The last week of August 2014 had plenty of headlines. Yet traders either were not interested or not paying attention. Volume was low, hitting the lowest levels of the year. Bloomberg reported that volume over the last eight trading days has seen the longest stretch of low volume since 2008. Are investors just on the sidelines or is everyone already in?

One scenario suggested in last week's market commentary was a sideways consolidation at resistance. That's what we got with the S&P 500. The large cap index traded above and closed above the 2,000 mark for the first time in history. The index spent the last few days hovering near the 2,000 mark. That was in spite of a growing chorus of geopolitical risk.

There was some hope that the Ukraine region might cool off when Russian President Putin and Ukraine President Petro Poroshenko met on Tuesday in Minsk, Belarus. Unfortunately, two days later there were new reports of Russian troops and Russian military vehicles crossing into Ukraine. The U.S. Ambassador in Ukraine said there is no doubt left that Russia is directly involved in the fighting. Poroshenko called it an invasion.

The U.S. markets ignored this escalation in Ukraine. Normally August is one of the worst months of the year for stocks but this year the seasonal patterns did not hold up. The S&P 500 climbed +3.6% making it the second best month for 2014 and the best August performance in 14 years. A parade of mostly positive U.S. economic data helped buoy equities.

The Dow Industrials added +0.5% for the week and ended August up +3.1% for the year. The NASDAQ is up +0.9% for the week and up +9.6% in 2014. The S&P 500 added +0.75% last week, boosting its 2014 gains to +8.3%. The small cap Russell 2000 index added +1.2% last week, which put it back into the green, ending August up +0.9% for the year. Transports underperformed for the week but are still up +13.6% in 2014. The SOX semiconductor index is up +20.6% year to date. Biotechs are still the best performer with a +34.3% rally this year.

Economic Data

The Chicago PMI came in at 64.3, significantly better than the 56.5 economists were expecting. The Richmond Federal Reserve manufacturing index hit 12, which is the best reading since March 2011. One surprise was the U.S. Q2 GDP estimate. The latest estimate was revised up from +4.0% to +4.2% growth. This was due to a revision in the real final sales that was adjusted from +2.3% to +2.8%.

One mystery last week is the divergence between consumer confidence and consumer spending. Normally analysts like to equate rising confidence with rising spending but isn't the case. Consumer confidence rose from 90.3 in July to 92.4 in August, which happens to be the highest reading since October 2007. The Consumer Sentiment survey also rose with an improvement from 81.8 to 82.5. Yet consumer spending dropped for the first time in six months.

Bloomberg surveyed almost 80 economists and no one expected consumer spending to drop. The consensus estimate was for a +0.2% gain. The Commerce Department reported a -0.1% drop in July following a +0.4% jump in June. Evidence suggests that the American consumer is postponing purchases and boosting their savings rate, which hit the highest level since late 2012. This might be problematic since almost 70% of the U.S. economy is consumer spending.

Elsewhere the pending home sales came in better than expected with a +3% gain. The Durable Goods number for July soared +22.6%, the biggest jump since 1992, following record-setting orders for aircraft. Yet if we subtract the transportation numbers then durable goods orders actually dropped -0.8%.

The weekly initial jobless claims continue to drop. The most recent data showed a -1,000 drop in new claims but that was enough to push the 4-week moving average to less than 300,000. There is going to be a lot of focus on the labor market this week with the ADP report and the Nonfarm payroll report.

Overseas Economic Data

The Eurozone continues to be a sinkhole for economic data. Right now Europe is deathly afraid of deflation. It's an issue that has been haunting the region for years. Last week they saw their inflation rate hit five-year lows. Germany reported that their retail sales declined -1.4% month over month. Spain also reported a drop in retail sales of -0.5%, which was worse than expected. All the geopolitical risk has investors seeking safety in German bonds and the yield on the 10-year German Bund hit a record low of 0.87%. Europe does not have a monopoly on disappointing economic data. Japan said their housing spending report fell for the fourth time in a row. Brazil has dropped back into an economic recession.

Ukraine-Russian Conflict

There is a growing mountain of evidence that Russia is actively involved inside Ukraine. At least 1,000 Russian soldiers, 100 tanks, 500 armored personnel carriers, and 200 artillery units have crossed into Ukraine. That's on top of what has already been smuggled across in the last few months. Russian President Putin is calling the satellite image proof of their invasion into Ukraine to be fakes.

