Stocks were battered by a hurricane of bearish headlines. The Dow Jones Industrial Average fell more than 460 points last week. The S&P 500 index delivered its worst weekly performance in two years. Argentina officially defaulted on its debt again. A major bank in Portugal is failing and raising worries about the European financial system.

The EU launched tougher sanctions at Russia. Yet Russia continues to ignore sanctions and the situation with Ukraine is escalating. Fighting between Israel and Hamas continues with a ceasefire failing within the first two hours.

New worries about the U.S. Federal Reserve might need to raise rates sooner than expected weighed on equities. The markets tried to digest a number of negative news stories and ended up with indigestion. The Dow Jones Transportation Average fell -3.65% for the week. Banks were down -3.4%. Housing stocks were off -3.5%. Oil stocks down more than 3%. Oil services plunged -4.5%. Crude oil slipped -4.2%. Gold and silver were no safe havens - both producing declines. Even the bond market sold off with the yield on the 10-year bond settling at 2.5%.

Russian & Israeli Headlines

Russia seems to be growing even more belligerent. The country is once again moving more troops toward Ukraine's eastern border. There is more evidence that Russian soldiers, not just Russian-backed separatists, have been operating inside Ukraine. NATO has scrambled jets as Russian fighters taunt their neighbors by violating non-Russian airspace.

Meanwhile in Gaza a 72-hour ceasefire lasted all of 90 minutes before Hamas started firing rockets again. Israel has intensified its pressure after an Israeli soldier was captured. U.S. President Obama has called for Gaza to release any captured Israeli soldiers. After 25 days of fighting the situation seems to be getting worse, not better.

Both the Ukraine-Russian conflict and the Israel-Gaza conflict are still just background noise for the market. Although the sanctions against Russia are starting to have an impact on the global economy. More on that in a moment.

Economic Data

It was a very busy week for economic data. The Chicago PMI manufacturing data deteriorated from 62.6 in June to a reading of 52.6 in July. The national U.S. ISM manufacturing index rallied from 55.3 in June to 57.1 in July. This is the fastest pace of manufacturing growth in three years. Numbers above 50.0 suggest growth. U.S. pending home sales fell -1.1% in June after a +6.0% gain in May. The Case-Shiller 20-city Home Price Index said prices rose +9.3% in May 2014 from a year ago. That's down from +10.8% the prior month.

The Conference Board's Consumer Confidence Index hit its highest level in almost seven years with a surge from 86.4 to July's reading of 90.9. The University of Michigan Consumer Sentiment Index also improved from its initial reading of 81.3 to a final July reading of 81.8. The consumer sentiment present conditions component inched higher from 96.6 to 97.4.

The annual pace of vehicle sales in the U.S. retreated from 17.0 million in June to a still healthy 16.5 million in July. General Motors had its best July sales since 2007 but they were outsold by Chrysler, Nissan, and Toyota. The market share held by U.S. brands fell below 45% and the lowest level this year.

One of the biggest surprises of the week was the advance Q2 U.S. GDP estimate. Economists were expecting Q2 growth of +3.0%. The government reported a +4.0% growth number. They revised the Q1 numbers from -2.9% to -2.1%. This much better than expected Q2 GDP estimate suddenly cast doubt on the Federal Reserve as analysts pondered if an accelerating U.S. economy might force the Fed to raise rates sooner than expected to avoid a surge in inflation.

Fortunately the jobs report on Friday helped soothe fears about the Fed, if only for the moment. The U.S. nonfarm payroll report came in at +209,000 jobs in July. That was below analysts' estimates of +235,000 and down from June's +298,000. The unemployment rate worsened from 6.1% to 6.2%. The labor force participation rate inched to a four-month high with an increase from 62.8% to 62.9%. The growth in private payrolls was disappointing with only +198K in July. That's a big drop from June's +270K in private job growth. On a positive note the U.S. economy has now added more than +200,000 jobs a month for six months in a row. We haven't done that since 1997.

