Stocks delivered another week of record-breaking performances. It was a holiday shortened week for the U.S. market thanks to the 4th of July. The Dow Jones Industrial Average closed above the 17,000 mark for the first time in history. It only took seven months since crossing the 16,000 mark in November last year. The S&P 500 index closed at a record high and is fast approaching the 2,000 level. The S&P 500 also marked 1,000 days without a 10% correction.

The big cap indices were not alone hitting new highs. The Dow Transportation average, the Russell 1000, the Russell 3000, the NYSE Composite, XLE energy ETF, XHS healthcare services ETF, XLV healthcare ETF, and the Dow Jones railroad index all closed the week at record highs. Meanwhile the SOX semiconductor index, the NASDAQ composite both hit multi-year highs.

We are three days into the second half of 2014. Looking at the year to date performances so far the Dow Industrials is up +2.9%. The small cap Russell 2000 is up +3.8%. Both the S&P 500 and the NASDAQ composite are up +7.4%. The transportation average and the oil stock index are both up +12%. The SOX semiconductor index is up +21.5% and the biotechs are up +22.5%. Meanwhile silver is up +8.1% and gold is up +9.5%. Volatility has vanished. The VIX volatility index has plunged to new seven-year lows, which many would consider to be a warning signal for the health of the bull market.

Weekly chart of the Volatility (VIX) index

Economic Data

Last week was the beginning of a new month and that meant lots of economic data. The Chicago PMI retreated from 65.5 in May to 62.6 in June but it marked the third month in a row above 60.0. Numbers above 50.0 indicate growth. The national ISM manufacturing index slipped from 55.4 in May to 55.3 in June. While that is not much of a move it was below expectations for growth to 55.9. The ISM non-manufacturing (services) index inched down from 56.3 in May to 56.0 in June, only slightly below expectations.

U.S. construction spending in May rose +0.1% while April's reading was revised from +0.2% to +0.8%. Pending home sales hit a four-year high with June's +6.1% surge. June also delivered continued strength in vehicle sales with the seasonally adjusted annual rate coming in at 16.92 million autos. The ADP Employment Change report delivered its best reading since 2012 with a gain of +281,000 new private sector jobs. That was above expectations for 210K. Of course that leads us to the monthly government numbers in the nonfarm payrolls (jobs) report.

Economists had been expecting the U.S. Bureau of Labor Statics to report job growth of +215,000 for June. The latest numbers came in at +288,000 new jobs. The May jobs report was adjusted +7,000 to 224K and April's was revised up +22K to +304K. The three-month average is now +272,000 and we just experienced the strongest six-months of job growth since 2006. The current pace of job growth in 2014 is almost 20% higher than 2013.

The unemployment rate was revised down from 6.3% to 6.1%. The government said the labor force participation rate was unchanged at 62.8%. Altogether it was a bullish number and the market reacted positively. Unfortunately we still have a problem with job quality. Almost all of the jobs gains were part time or low paying jobs.

The accelerating job growth could start to put pressure on the Federal Reserve. The Fed claims any decisions they make will be data dependent. Last week Fed Chairman Janet Yellen basically reaffirmed the low rates for an extended period party line. There are a growing number of analysts predicting the fed will have to move faster. The Fed is on pace to end their current QE asset buying program this year. Most believe that the Fed will not start raising their interest rates until the middle or late 2015. However, this past week saw a couple of economists move that estimates up. They expect the Fed to start raising rates in the first or second quarter of 2015. In the past, when the "market" worried that the Fed might raise rates sooner than expected stocks tended to drop. We're not seeing that fear in stocks yet.

Overseas Data

The economic data out of Europe was uninspiring. The Eurozone's newest estimate on Q1 GDP was unchanged at +0.2% growth quarter over quarter. Eurozone retail sales were also unchanged month over month (-0.2%). Germany said they saw their retail sales fall -0.6% for the month, which follows last month's -1.5% drop. Germany unemployment also rose for the second month in a row. Yet Eurozone unemployment hit its lowest level since late 2012 at 11.6%.

