The U.S. stock market continues to drift higher. Last week produced minor gains for the S&P 500 but they were still gains and the third weekly gain in a row. The index is up seven out of the last eight weeks. Momentum is slowing and volume on Friday was very light since no one seems willing to place any new bets as we approach the fiscal year end for many mutual funds (October 31st), and the midterm elections (November 2nd), and the next FOMC meeting (Nov. 2-3rd). Market participants were also keeping a wary eye on the G20 meeting this weekend. Last week's surprise rate hike by China cause some turmoil in the currency markets. Rhetoric has been escalating over the sharp decline in the U.S. dollar. The potential for more volatility in the currency markets this week following the G20 meeting was another reason for traders to stick to the sidelines.

In addition to the major events listed above we will also see a parade of new economic data this week. Markets will digest the new and existing home sales numbers and the Case-Shiller home price index. Plus, we'll see another reading on consumer confidence, durable goods orders, and the Chicago PMI. One of the biggest economic reports out will be the advanced GDP estimate for the third quarter. Currently consensus estimates expect +2.0% GDP growth last quarter. Naturally we might expect a disappointment in the GDP number to spark some selling in stocks and increase fears of a double dip. However, lately any bad news has been accepted as just another reason for the Federal Reserve to start a new round of quantitative easing.

If you study the S&P 500 you can see the index has been struggling with the 1185 level this past week. If the intermediate up trend continues we could see the index hit 1200 before the month is out but if I had to bet I would expect stocks to churn sideways into month end. Short-term support for the S&P 500 is the 1160, 1150 and 1130 levels. On the upside there is potential resistance at 1200 and 1220. If stocks actually see a correction then I would look for a pull back toward the 1130 area, which lines up with the 38.2% Fibonacci retracement level.

Daily chart of the S&P 500 index:

The tech-heavy NASDAQ composite remains strong, if overbought, and closed near its five-month highs just under 2480. Strength in the NASDAQ has been driven by amazing gains in the big cap tech names, which is clearly evident in the NASDAQ-100's (NDX) bullish breakout to new multi-year highs. These stocks can't keep this pace up for long but for now the trend is still up. The 2500 level might be round-number resistance for the NASDAQ composite but I would watch the 2010 highs near 2520 as the real level to watch. The 2400 level should offer some support but a normal correction would bring the NASDAQ composite back down toward the 38.2% Fib retracement area (currently 2335). Long-term the breakout in the NASDAQ-100 (NDX) is very positive but it's too overbought and overextended at current levels.

Daily chart of the NASDAQ index:

Daily chart of the NASDAQ-100 (NDX) index:

The small cap Russell 2000 index has also seen its upward momentum stall. The $RUT is actually flirting with a breakdown from its bullish channel. I suspect that a drop under short-term support near 690 could portend a deeper correction toward support (prior resistance) near 670. I would view a pull back to or bounce from the 670 level as a new bullish entry point on the small cap sector, especially as we head deeper into the fourth quarter.

Daily chart of the Russell 2000 index:

We also want to keep a close eye on the transports ($TRAN) and the semiconductor index (SOX). Traditionally the market can't rally without participation in the Dow Jones Transportation index. Meanwhile the SOX tends to lead the NASDAQ higher or lower. That hasn't been the case lately but the chips still have a big impact on the index. Currently the transports have been performing very well but the $TRAN is nearing potential resistance at its 2010 highs around the 4800 level. This would be a good spot for the $TRAN to tag resistance and reverse into some profit taking. The 4500 level should be decent support for the transports.

Daily chart of the Dow Jones Transportation index:

The SOX semiconductor index still has a bearish pattern of lower highs and lower lows on the weekly chart but the sector has produced a decent bounce from its August lows. On a short-term basis the SOX looks poised to breakout over resistance near 360, which could inspire more confidence in the NASDAQ. We're going to see earnings from some chip stocks this week and these results could be the catalyst the SOX needs to breakout or roll over under resistance.

Daily chart of the SOX semiconductor index:

Earnings season is still very much in full swing. Corporate results will dominate the headlines. Individually stocks could see lots of volatility based on their results but bigger picture I would expect the market to just churn sideways through the last week of the month. Mutual funds should already be done with their window dressing before their fiscal year ends. Normal traders are unlikely to place any new bets ahead of the midterm elections and the FOMC meeting. Currently there are huge expectations for the Federal Reserve to announce a new quantitative easing program on November 3rd. If they do not announce a QE program or they do announce and the size of the program is too small then the stock market, which has been rising on QE expectations for weeks now, could see a significant sell-off.

I remain optimistic for a fourth quarter rally but would love to see a strong two-week correction lower to provide us a new entry point to launch bullish positions. I would be very hesitant to open new long-term positions ahead of the November 2-3rd time frame. Even if the FOMC does announce a new QE program the market could see a "sell-the-news" reaction no matter what size the program is. Actually, one of my biggest concerns right now is that we might see stocks initially spike higher on the QE news, the indices could hit their 2010 highs, and then reverse lower. This could form a potential bearish double top pattern. You could say we have a lot of headline risk with the elections and the FOMC meeting just days away. Ideally we see some sort of pull back in mid November that stops at support and sets us up for a rally into December and January.

- James