The worst than expected jobs data gives the Fed some room to not rush a hike in interest rates. That is probably the main market concern right now - the Fed raising rates and when they do it. The FOMC held a two-day meeting last week. As expected the Fed reduced its QE purchase program to $25 billion a month. This stimulus program is expected to end in October this year. Most market participants expect the Federal Reserve to start raising interest rates in 2015. Many of these estimates have moved from late 2015 to now the first half of 2015. A few analysts are estimating the Fed might start in Q1 2015.

Last week the analysts at the Stock Trader's Almanac noted that every time the Fed starts tightening monetary policy (raising rates) the stock market declines. History says the stock market has never gone up the month after the Fed started raising rates. Three months after the Fed starts raising rates the market was still negative. Investors know that the Fed will raise rates next year, assuming our economy doesn't fall off a cliff again. The market feels a shiver down its back any time a piece of economic data suggest the Fed might need to raise rates faster than previously expected.

Overseas Data

Most of the economic data overseas was negative. Japan reported that retail sales dropped -0.6% year over year, which was worse than expected. Household spending in Japan was worse with a -3.0% decline. Their unemployment rate also worsened with a rise from 3.5% to 3.7%. China was a bright spot with better than expected manufacturing data. The official Chinese purchasing managers index (PMI) was reported at 51.7, the fastest pace in two years. That was above estimates and up from June's 51.0. The HSBC manufacturing PMI reading remained near an 18-month high at 51.7. Numbers above 50.0 indicate growth.

The news was not so great in Europe. European stock markets are slipping with a -3.2% drop in just the last two days. The broad-based European market index is now negative for 2014. The Eurozone manufacturing PMI data came in below estimates at 51.8. Germany's PMI dropped from 52.9 to 52.4. Portuguese bank Banco Espirito Santo has filed for creditor protection after losing 3.6 billion euros in the first six months of 2014. The central bank of Portugal is trying to cobble together a bailout but the situation may be too big for a bailout. This has reawakened all the fears of the European debt crisis and throws doubt on the health of the European financial system.

If that wasn't enough the situation with Russia is beginning to take a toll. Last week the EU launched tougher sanctions on Russia for continuing to support the Ukraine separatists. Unfortunately the European economy is starting to suffer the side effects of the previous financial sanctions against Russia. Companies are starting to issue earnings warnings. Germany, the EU's biggest economy and the biggest trading partner with Russia (in the EU), will see an economic drag due to the sanctions.

The European economy was already slowing down before sanctions with Russia. The impact of the sanctions will merely accelerate the slowdown and odds of another recession in Europe are growing. If Europe falls back into recession it's going to impact both the U.S. and Asia. Another big worry is deflation. If the region slows down any more then deflation becomes an even bigger threat.

Another thorn in the side of the global economy is Argentina. It was widely anticipated that Argentina would default on its debt again. July 31st was the end of its 30-day grace period after not making a debt payment in June. This new default will trigger $1 billion worth of credit-default swaps, which could pressure many of the large international banks.





Major Indices:

The S&P 500's -2.69% drop last week marked its worst weekly performance in two years. The index sliced through potential support at 1950 and its simple 50-dma with Thursday's big drop. Now the big cap index looks headed for round-number support at the 1900 level.

I do expect the S&P 500 to bounce near 1900. The question is whether or not this is a bounce that reinforces the longer-term up trend or if it's a temporary, oversold bounce that rolls over in a couple of days. You can see on the weekly chart below that the bottom of its long-term, bullish channel lines up nicely with the 1900 area.

Currently the S&P 500 is down 63 points or -3.1% from its all-time high set just two weeks ago. Until the trend actually breaks the path of least resistance should be up. Regular readers know that we're due for a correction. The S&P 500 has gone more than 1,000 days without a typical -10% pullback.

Hypothetically if we are seeing the beginning of a correction than a -10% pullback would mean a drop to 1,789. Over the last few years the average correction has been closer to -13%. That would suggest a drop toward 1,729.