European Central Bank President Mario Draghi made some interesting headlines on Thursday. Europe is desperately worried about their slowing economy. The ECB is trying to stimulate the economy by making it easier for banks to lend money. Initially the ECB's Targeted Long-Term Refinancing Operations was expected to lend out 400 billion euros. Draghi suggested the bank could eventually lend up to one trillion euros.

Economic data from Asia's biggest economies was mixed. Japan said their industrial production rose +0.5%. That's up from the prior month's -2.8% decline. Unfortunately Japan reported that housing starts plunged -15%, which was worse than expected. China reported their manufacturing PMI inched higher from 50.8 to 51.0. Yet the HSBC Chinese manufacturing PMI slipped from 50.8 to 50.7. Numbers above 50.0 suggest growth and below 50.0 indicate economic contraction.





Major Indices:

The large cap S&P 500 index has been sprinting higher with gains in five of the last seven sessions. The index rose +1.25% last week to extend its yearly gains to +7.4%. That's on top of last year's +29% gains.

Normally the stock market sees a -10% correction twice a year. The S&P 500 has now gone 1,006 days without a 10% correction. This is only the fifth time since 1928 it has managed this feat. It would be natural to think we are due for a pullback, and we are. However, stocks can keep running a lot longer than anyone expects. The longest streak on record without a -10% pullback was 2,553 days back in the 1990s.

I am concerned that the 2,000 level will prove to be significant round-number, psychological resistance. The index looks overextended so it's tough to say what real support would be. If we do see the S&P 500 hit 2,000 and then correct lower a -5% pullback would mean a drop to the 1900 level. A -10% correction would mean a drop to 1800. Such a move is not going to happen in a straight line but we all know stocks move faster going down than they do going up.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

The NASDAQ raced higher last week with a +2.0% gain. After breaking out past its Marc highs and the 4400 level now it's quickly approaching potential round-number resistance at the 4,500 mark. This index is now up 7 out of the last 8 weeks.

If the NASDAQ does see a pullback from the 4,500 level we can look for support near 4400 and 4300.

Bespoke Investment noted some interesting numbers on the NASDAQ's performance. The NASDAQ plunged from 5,132 in March 2000 to a low of 1,108 in October 2002. That's a -79% drop. It's been 4,285 days since its closing low in 2002. Since then the index is up +302%. Believe it or not but the NASDAQ is only 12.5% away from its all-time highs.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index

The small cap Russell 2000 index managed a +1.5% gain last week. Unfortunately the rally stalled right under its March 2014 highs in the 1210 area. That is a bit troubling. A failure here would look like a bearish double top pattern. If the small caps fail it will weigh on the entire market. Bears could argue the $RUT is overbought with a six-week surge from its May lows near 1090 to today near 1210 (+11%).

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

After last week's flurry of economic data this week is going to be pretty quiet. The FOMC minutes are the only real "event" to watch for. We are not expecting the minutes to be market moving. That means the market should start to focus on Q2 earnings.

Alcoa begins the Q2 earnings season on Tuesday. The pace of earnings does not really pick up speed until the following week.

Economic and Event Calendar

- Monday, July 07 -
(nothing significant)

- Tuesday, July 08 -
Alcoa (AA) kicks off Q2 earnings season

- Wednesday, July 09 -
FOMC minutes from the last meeting

- Thursday, July 10 -
Weekly Initial Jobless Claims
Wholesale inventory data

- Friday, July 11 -
Wells Fargo (WFC) the first big financial company to report Q2 earnings

Additional Events to be aware of:

July 18th - G20 Meetings
July 30th - FOMC meeting
Sept. 1st - U.S. market closed for Labor Day

Looking Ahead:

Corporations blamed the terrible winter weather on their disappointing Q1 earnings results. They will have no such excuse this time. Almost 20% of the S&P 500 companies have already warned about their Q2 results. That doesn't bode well. Then again it could be a blessing in disguise. If they have issued an earnings warning then they've set the bar low. Investor reaction could be muted since they are already expecting disappointing results. On the other hand if almost 100 of the 500 S&P 500 companies have warned, how many more are struggling and hoping to just meet estimates. Analysts have downgraded their estimates on earnings growth from +7.3% to +5.2% in the second quarter.

