Investors appear to be facing two different markets. We have the big cap blue chip names, which are hitting new highs and the small cap and momentum names, which are hitting new relative lows. It was a slow week for domestic economic and foreign economic data was generally weak with China still showing signs of a slowdown. Meanwhile Russian President Putin urged Ukrainian rebels to postpone a controversial vote this weekend. It was a request they ignored and the fallout could impact markets. The week ending May 9th saw the Dow Jones Industrial Average tag new all-time highs and close up +0.4%. The S&P 500 index lost -0.14% for the week. The NASDAQ composite lost -1.26%. The small cap Russell 2000 index fell -1.9% with the $RUT closing below technical support at its simple 200-dma for the first time since 2012.

Economic Data

There were only a couple of notable economic reports last week. The wholesale inventory data rose +1.1% in March. This follows an upwardly revised February gain of +0.7%. The ISM non-manufacturing index improved from 53.1 in March to 55.2 in April. Numbers above 50.0 suggest growth and April was the best reading since August 2013.

Overseas Data

The Bank of England (BoE) and the European Central Bank (ECB) both held an interest rate meeting last week. The BoE left rates unchanged at 0.5% and left their QE program unchanged at 375 billion pounds. The ECB also left rates unchanged but ECB President Mario Draghi said the central bank is ready to act (that means they're ready with their own QE program) at the next meeting in June if the data warrants new action.

The European Commission lowered their 2015 GDP estimates for the Eurozone from 1.8% down to 1.7% growth. Meanwhile Eurozone Retail Sales increase +0.3% for the month, which was better than the -0.2% estimate. Eurozone PPI (wholesale inflation gauge) dropped -0.2% month over month. The year over year reading is down -1.6%. Germany said their industrial production dropped -0.5% for the month, which was worse than expected. German factory orders also came in worse than expected with a -2.8% decline.

The big headline for the week was China's HSBC manufacturing PMI number, which fell from 48.3 to 48.1, marking yet another month below the 50.0 level suggesting a continued decline in their economy. The China HSBC services PMI dipped from 51.9 to 51.4. China did say their trade surplus improved last month jumping from $7.71 billion to $18.45 billion, which was better than the $14 billion estimate. Exports improved significantly from a -6.6% drop to +0.9% gain. The country continues to work on massive infrastructure projects and imported a record-setting 83.4 million tons of iron ore in April.

China continues to bully their neighbors. You may recall how China started provoking Japan with a new aggressive stance over some uninhabited islands in the East China Sea last year. We're talking about eight small islands with a total area of about seven square kilometers. Japan's claim dates back to 1895. China started claiming the islands were theirs and recently enlarged their official air space defense zone to include the islands. You can read more about the disagreement here.

Now China is trying to bully its southern neighbor Vietnam. Last week China moved their brand new deep water oil rig into Vietnam waters and started drilling. Vietnam is loudly protesting this invasion into their exclusive economic zone. Of course China says it's not Vietnam's. The two countries have been ramming each other's ships as the tensions rise. You can read more about it here and here.

Ukraine-Russian Conflict

The situation in Eastern Ukraine seemed to cool a bit last week. Russian President Vladimir Putin "tried" to help de-escalate the crisis by urging Ukraine seditionists to postpone a vote on an independence referendum scheduled for May 11th in the Ukraine cities of Donetsk and Lugansk. The rebels declined Putin's request and the vote is in progress.

Plenty of local Ukrainians consider these referendums to be fraud but that hasn't stopped a significant turnout by citizens in these two cities. The rebels hope to have all the ballots counted by Monday afternoon so there could be an official announcement of east Ukraine independence by Monday night or Tuesday. This will only heighten tensions in the area and could rattle equity markets.

The Kiev government and western nations like the United States will not recognize these votes just like they did not recognize the vote in Crimea. That didn't stop the Crimean vote from happening or stop Russia from annexing the region. One likely scenario is that these new "independent" Eastern Ukraine republics, assuming a successful vote in favor of self rule, will label the Ukraine army as terrorists and will then request Russia to intervene and send in Russian troops as peace keepers. Fast forward a few weeks and they will be another vote to join the Russian Federation and Russia gains the eastern half of Ukraine.





Major Indices:

The S&P 500 index has spent the last two weeks churning sideways. Last week saw a bounce off 1860 and a failure at resistance near 1890. The long-term trend (see weekly chart) is still higher but technical indicators are mixed.

The 1890-1900 zone remains significant resistance but a breakout past 1900 would be very bullish and likely spark significant short covering. Any such "breakout" needs to be more than just a few points above the 1900 level.

If this index rolls over again then we can watch for short-term support at 1860, 1840 and probably the 1800 level.

