The August melt up in U.S. stocks continued last week. Generally positive economic data in the U.S. overshadowed disappointing economic reports overseas. The FOMC minutes from the July meeting suggested that Federal Reserve members are leaning towards a rate hike sooner rather than later due to improving job gains but they are still willing to wait for more data. The market stalled on Friday as investors digested the Federal Reserve Chairman's speech on the labor market from the Fed's annual conference in Jackson Hole, Wyoming. Janet Yellen reiterated concerns over the U.S. labor market and reaffirmed her outlook that in spite of the labor market recovery thus the U.S. hasn't fully recovered from the Great Recession.

Overall it was a bullish week for stocks. The S&P 500 index broke out to new all-time highs and the NASDAQ composite broke through resistance to hit new 14-year highs. Small caps continued to bounce and the Russell 2000 is up three weeks in a row. The bond market saw a pullback from the prior week's highs. Meanwhile commodities retreated with oil, gold, and silver all posting losses. Natural gas eked out a small gain for the week. Copper was an exception with a big bounce likely due to better than expected housing data last week. Geopolitical risks remain. The Islamic State terrorists made headlines when they beheaded American journalist James Foley and uploaded a video of his murder last week. The White House considers this a "terrorist attack" against the U.S. ISIS terrorist are promising more terrorist attacks actually in the U.S. Elsewhere Russia continues to make headlines. After a relatively quiet week on the eastern Ukraine border Russia fueled new concerns on Friday when their convoy of aid trucks crossed into Ukraine without permission. More on that in a moment.

Economic Data

The U.S. housing market was showing improvement last week. Existing home sales rose +2.4% in July to a seasonally adjusted annual rate of 5.15 million units. That follows a 5.03 million rate in June. July's gain is the biggest increase in almost a year and marks the fourth monthly gain in a row. Yet in spite of the improvements existing home sales are still -4.3% from a year ago. Bloomberg noted that house flipping is decreasing. American investors are finding fewer bargains and thus purchasing fewer homes to fix and flip. The NAHB home builder confidence survey rose 2 points to 55, which was better than expected. The U.S. said housing starts soared +15.7% month over month, which was the strongest pace in eight months. Housing permits were up +8.3%.

The Philadelphia Fed survey improved from 23.9 in July to 28.0 in August. That's the best reading since March 2011. The Markit flash PMI hit its best reading since April 2010 with an increase to 58. The U.S. government said the Consumer Price Index (CPI) rose +0.1% in July. That follows +0.3% jump in June. Food prices continue to climb with a +0.4% increase in July. Food inflation in the U.S. is running about +20% driven by big increases for meat, eggs, and dairy.

The big event for the week was Fed Chairman Janet Yellen's speech on the U.S. labor market. Yellen has been considered one of the most dovish (easy money) members of the Federal Reserve. Her comments in Friday's speech suggest she is moving more towards the middle. As mentioned above Yellen reiterated that the country has not fully recovered even though the unemployment rate has fallen to 6.2%. That's down from 7.3% a year ago. Some see this drop in the unemployment rate as a potential sign of inflation. Yet at the same time we have a terrible labor force participation rate that has been hovering at multi-decade lows near 63%. While there has been some improvement in the job market there has been very little improvement in wage gains.

Yellen pushed the idea that there is still too much slack in the labor market. She mentioned the broader U6 unemployment reading, which counts unemployment and under-employed, that's people who want a full time job but can't find one so they're working part time. Many consider the U6 rate the real unemployment rate for the U.S., which currently sits above 12%. Yellen also reaffirmed the Fed's position that any changes to policy will be data dependent. If the market continues to see strong job gains then the Fed will hike rates more quickly. Yet if the opposite happens and the labor market softens the Fed might turn more accommodative again.

Overseas Economic Data

The economic data in Europe continues to disappoint. The Eurozone manufacturing PMI fell from 51.8 to 50.8. Germany's dropped from 52.4 to 52.0. France's manufacturing PMI slipped from 47.8 to 46.5. Numbers above 50 suggest growth and below 50 economic contraction. This only reinforces concerns that a growing chunk of Europe is in recession or nearing a recession.

European Central Bank President Mario Draghi was in Wyoming for the Federal Reserve conference. Draghi said the ECB is ready and willing to add more stimulus to help Europe. However, they need more help from government leaders and better fiscal policy to be more effective. Investors have been expecting Draghi to launch some form of QE program to bolster Europe for years. He's running out of time as more country's slip into recession.