NATO is getting nervous. One of the main reasons the North Atlantic Treaty Organization was created was to deter the Soviet's expansion plans. Now that Putin has reignited plans for a great Russian federation the 28 members of NATO are sitting uneasy. No one wants to get involved in a military conflict with Russia.

Right now there are at least three Russian neighbors that used to be satellites of the prior Soviet empire, Latvia, Lithuania, and Estonia, that are praying NATO's threat of collective defensive will be a big enough deterrent. Ukraine would love to join NATO right now but that's not going to happen. NATO would not be in a rush to accept their application to join the club. We could hear more about NATO as the organization has a two-day summit coming up later this week.

Several of the eastern NATO members are fortifying their military defenses just in case Russia decides to test NATO's mettle. Speaking of testing, Russia has been testing (a.k.a. invading) the airspace of several neighbors including Finland and the U.S. Russia crossed into Finland air space multiple times last week.

The conflict with Russia is not just on the ground. Last week it was unveiled that several major U.S. banks had been hacked. The biggest was banking giant JP Morgan (JPM). Research on who did the hacking traces it back to Russia. According to the story the hackers were able to steal gigabytes of data including personal information. On a side note, security specialists disclosed that there are 650,000 hacking attempts against U.S. targets, including businesses, every single hour! Fortunately the vast majority are not successful but it only takes one success to do significant damage.

There is also a public relations battle going on. One of Russia's reaction to U.S. sanctions has been to target McDonald's restaurants in Russia. Suddenly Russia has had to shut down 12 of the biggest McDonald's in their country due to "health reasons". There are over 400 McDonald's stores in Russia and the government has targeted the busiest locations for closure.

The economic sanctions that the U.S. and Europe have levied against Russia are having an impact. Money has been fleeing the country. The ECB said over $220 billion exited Russia last quarter. The Russian economy is expected to drop -6% to -10% this year. There have been food shortages due to the lack of European imports. The real impact could be 12-24 months down the road. Almost 25% of the foreign debt of Russian banks and businesses, about $157 billion, is scheduled to come due in 2014. They will not be able to refinance this debt on the global market. They'll have to try and do it internally or with help from someone like China. There is even more debt coming due in 2015. Some of the companies affected are major corporate like Rosneft, Russia's national oil company.

No one expects the West to get involved in a military conflict with Russia. That doesn't mean this fight can't go one for a long time, especially if the West starts secretly supporting Ukraine with military aid. Some have suggested that Russia merely wants a big enough chunk of land to access their newly annexed Crimea state. The stakes are going to get higher as we get closer to winter. Europe depends on Russia for about 33% of its natural gas and a significant chunk of its crude oil supplies. Almost 2/3rds of the natural gas Europe does import from Russia runs through Ukraine. Russia could choose to raise prices or cut off supplies if the Ukraine situation drags on into the winter. Russia has already warned that Ukraine might try and siphon gas meant for Europe to supply their own needs.





Major Indices:

The S&P 500 index saw its upward momentum stall a little bit as the index tried to break through round-number, psychological resistance at the 2,000 mark. Traders were in a buy the dip mood and the S&P 500 bounced near its rising 10-dma on Thursday.

The trend is clearly higher but after a four-week surge from almost 1900 to 2000 you could argue that stocks are short-term overbought here. Of course we all know that stocks can remain overbought (or oversold) a lot longer than we think might be normal.

If the rally continues then look for potential resistance in the 2020-2025 area. If the 10-dma fails to hold as support then watch for potential support near 1985. If the S&P 500 falls below 1985 then the next stop might be the 1950 region.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

The NASDAQ continues to show relative strength. This tech-heavy index is up more than 250 points or +5.8% from its August lows. The index is now up four weeks in a row and above resistance near 4500. These are new 14-year highs for the NASDAQ composite.

