Economic data was pretty much ignored last week. Earnings results were ignored as well. Individual stocks moved on their earnings news but the market was focused on next week. Fund managers were holding their breath until the end of their fiscal year (Oct. 31st) and Monday begins a new year for Wall Street. The Republicans are expected to do well in the midterm elections on Tuesday but it's not clear if they can actually gain majority in the Senate. Meanwhile the market's main focus will be on the conclusion of the two-day FOMC meeting this Wednesday. Any announcement regarding monetary policy, interest rates, and any new quantitative easing program is expected around 2:15 p.m. on Wednesday afternoon. It would not surprise me at all to see the market levitate sideways until that announcement on Wednesday and then suddenly see an eruption in volatility.

The big report last week was the Q3 GDP number. Economists were expecting +2.0% growth and that's what the report delivered. It was an improvement over the +1.7% we saw in Q2 and a lot better than some of the +1.0 to +1.5% estimates some of the bears were throwing around about a month ago. Unfortunately if you back out inventory rebuilding (+1.4%) and government spending (+0.7%) then the GDP would have been very negative. Naturally there will always be some inventory replenishment and government spending so that's not realistic. What's important here is that the inventory build out cycle is almost complete. All the orders for this coming holiday season have been made weeks ago. Most of the government stimulus for 2010 has already been spent. Thus these two components should see significant declines next quarter. It's going to come down to business and consumer spending. Business spending has been holding up pretty well, especially spending on technology. Consumer spending has been mediocre but analysts are predicting one of the best holiday shopping seasons in years (mainly because the last couple of years have been so bad!).

Speaking of the consumer, last week saw consumer sentiment for October drop to a new eleven-month low at 67.7. September's reading was 68.2. I am a little surprised that the October reading wasn't stronger given the strong gains in the stock market. Then again retail investors have been taking money out of the market for weeks and weeks (following the May flash crash) and last week was the first week that stock funds actually saw positive inflows. The elections could be having an impact on sentiment. I warned readers here that all the negative campaign ads could have a bearish effect on consumer sentiment. I will mention that some analysts suggest consumer sentiment doesn't really have much effect on consumer spending. We report on it because traditionally strong consumer sentiment numbers are supposed to translate into healthier consumer spending, which is widely quoted as accounting for 70% of the U.S. economy.

There were a couple of ISM reports last week. Both reports were positive and both suggest the national ISM coming out this week should be bullish. The ISM Chicago report eked out +0.2% gain to 60.6 compared to September's 60.4 but economists were actually expecting a -2.0 decline. The employment component jumped from 53.6 to 54.6. Meanwhile the New York ISM gained +7 points to 477.9, the largest gain three months. New York also saw its employment component strengthen.

This coming week is jam packed with economic data. There will be multiple reports almost every day. The big ones to watch are the national ISM index on Monday, which is forecasted to drop from 54.4 to 54.0. After the two ISMs this past week the national index could see an upside surprise. Wednesday will see the ADP employment report and economists predict an improvement from -39,000 jobs to +23,000 jobs. The ISM Services index also comes out on Wednesday and it is forecast to come in nearly unchanged at 53.4. Of course Wednesday will also see the FOMC meeting announcement. Friday brings the non-farm payroll (jobs) report for October. Economists are forecasting +60,000 new jobs in the government report.

The market's impressive rally off the August lows has stalled. I'm expecting investors to sell the FOMC announcement no matter what Ben Bernanke says about QE2. If the Fed does announce a large number then stocks might see an intraday spike but I still think it fails. If you are a technical trader I wouldn't be surprised to see a "blow-off" top. This will be short-term bearish that will hopefully bloom into a normal correction that we can take advantage of and buy the dip in preparation for another strong yearend rally. In the charts below I'll outline what could happen following Wednesday's news.

On a short-term basis the S&P 500 has been oscillating on either side of resistance near 1185 for over two weeks. The 1200 level and the 2010 highs near 1210-1220 should be overhead resistance. On a correction I would like to see a pull back toward 1150 or better yet 1130.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The tech-heavy NASDAQ composite has been exceptionally strong with a +19% gain off its late August lows. I'm looking for a brief rally toward the 2010 highs near 2530 and then a correction. I'm crossing my fingers that the NASDAQ sees a pull back toward the 2380-2360 area but it's possible the 2400 level will hold as support.

Daily chart of the NASDAQ index:

Weekly chart of the NASDAQ index:

I normally don't discuss the Dow Jones Industrial Average because it's only 30 stocks versus 500 stocks in the S&P 500 index and 3,000 components in the NASDAQ Composite. However, moves in the DJIA can impact investor sentiment. Currently the DJIA has rallied toward its 2010 highs and what should be significant resistance near 11,200. This is the perfect spot for the rally to fail and begin a correction back toward the 10,800-10,700 range.

Weekly chart of the Dow Jones Industrial Average:

Much like the S&P 500 the small cap Russell 2000 index has stalled at resistance and has been drifting sideways for the last two and a half weeks. The 710 level seems to be the top for the $RUT and I'm hoping for a pull back toward the 670-660 zone so we can launch new positions on the correction. If the $RUT rallies instead we can look for additional resistance near 720 and then at the 2010 highs near 740.

Daily chart of the Russell 2000 index:

In summary this seems to be the perfect week for the market's rally to finally end and a normal healthy correction to begin. However, no one has ever accused the stock market of being logical. While I expect some sort of sell the news move on the FOMC announcement there is no telling what could happen. The first move might be a trap or we could see an intraday spike higher on the FOMC news only to watch it reverse lower.

I'm not picking sides but what if Republicans don't do as well as the market expects them to on Tuesday. What if the Federal Reserve does not announce any quantitative easing plans on Wednesday? If the Fed does announce, what if the program is too small ($250 billion)? Or too big ($2 trillion)? What if the jobs data on Friday is a complete miss and shows up negative again? There are a lot of potential landmines this week. I'm even willing to consider the unlikely possibility that after almost three weeks of churning sideways that the market's rally continues and we see new 52-week highs before the end of November. Fortunately, the better bet seems to be wait for the correction and then initiate positions as stocks dip to (or rebound from) support.

- James