Economic data in Asia was mixed. Japan's manufacturing PMI data improved from 50.5 to 52.4, which was better than expected. Japan's exports also improved and snapped a three-month losing streak with a +3.9% bounce. Japan said exports improved to both Asia and the U.S. but it was Europe that saw the most strength.

Nearby China continues to struggle with an economic slowdown. The China HSBC manufacturing PMI index retreated from 51.7 to 50.3. This was worse than expected and on the verge of contract. The news sparked new speculation that China might increase their stimulus efforts.

Ukraine-Russian Conflict

Russia remains one of the biggest market-moving catalysts. After a relatively quiet week they were making headlines again on Friday. Russia's convoy of more than 200 trucks full of humanitarian aid had been sitting on the Ukraine border for days. On Friday Russia sent them into Ukraine without permission. The Ukraine government is calling this an invasion and a direct violation of Ukraine's sovereignty. Yet the Ukraine government chose not to attack the trucks. If they were full of food and aid it would have been a public relations nightmare. We don't know what was in the trucks as they headed to rebel-controlled regions of Ukraine.

If that wasn't bad enough NATO leadership says they are seeing an alarming build up of Russian ground and air forces on the Ukraine border again. They've also seen Russian armor, including tanks and APCs, as well as artillery and anti-aircraft systems cross into Ukraine. If this is true it certainly sounds like an invasion. The White House is threatening "additional costs" if Russian doesn't back down. Germany chancellor Merkel also said that Russia's actions are a "dangerous escalation" of the situation. Yet the stock market doesn't seem to care.





Major Indices:

The S&P 500 index added another +1.7% last week. That bumps is year to date gains to +7.5%. It's also worth noting that the S&P 500 tagged a new all-time high on Thursday. The next challenge is potentially major resistance at the 2,000 mark.

A breakout past 2,000 could spark some serious short covering. You can see on the long-term weekly chart below that the S&P 500 remains inside its bullish channel.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

The same groups that powered the NASDAQ higher two weeks ago continued to show strength last week. Gains in technology, semiconductors and biotechs helped boost the NASDAQ. The NASDAQ composite broke through resistance near 4,500 to close at new 14-year highs.

If you believe in using a measured move analysis then the NASDAQ could be forecasting a run towards the 4800 area. Year to date the NASDAQ is up +8.6%.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index

The rebound in the small cap Russell 2000 index continued last week. The $RUT is now up three weeks in a row. Last week's +1.6% gain reduces its 2014 loss to just -0.28%. The $RUT is hovering near resistance in the 1160 region. If this rally continues then 1180 and the 1200-1210 zone could be overhead resistance.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

The pace of economic picks up a bit. We'll see two Federal Reserve regions report their economic activity surveys. We'll get two updates on consumer confidence. Thursday will bring an updated guess on U.S. Q2 GDP growth.

Keep in mind that the U.S. stock market will be closed on Monday, September 1st.

Economic and Event Calendar

- Monday, August 25 -
New home sales (for July)

- Tuesday, August 26 -
Durable goods orders
Case-Shiller 20-city home price index
Richmond Fed manufacturing survey
Consumer confidence survey

- Wednesday, August 27 -
(nothing significant)

- Thursday, August 28 -
Weekly Initial Jobless Claims
Pending home sales (for July)
Kansas City Fed manufacturing survey
2nd estimate on U.S. Q2 GDP growth
Eurozone unemployment data

- Friday, August 29 -
Personal income and spending data
Chicago PMI data
University of Michigan Consumer Sentiment Survey

Additional Events to be aware of:

Sept. 1st - U.S. market closed for Labor Day
Sept. 17th - FOMC meeting and updated economic forecast
Sept. 17th - Fed Chairman Yellen press conference

Looking Ahead:

Looking ahead the path of least resistance is still higher. However, it's worth noting that stocks look short-term overbought with a nearly straight up three week bounce from its August lows. The Dow Industrials has bounced +600 points from technical support at its 200-dma and still has potential resistance at its July highs. The small cap Russell 2000 index, with its 2,000 stocks, is still underperforming the large cap indices. The S&P 500 is up 84 points or +4.4% from its August lows with barely any pullback. Odd of tagging resistance near the 2,000 mark and then seeing some profit taking seem pretty high. The only index that looks healthy is the NASDAQ composite, which just broke out past resistance after a six-week consolidation. After three weeks of gains investors are turning more bullish. The latest AAII investor sentiment survey reported 46.1% of investors are bullish on stocks. That is a new high for 2014.