The next resistance level might be 4600. I would look for support in the 4485-4500 region.

chart of the NASDAQ Composite index:

The small cap Russell 2000 has delivered a strong four-week bounce from its early August lows. The $RUT has found support near its rising 10-dma the last few weeks. Now it looks poised to breakout past potential resistance near 1180. If this rally continues then the 1200-1210 zone could be overhead resistance.

chart of the Russell 2000 index



Economic Data & Event Calendar

It's a new month and that means lots of economic data. The big reports will be the ADP employment change report on private payrolls and the U.S. government's nonfarm payrolls (jobs) report. Economists are looking for +200,000 new jobs in August. The U.S. Federal Reserve is keenly focused on the labor market. Any big miss or big increase could influence the timing on when the Fed starts raising rates, or at least the market's perception on when the Fed might start raising rates.

It's also a big week for central bank moves. The Bank of Japan, Bank of England, and the European Central Bank will all announce their latest interest rate decisions on Thursday. ECB President Draghi will hold a press conference afterward. If Draghi doesn't deliver on some sort of stimulus package the markets could be disappointed.

The U.S. market will be closed on Monday, September 1st for the Labor Day holiday. Also worth noting is the next U.S. Fed meeting the 16-17th this month. In corporate news Apple (AAPL) will be holding a big event on September 9th, presumably to unveil their latest iPhone and other product launches.

Economic and Event Calendar

- Monday, September 01 -
U.S. market closed for Labor Day
Eurozone GDP estimate

- Tuesday, September 02 -
ISM index (for August)
Construction spending

- Wednesday, September 03 -
Factory orders
Federal Reserve Beige Book
Auto and truck sales for August

- Thursday, September 04 -
Weekly Initial Jobless Claims
ADP Employment Change report
Bank of Japan interest rate decision
European Central Bank (ECB) interest rate decision
ECB President Mario Draghi press conference
ISM Services

- Friday, September 05 -
Unemployment rate
Nonfarm payrolls (jobs) report for August

Additional Events to be aware of:

Sept. 17th - FOMC meeting and updated economic forecast
Sept. 17th - Fed Chairman Yellen press conference

Looking Ahead:

Congratulations! We are eight months into 2014 and stocks continue to perform with the S&P 500 at record highs. Now what? Seasonally this is not a good time of year for stocks. September is actually the worst month of the year for the Dow Industrials and the S&P 500 going back almost 65 years. The same holds true for the NASDAQ over the last 40 years. It's also the worst month for the small cap Russell 2000 since 1979.

The average monthly loss for September is only about -1% but that doesn't tell you the whole story. Septembers have a history of being more volatile than other months with nearly 5% swings. Of course August just proved that seasonal patterns can be broken so there is no guarantee that stocks are going down in September. However after a four-week rally we might be due for a pullback.

You and I look at the calendar and see four months left for 2014. Yet a lot of mutual funds have their yearend on October 31st. That means they only have two months left. A recent survey found that over 80% of fund managers are underperforming the market. That's going to put a lot of pressure on them to try and catch up to the major indices in the next several weeks, which could mean more money to buy the dips.

Last weekend we talked a little bit about terrorist attacks. This past week there have been new developments. David Cameron, the Prime Minister of the United Kingdom raised his government's terror threat level to "severe", which means an attack is "highly likely". Severe is just below the highest level of "imminent". Europe, the U.K., and to a lesser extent the U.S. have seen hundreds of citizens travel to Syria or Iraq to join ISIS (the Islamic State terrorists). The U.S. defense minister has recently stated that ISIS represents the most extreme threat we have seen yet. They are the most funded and best trained terrorists to date. The risk is that the American or British citizens fighting for ISIS could get training, return home and perform terrorist acts domestically.

The U.S. has already warned that its intelligence machine is picking up a high amount of chatter among terrorist organizations as we approach the 9/11 anniversary. There is always a risk that we could see another attack near the anniversary. Just this past week Homeland security has warned that we could have a serious threat to our southern border (like we didn't already know that). This time the attack could actually be at our southern border, most likely a car bomb of some kind. A couple of days ago the King of Saudi Arabia has also warned terrorists could attack Europe and the U.S. soon. The White House has no plans to raise the U.S. terror threat level and the National Terrorism Advisory System (NTAS) is currently blank.
http://www.dhs.gov/national-terrorism-advisory-system

On a short-term basis the market looks poised to rally after a three-day consolidation sideways. Bigger picture the market direction could depend on geopolitical headlines. Fortunately stocks have managed to ignore geopolitical risks for most of this year.

James