Stock market volatility is soaring thanks to a tidal wave of negative headlines. The S&P 500 index suffered its worst weekly performance in two years as the volatility index (VIX) spikes to two-year highs. It was a rough week for stock markets around the world and an index of global stocks sank to eight-month lows. The U.S. dollar snapped a seven-week winning streak but was paring its losses to end the week with a two-day bounce. Meanwhile investors were desperate for safety, which fueled a rally in bonds and the yield on U.S. ten-year treasuries sank to 2.3%.

Stocks really tumbled on Tuesday following terrible industrial production numbers out of Germany. The IMF only added to the bearish tone when they lowered their 2015 global growth guidance that same day. Yet stocks bounced on Wednesday. The FOMC minutes from the last meeting were released on Wednesday afternoon and stocks surged on its contents. The key appeared to be that several fed governors have noted the slowdown in China, Japan, and Europe and they're concerned this global slowdown might impact U.S. growth. Investors chose to interpret that to mean the Fed would keep rates low for longer than previously expected. This sparked some serious short covering on Wednesday afternoon and the Dow Industrials had their best day of the year with a +275 point rally.

The Dow's best day of the year was immediately followed by its worst day of the year with a -335 point plunge on Thursday. Again economic data out of Europe sparked the sell-off. Germany reported that its exports crashed -5.8% in August. Stocks collapsed both in Europe and in the U.S. The selling continued on Friday after Microchip Technology (MCHP) issued an earnings warning and issued a warning for the entire semiconductor industry. This fuel massive selling in the SOX semiconductor index, which weighed heavily on the NASDAQ composite. Pouring salt in the wound was Standard & Poor's lowering its outlook on France from "stable" to "negative". S&P left their credit rating on France unchanged at AA but warned they might downgrade the country in the future.

The weekly performance numbers were terrible. The Dow Jones Industrial Average fell -2.74%. The S&P 500 dropped -3.1%. The NASDAQ lost -4.45%. The small cap Russell 2000 plunged -4.65%. Transports stumbled -6.9% and the SOX semiconductor index lost -9.9% on the week. WTI crude oil ended the week near $85 a barrel and Brent crude traded under $90 a barrel for the first time in more than two years. These are four-year lows for oil. The Mid cap index traded below its 200-dma for the first time in almost two years.

Economic Data

It was a quiet week for economic data in the U.S. We did see the four-week moving average on initial jobless claims drop to 287,750. That is the lowest reading since early 2006. Globally the IMF is expecting growth to slow. A few days ago the economists at the IMF adjusted their 2015 growth rates from +4.0% to +3.8%.

The whirlpool of bearish economic data out of Europe continues to drag equities lower. The Eurozone said their retail PMI dropped to 44.8. Numbers under 50.0 are bearish. Odds are growing the entire Eurozone will fall into their third recession thanks to a serious slowdown in Germany and ineffectual policies at the European Central Bank. Germany has long been the strongest economy in the EU but weakness in Asia and the economic sanctions against Russia are taking a toll.

Last week Germany reported a -4.0% drop in its industrial production numbers. That's significantly worse than expected (-1.5%) and the biggest drop in more than five years. German exports also plunged -5.8% in August, which is the biggest drop since January 2009. This all but guarantees that Germany will fall into a recession (two consecutive quarters of negative growth) following the -0.2% GDP growth in the second quarter. Evidence of the economic slowdown is showing up in shipping rates. The cost to ship goods between Europe and Asia plunged -10% to $738 per container. That's the fourth weekly drop in a row and the lowest level since October 2013.

Speaking of Asia, the news out of Japan was negative. The country said latest consumer confidence survey dropped to a four-month low. There was an upside surprise with their machine orders up +4.7% for the month but overall the country is slowing down. Economists are also expecting China to grow at its weakest pace in more than five years. Analysts expect that China will lower its 2015 growth forecasts soon.




Major Indices:

It doesn't look good for the S&P 500. The large cap index went 685 days without touching its simple 200-dma. The average hit this level of technical support on Friday. The S&P 500 is also down -5.2% from its all-time high set just four weeks ago so it wouldn't surprise me to see a bounce. Unfortunately the S&P 500 has broken down from its two-year bullish channel. That means the bottom of the channel is now new resistance.

We shouldn't be too surprised to see the S&P 500 finally start to pullback. Over the last 85 years the S&P 500 has averaged three -5% corrections every year. The current -5% pullback is the third one since November 2012. We were definitely due. Speaking of due it's been over 1,100 days since the S&P 500's last -10% correction so this pullback may not be over yet.

The 1900 level and the 200-dma near 1906 should offer some support. Yet broken support at 1925 and in the 1950-1970 area is new overhead resistance. If the S&P 500 breaks down under 1900 then the next key support area to watch is probably the 1850 region.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

A sharp sell-off in the SOX semiconductor index boosted the weakness in the NASDAQ. The technology-heavy NASDAQ composite lost -2.3% on Friday and sliced through potential support at 4300 and its 200-dma. This drop also puts the NASDAQ under a key trend line going back to the late 2012 lows (see weekly chart).

New data suggest the NASDAQ could be in for more declines. Nearly half of the NASDAQ stocks are already down -20% from their one-year highs. That means a huge chunk of the NASDAQ is already in a bear market.