If I had a working crystal ball the picture I suspect it would show for the week ahead is the S&P 500 index does hit 2,000 and then sees a dip of -3% to -5%. However, it's entire possible that the S&P 500 inches up to the 2,000 level and then drifts sideways flirting back and forth across this psychological resistance barrier all week long. Maybe it drifts sideways for two weeks as investors look ahead to the August jobs report, which will come out on Friday, September 5th. Unfortunately I do not have a crystal ball to see the future. I am confident that volume will remain low and that could allow or an uptick in volatility, which wouldn't be too surprising since volatility has crashed back toward its lows in the last three weeks.

The stock market is still ignoring disappointing economic data overseas. A slowdown in Europe and Asia could be pushing foreign capital into the U.S. markets as a safe haven trade. At the same time it could keep U.S. investor money here at home since we're the cleanest shirt in the dirty laundry hamper.

The Chief Economic Adviser for Allianz, formerly of PIMCO, Mr. Mohamed El-Erian said it best a couple of weeks ago. He believes equities are rising because investors are betting that central banks around the world will continue to do whatever it takes to keep their economies afloat. While he is probably right there is one huge wildcard that could upset the market and that is geopolitical risk.

The world is growing more dangerous and there are geopolitical hotspots all over the globe. Yet the only one investors seem to care about is the conflict between Ukraine and Russia. Or what we should call it is the slow-motion invasion of Russia into eastern Ukraine. The Israel-Hamas conflict continues even though it's no longer front page news. A few days ago an Israeli airstrike killed a handful of Hamas' top commanders. In response Hamas has just murdered 21 people that suspected of being Israeli informers. I'm sure they had a fair trial, don't you?

Another potential issue is China. They may be a huge trading partner with the U.S. but they're also our biggest rival. They do not appreciate the U.S. meddling in the Pacific. A few days ago a Chinese fighter jet flew within 30 feet of a U.S. Navy surveillance aircraft. This is a dangerous stunt. The Chinese pilot made sure the Americans could see he was fully armed with missiles. This incident occurred 135 miles east of the southern tip of China. The U.S. is calling this a serious provocation. The White House has responded by sending a second aircraft carrier group into the Asia Pacific region as a response.

Meanwhile the Islamic State (a.k.a. ISIS terrorists) continue to fuel violence in the middle east. ISIS is the dominant rebel group fighting the Syrian government. The U.N. just updated their figures and estimate that the Syrian civil war has killed over 191,000 people. While ISIS fights the Syrian government they're also fighting the Kurds in northern Iraq and the Iraqi military in central Iraq.

The previous Iraqi prime minister recently stepped down so new leadership could help pave the way for a stronger coalition government and present a unified front against ISIS. That could be more challenging now since the Sunni lawmakers in Iraq just quit all negotiations. Why did they quit? A Shiite militia massacred 73 Sunni men, women, and children at a mosque in an Iraqi village. If you didn't know the Shia and Sunni Muslims have been killing each other for about 1,500 years. There doesn't seem to be anything on the horizon that's going to stop that soon. Iraq is becoming a proxy war between Iran and Syria, which are Shia, and Saudi Arabia, which is Sunni. Although officially Saudi Arabia does not endorse the Islamic State, which is comprised of hard-line, fanatic Sunni terrorists.

Last week ISIS made headlines when they beheaded an American journalist. Now ISIS is threatening to kill more Americans and they're warning they will strike inside the U.S. That's a real threat because we already know they're here. ISIS has uploaded photos to social media with hand-written notes held up in front of American government buildings saying "we are here". Oklahoma Senator Jim Inhofe is also warning that ISIS is a real threat. He believes that ISIS is working on a way to set off a bomb in a major American city. Last week U.S. Defense Secretary Chuck Hagel also warned about ISIS calling them a serious threat and an imminent danger. Hagel described ISIS as the most sophisticated and well-funded group that they have ever seen.

I'm not sharing all of this to say ISIS is going to be the reason stocks go down next week. We don't know. Thus far the U.S. equity markets have been very strong in spite of all the geopolitical risks. Sadly there will come a day when there is another terrorist event inside the U.S. The U.S. is a powerful country and we have some amazing people and amazing technologies that have protected us so far. We do not hear about all the successful counter terrorism efforts that have prevented new attacks since 9/11. Unfortunately we can succeed a thousand times while the terrorists only have to succeed once to shock the U.S. psyche and markets.

We could have a terrorist event in the U.S. next week or it could be ten years from now. The shadow of terrorism is not a good reason to avoid being in the stock market but we cannot be alarmed that if an event happens that stocks will see a serious drop. That's why you have to trade with stop losses. Stop losses aren't perfect but they can save you from serious financial harm.

James