Day.

Economic and Event Calendar

- Monday, December 30 -
pending home sales data

- Tuesday, December 31 -
Case-Shiller 20-city home price index
Chicago PMI data
Consumer Confidence data for December

- Wednesday, January 01 -
HSBC China manufacturing PMI data
U.S. stock market closed for New Year's Day

- Thursday, January 02 -
Weekly Initial Jobless Claims
Eurozone manufacturing PMI data
ISM index

- Friday, January 03 -
auto & truck sales

Additional Events to be aware of:

Jan. 6th - Janet Yellen should be confirmed as next Fed Chairman
Jan. 10th - December jobs report
Jan. 20th - stock market closed for Martin Luther King day
Jan. 28th - President Obama's state of the union address
Jan. 29th - FOMC policy update
Feb. 7th - U.S. debt ceiling is reached




Looking Ahead:

There are plenty of opinions about where the market might be headed in 2014. Most of the opinions I have heard are positive. Goldman Sachs is expected the S&P 500 index to hit the 2,000 mark in 2014. That would be another +8.6% gain from current levels. It seems like an easy task after this year's +29% gain.

We should remember that markets do not go straight up forever. Market technician Carter Worth pointed out that only seven times in history has the S&P 500 rallied five years in a row and 2013 just marked our fifth up year in a row. Now seven times is not a very large sample of data but history would suggest that the following year, after a five-year rally, tends to be down. Of course everyone has an opinion and other market pundits point out that in 2011 the S&P 500 produced a -20% peak to trough decline, which was enough to "reset" the bull market. Instead of being a five-year old bull market they argue it's only two years old.

On a short-term basis the first week of January should be bullish. Yearend fund flows are normally strong. Money managers will have another round of quarterly contributions to work with plus individuals will be plying some of their yearend bonuses toward their retirement accounts. Yet once we get past the first couple of weeks the market will focus on earnings season.

The Q4 earnings season is only about three weeks away. Alcoa (AA) kicks off earnings season on Thursday, January 9th but the season won't pick up speed until mid-month. Unfortunately the trend of negative guidance for Q4 results has been terrible. The number of companies that have warned versus the number of companies that have issued positive guidance is running at 10:1. That's about three times higher than expected. Now maybe this negative trend will spur analysts to lower their estimates, which would give companies a better chance to meet or exceed them when they actually report. It does cast a black cloud over the Q4 earnings report. More importantly Wall Street will want to hear corporate guidance for 2014. It will be guidance that helps set market direction for the rest of the first quarter.

We have noted in the last few weeks how investor sentiment has been overwhelmingly bullish. The AAII Investor Sentiment survey surged to its highest level in three years with 55.1% of investors saying they are bullish. The number of bears fell to 18.5%. A number of professionals like to use this data as a contrarian signal. When the number of bulls gets too high it's a signal to get out. Unfortunately this is more art than science. There is no black and white sell signal here. The number of bullish investors can go higher and stocks, while overbought, can always grow more overbought. It is a warning signal.

Another warning signal is the CBOE SKEW index. What's the SKEW index? Good question. According to the CBOE website:

" The CBOE SKEW Index ("SKEW") is an index derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options. SKEW typically ranges from 100 to 150. A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant. One can estimate these probabilities from the value of SKEW. Since an increase in perceived tail risk increases the relative demand for low strike puts, increases in SKEW also correspond to an overall steepening of the curve of implied volatilities, familiar to option traders as the "skew".
This indicator has been popping up in the financial media lately after soaring to its second highest reading ever. J. Lyons Fund Management has a great chart of the SKEW index contrasted with the S&P 500 index. They have pointed out that when the SKEW spikes toward the upper end of its range it tends to be a warning sign that the market is near a top. Again, this is not an immediate sell signal but it is another warning signal that the market could be near a top.

chart of the CBOE SKEW index vs. S&P 500

Looking farther out into 2014 the market could be facing external pressures. Back in 1997 the U.S. market suffered in reaction to the Asian financial crisis sparked by a collapse of the Baht, Thailand's currency. Once again Thailand's Baht is plunging and investors are rushing to pull the money out of the country. Another market that is in trouble appears to be Turkey, which could be way more significant. The Turkish markets have been crashing as the Turkish government struggles with a corruption scandal surrounding its Prime Minister, Mr. Erdogan. Turkey has seen a number of high profile protests in 2013 but this time the Turkish financial markets are plunging. The yield on a 10-year bond in Turkey is 10%, which is well above the normal 7% danger zone.

In summary, the market's momentum is still higher but on a short-term basis we look overbought and the U.S. indices seem poised to retreat from resistance. Early January should be bullish but the second half of January will be dictated by earnings results and guidance. Bigger picture the markets could be jostled by foreign markets and the pace of the Federal Reserve's tapering of their QE program.

James