If the S&P 500 index does break support near 1900 I would expect a bounce near 1850 and its simple 200-dma and near the 1800 level.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

The NASDAQ composite fell almost 100 points last week. It traded below support near 4350 on an intraday basis Friday and did close under its 50-dma. If the NASDAQ does not recover soon I suspect we will see it correct toward its long-term trend line of higher lows near 4200 and its simple 200-dma (currently 4175).

If we are seeing a market correction in process than a -10% pullback would mean a drop toward 4,036. A -13% correction would be closer to the 3,900 level.

Should the NASDAQ break support near 4200 then a drop toward 4000 is probably a good bet.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index

The small cap Russell 2000 index continues to underperform and lost -2.6% last week. That pushed its loss for the year to -4.19%. The $RUT is now down four weeks in a row and looks headed for support in the 1080-1085 region. The bad news is that the $RUT has formed what looks like a major bearish double top with the peak in March and July. Even if we see a bounce from the 1080-1100 area I would not trust it for more than a temporary rebound. The 1140-1160 area is now overhead resistance.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

After last week's parade of economic data the pace of reports slows down significantly. The only event of note is probably the ECB meeting on Thursday. We're still in Q2 earnings season but the number of earnings announcements is dwindling.

Economic and Event Calendar

- Monday, August 04 -
Eurozone Producer Price Index (PPI)

- Tuesday, August 05 -
Factory orders (June)
ISM Services (for July)
Eurozone Retail Sales

- Wednesday, August 06 -
(nothing significant)

- Thursday, August 07 -
Weekly Initial Jobless Claims
European Central Bank interest rate decision

- Friday, August 08 -
Wholesale inventories (June)

Additional Events to be aware of:

Aug. 28th - 2nd estimate on U.S. Q2 GDP growth
Sept. 1st - U.S. market closed for Labor Day

Looking Ahead:

Looking ahead the stock market continues to ignore geopolitical risks. The conflict between Israel and Gaza and between Ukraine and Russia will make headlines but unless something really unexpected happens they are unlikely to hurt stocks. That's aside from the economic impact that sanctions against Russia might have on companies. It is worth noting that we could see more headlines out of Libya and Iraq. The fighting in Libya is escalating and other countries have started evacuating personnel out of Libya, which is never a good sign. Plus the ISIS, now calling themselves the Islamic State, in mid Iraq and Syria appear to be gearing up again for another push towards Baghdad.

The stock market internals have deteriorated rapidly in the last several days. This chart shows the number of S&P 500 components that are still above their simple 50-dma. Investors should consider this a warning signal.

chart of the S&P 500 stocks above their 50-dma

I've mentioned several times that historically August and September are normally the worst months of the year for stocks. There are always exceptions but August has been down four out of the last five years. The fact that we have so many different issues pressing on investor sentiment it is a bit surprising that the market weakness hasn't been worse. The NASDAQ composite is only -2% from its 2014 high. The S&P 500 is only down about -3% from its high. Looking at the big picture these are minor dips.

This is hardly time to panic. Yet there are plenty of warning signals. I must have seen a dozen articles and opinions this weekend about how the market has topped and we're about to head into a new bear market. The funny thing is how this stock market has shrugged off every call for a market top for the last couple of years. That doesn't mean stocks can't see a painful pullback. Sometimes we forget that pullbacks are normal. Think of the next correction is a great entry point.

Now is a good time to consider your risk on any current bullish positions. You may want to consider taking some money off the table or reconsidering your stop loss placement. You might want to free up some cash so when the correction does happen you have the money available to put it to work. There is a big difference between fearing the correction and welcoming it and that depends on if you're watching your positions decline or poised to jump in and take advantage of the sell-off.

The number of issues that could be pressuring investor sentiment seems to be growing. I would hesitate to launch new bullish positions at this time. Why buy stocks (or LEAP options) now if we might have a significantly better entry point four to six weeks down the road?

James