This week is going to be a quiet one for economic news and while earnings season will start the pace of earnings doesn't really pick up until the following week. This vacuum of information might let geopolitical concerns steal the spotlight.

Geopolitical Concerns

The situation in Ukraine is escalating. After an unsuccessful ceasefire a week ago the Ukraine government has gone on the offensive. This weekend Ukraine forces have retaken a key rebel stronghold in the city of Slavyansk. Meanwhile there are new reports of Russian helicopters crossing over Ukraine's eastern border. It does not help when Ukraine's minister of the interior publically claims they will retake Crimea from Russia.

The fighting in Iraq continues. The ISIS Sunni insurgents are trying to solidify their positions while Iraqi forces regroup. Iraq has been using airstrikes thanks to Russian jets to pound rebel locations. ISIS leaders are calling for support from Sunnis around the world as they declare a new caliphate. Saudi Arabia, Iraq's southern neighbor, has moved 30,000 troops to its border with Iraq. Saudi claims it is an effort to protect themselves from the "terrorists" but other claim that the Sunni-dominated Saudi has actually been sponsoring the Iraqi insurgents. There is actually speculation that Saudi might make a land grab if Iraq starts to crumble.

North of Baghdad the Kurds are moving closer to their own independence. The semiautonomous region has been fighting a political battle with the Iraq government for months. Now that Iraq is struggling to stay alive the Kurds have decided that maybe now is a good time to declare their own separate statehood. New development suggest the Kurdish parliament could vote on their independence within the next two months.

We are also seeing a significant flare up in violence in Israel and Gaza. There is always a level of violence just simmering beneath the surface between the Israelis and Palestinians. Two weeks ago three Israeli teens were kidnapped. Their bodies were found last Monday and the blamed on Hamas. In response someone has killed a Palestinian teenager (blamed on Israelis). These killings have sparked a new level of violence. Rockets and mortars fired from Gaza continue to land in Israel and Israel has responded with new airstrikes. The dead teens have stirred up public passions on both sides.

The U.S. markets have so far turned a blind eye to all of these geopolitical events. Unfortunately we can never know when the next even might be the match that lights a sell-off in equities. The markets have also ignored the rising inflation in food prices in the U.S. and rising gasoline prices. Food is up significantly this year and while gasoline prices normally rise in summer they are at significant highs again.

The national average for gas in the U.S. is about $3.67 a gallon. On the west coast it's about $4.50 while drivers close to the Gulf of Mexico play about $3.25. Deutsche bank noted a while ago that every penny increase in the cost of gasoline costs the U.S. consumer about $1 billion (actually about $1.4 billion). That's a lot of disposable income that is going into the gas tank and not spent shopping elsewhere.

Stock market gains are supposed to be driven by corporate earnings. If Q2 earnings do not deliver we could see analysts start to revise their estimates lower for the rest of the year including their estimates on market performance. Most stock market analysts were not expecting the S&P 500 to rally past 2,000 this year. Now that we're almost there (at the 2,000 mark) do they raise their targets or tell clients to take some money off the table? Keep in mind that U.S. Q1 GDP growth was -2.9%. It certainly looks like the economy improved in Q2 but we will not meet current estimates for 2014 growth at the current pace. If you're a fund manager what would you do today?

Now consider that we are about to hit the worst two months of the year for stock performance in August and September. If that wasn't enough throw on top of that the facet of a mid-term election in November. Late summer will be filled with political noise, which tends to push consumer confidence lower.

I am not saying the rally is over. The S&P 500 could slice through 2,000 and keep right on trucking. Or it could reverse as everyone lightens up to take profits. As long as investors continue to ignore all of the geopolitical issues in the world, I suspect that Q2 corporate guidance will be the deciding factor on new highs above 2,000 or a correction that starts in the second half of July.

Individual investors will have to decide if you want to take some money off the table now or if you hang on and hope the ride continues.

James