Friday's close at 4276 leaves the NASDAQ -7% from its 2014 highs. A -10% correction would mean a drop toward 4,140.

chart of the NASDAQ Composite index:

Intraday chart of the NASDAQ Composite index

The small cap Russell 2000 continues to lead the market lower. The $RUT lost -4.6% last week, which puts its 2014 performance at -9.48%. Last week was its sixth weekly loss in a row. One more weekly decline would be a record. This index is now down -12.8% from its 2014 closing high.

The breakdown under support near 1,080 was very bearish. If the 1,050 level fails then 1,000 is the next likely area to look for a bounce. That also means broken support at 1,080 is new resistance.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

We have a quiet week ahead of us for economic reports. Anyone paying attention will be watching the New York and Philadelphia fed surveys. Odds are the headlines will be filled with earnings results. This is the first full week of Q3 earnings season.

Economic and Event Calendar

- Monday, October 13 -
The first full week of Q3 earnings reports begins.

- Tuesday, October 14 -
German ZEW survey

- Wednesday, October 15 -
U.S. retail sales
Producer Price Index (PPI)
New York Empire State Fed survey
Federal Reserve Beige Book

- Thursday, October 16 -
Weekly Initial Jobless Claims
Philadelphia Fed survey

- Friday, October 17 -
Housing starts & Building Permits
University of Michigan Consumer Sentiment

Additional Events to be aware of:

October 29, FOMC policy update

Looking Ahead:

Several of the headlines last week were pretty ominous. The Microchip Technology (MCHP) earnings warning on Friday doesn't bode well for technology stocks. MCHP warned their Q3 sales would come in under estimates. More importantly MCHP warned that the semiconductor industry might see an inventory correction. A Citigroup analyst commented on MCHP's warning and said, "an inventory correction occurs whenever demand drops off for a moderate period of time and can occur during economic expansion or contraction." More importantly the Citigroup analyst said, "inventory corrections typically last 2-3 quarters with a step-down in demand and reduced visibility. The economic impacts are lower sales and margins."

Ebola Virus Outbreak

The Ebola virus outbreak doesn't have an immediate impact on the stock market but if it continues to spread it could definitely have consequences. The first patient diagnosed with Ebola in the U.S., Mr. Thomas Duncan, has died in Dallas, Texas. What is really making for scary headlines on Sunday night is news that one of the healthcare workers who was trying to save Mr. Duncan has now been diagnosed with Ebola. What makes this alarming is the nurse had a complete safety suit on to prevent infection and she got it anyway. It's possible she infected herself by removing her protective gear incorrectly but it does raise concerns. There have been new cases reportedly diagnosed in Spain and Brazil.

There are members in the U.S. government warning that if Ebola hits South or Central America it could spark another stampede of illegal aliens trying to get through the U.S. southern border. This is the worst Ebola outbreak in history and it's having a serious impact on the economy of western Africa. If we continue to see it spread the impact on the global economy could be huge. People will travel less. Consumers will shop less. Fear will keep more people indoors, which will encumber an already struggling global economy.

ISIS/ISIL Terrorists (Islamic State)

Last week we had more bad news on the war against ISIS. The terrorist fighters of this Sunni Muslim Al Qaeda offshoot were making progress on both their northern and southern borders. The U.S. led coalition to stop the spread of ISIS with air strikes is not having a big enough impact. Right now ISIS is on the verge of taking the Anbar province in Iraq. According to the Washington Post this would give ISIS control of Iraq's most important dam and several large army installations. It would also help ISIS create a strong supply line from Syria into Iraq and allow ISIS a much more strategic position to attack the Iraqi capital, Baghdad.

ISIS is also on the verge of capturing the Syrian city of Kobani. This city is located right on the northern edge of Syria and Turkey. The United Nations is warning that if ISIS wins Kobani they could massacre the civilians still in the city. So far the Kurdish defenses inside have already stopped five ISIS suicide car bomb attacks but the ISIS fighters are slowly gaining more and more ground.

Closer to home the U.S. State Department has issued a warning of a potential ISIS attack inside the U.S. There have already been several ISIS soldiers captured at the southern U.S. border with Mexico. Depending on who you listen to there could be dozens to hundreds of ISIS fighters already in the U.S. The State Department warned that terrorists could target "high-profile sporting events, residential areas, business offices, hotels, clubs, restaurants, places of worship, schools, public areas, shopping malls, and other tourist destinations both in the United States and abroad where U.S. citizens gather in large numbers, including during holidays."

Right now, assuming the Ebola outbreak does not spread in the U.S., the holiday shopping season could be a strong one for retailers. Yet if terrorist successfully stage a random attack it could hamstring holiday sales as fearful consumers stay inside. It might seem morbid but Amazon.com is probably the winner this season if we do see a terrorist attack inside the U.S.

Q4 Market Performance

On a much brighter note the stock market delivers some of its best performances in the fourth quarter. The folks at the Stock Trader's Almanac report that over the last 32 years there is a 75% chance of market gains if you bought the S&P 500 near the end of October and sold just before Christmas. However, this year the bulls have a significant wall of worry to climb. Europe's economy is sinking. China and Japan are slowing down. ISIS seems to be growing in spite of allied air strikes. West Africa is not showing much improvement in the fight against Ebola. Plus, U.S. corporate earnings could come in worst than expected. The key will be corporate guidance for the fourth quarter and into 2015.

I would not be in a rush to open new bullish positions. If the current market pullback is going to end it will probably be in the second half of October.

James