Year to date the S&P 500 is up +1.6%.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ composite lost -1.26% for the week. It did bounce twice near the 4,025 level but the index is still struggling with a bearish trend of lower highs. The 50-dma is rolling over. The trend is likely down until the NASDAQ closes above 4200 again.

If we see the NASDAQ close below its simple 200-dma it will probably signal a deeper correction. A normal -10% correction from the recent highs near 4370 would be 3933 (most likely the 3900 level). If you subscribe to the view that the NASDAQ is building a bearish head-and-shoulders pattern then a close below the 3950 level could signal another -400 point drop toward 3500-3600.

Year to date the NASDAQ composite is down -2.6%.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ index:

The small cap Russell 2000 index ($RUT) bounced on Friday (+0.89%) and pared its weekly loss to -1.9%. The index is down about -9.5% from its highs and it closed below technical support at its simple 200-dma for the first time since 2012.

Is the correction over with the $RUT down -10% or does it still have farther to fall? Last year's rally is broken and the intermediate trend is lower. Until we see the $RUT break through its trend line of lower highs we have to assume the path of least resistance is down.

The $RUT is down -4.6% year to date.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index

There are pockets of strength in the blue-chip names. The Dow Jones Industrial Average (a 30-component index) tagged new all-time highs this past week. The Industrials look poised to breakout to new highs on its weekly chart. The Dow Jones Transportation Average ($TRAN) is also flirting with all-time highs, which is bullish for the broader market if you believe in Dow Theory.

Weekly chart of the Dow Jones Industrial Average

Weekly chart of the Dow Jones Transportation Average



Economic Data & Event Calendar

The pace of economic data picks up again this week. We'll get retail sales data in the U.S. There will be two Federal Reserve regional surveys. We'll see GDP estimates from Japan and the Eurozone.

We will also see the tail end of Q1 earnings season. The earnings cycle is considered over when Wal-mart (WMT) reports earnings on Thursday. Thus far 451 of the S&P 500 components have reported. 68% of them have beaten Wall Street's lowered estimates. 22% have missed estimates.

Economic and Event Calendar

- Monday, May 12 -
reaction to independence referendums in Ukraine

- Tuesday, May 13 -
U.S. Retail Sales data for April
Import/export prices
Business Inventories for March

- Wednesday, May 14 -
Producer Price Index (PPI)
Japan's GDP estimate

- Thursday, May 15 -
Weekly Initial Jobless Claims
Eurozone GDP estimate
Consumer Price Index (CPI)
New York Empire State manufacturing survey
Industrial Production data
Philadelphia Fed survey
NAHB housing market index

- Friday, May 16 -
Housing Starts & Building Permits
University of Michigan Consumer Sentiment Survey

Additional Events to be aware of:

May 26 - U.S. market closed for Memorial Day


Looking Ahead:

Technically U.S. stocks are still in a bull market. It just doesn't feel like one as market leadership narrows. The NASDAQ and Russell 2000 are sinking while money flows into the perceived safety of big cap blue chip names. Money managers want to be in liquid securities so they can get out of quickly if the market really starts to sink.

Speaking of flows the latest fund flow data suggest the sell-in-May theme is real. Data from ICI showed that investors pulled out $3.9 billion from the stock market for the week ending April 30th. That's the biggest outflows of the year. We haven't seen outflows that large since the $4.9 billion investors pulled out back in May 1st, 2013.

The folks at Avondale Asset Management posted some great observations this week. Defensive names have been outperforming, which is not normally a positive signal for further market gains. Mom and pop investors are the most invested in the stock market since September 2007. That happened to be the top of the market just before stocks rolled over into the 2008-2009 bear market. The current U.S. economic expansion, however slow it might seem, is now the 6th longest on in the country's history. The bull market is the 4th longest in history. At the same time investors seem to be more willing to overlook or ignore disappointing economic data. This is not a recipe for strong market gains.

Investors still need to keep one eye on U.S. bond yields. The bond market looks poised to rally and the yield on the 10-year note looks like it's coiling for a breakdown from its recent trading range. A drop past last week's low of 2.57% or the 2.5% level, depending on your risk tolerance, could be seen as a sell signal for stocks. It means "smart money" is pouring money into bonds, likely because they're worried about the stock market.

chart of the 10-year U.S. bond yield

I am suggesting caution. Summers are seasonally the weakest time of year for stocks and summers ahead of a midterm election tend to be more volatile. This year we have the added bonus of a civil war brewing in Ukraine.

There are pockets of strength with big cap names still drifting higher but if the broader market continues to sink it will eventually drag everything lower. You've probably heard the term, "a rising tide lifts all boats." The opposite is true as well. All boats are going to sink in a receding tide of investor sentiment.

James