Stocks have rallied to new two-year highs. Gains last week were fueled by strong moves in the financials and insurance sectors, plus relative strength in the small caps. Both the S&P 500 and small cap Russell 2000 have broken out past key resistance levels. December's historical trend for bullishness is off to a strong start this year. Aside from some volatility early last week the action in the U.S. dollar and commodities seemed to flatten out. Gold futures tagged new all-time highs on Tuesday before suddenly reversing course.

One of the most notable events last week was the improvement in consumer confidence. The preliminary reading for December showed consumer confidence rising from 71.6 in November to 74.2. Economists were only expecting an improvement to 72.5. This is a six-month high and the uptrend in confidence should bode well for consumer spending patterns. You've heard it before. Consumer spending accounts for nearly 70% of the U.S. economy.

General Electric (GE) made headlines when it raised its quarterly cash dividend for the second time this year. When companies raise their dividend investors see it as a sign of confidence in the future.

The S&P 500's breakout past resistance in the 1220-1225 zone is very encouraging. Not only is this a breakout past the 2010 highs it is also a rally through resistance at the 61.8% Fibonacci retracement of the bear-market decline (see the weekly chart below). The S&P 500 closed the week at 1240. Readers might recall that the inverse head-and-shoulders pattern from the spring and summer was projecting a 1240 target. Now that we're hear this could be some short-term resistance. That's okay with me. I'd love to see some profit taking here so we can use the pull back as a new entry point to launch new positions. The S&P 500 should find support near 1225-1220 now since broken resistance tends to act as new support. The next major obstacle for this index is the 1300 area.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The tech-heavy NASDAQ index is very close to three-year highs. Broken resistance in the 2550-2500 zone should be new support. The next significant hurdle for the NASDAQ is the 2725-2730 area. I would keep an eye on the 40-dma, which is where traders were buying the dip last month.

Daily chart of the NASDAQ index:

Strength in the semiconductor sector has played a big part in the NASDAQ's rally. The SOX index has been very strong with a breakout past resistance near the 400 area. Now the SOX is nearing its next hurdle with resistance in the 420-425 area. With the sector looking overbought and extended it might be time to expect some profit taking.

Weekly chart of the SOX semiconductor index:

The action in the small cap Russell 2000 index ($RUT) this past week is very positive. The 760-765 zone was major resistance and the $RUT powered right through it. That doesn't mean that the $RUT is not overbought and due for some profit taking. It is. However, bulls are clearly in control here and fund managers seem confident enough to bet on the small caps as they look ahead into 2011. Broken resistance near 740 would be support but I'm not sure the $RUT would decline that far. Keep an eye on the short-term moving averages.

Daily chart of the Russell 2000 index:

Weekly chart of the Russell 2000 index:

Looking ahead we have a very full economic calendar this week. The big event will be the FOMC meeting on Tuesday, Dec. 14th. No one expects a change in interest rates. The news will focus on the Fed's comments, their economic outlook, and any updates on the QE2 program. Tuesday will also bring the Producer Price Index (PPI), which looks at inflation at the wholesale level. We'll also hear the November retail sales numbers. Plus, Tuesday will bring the October business inventory data. Wednesday is another busy day with the Consumer Price Index (CPI), which is a wider look at inflation. The New York Empire State manufacturing survey is released on Wednesday. Plus, we'll see the latest industrial production and capacity utilization numbers. Thursday will bring the November housing starts and building permit data. Plus the weekly initial jobless claims. The big report on Thursday could be the Philadelphia Fed survey.

We still need to keep an eye on China. The market has been worried that if China raises their interest rates they might go too far and slow down their economic growth, which in turn would slow down the global recovery. Of course we've been talking about a potential rate hike in China for months so when it finally happens the market may not react with the same volatility it would have weeks ago. China is facing a challenge with rising inflation so they need to do something. On Friday the Chinese government just raised bank reserve requirements for the umpteenth time this year. I'm exaggerating but they have raised bank requirements several times to slow down loan growth. There was some speculation that China could announce a rate hike this weekend or on Monday. Let's hope they do. That could be the catalyst we need to spark some profit taking in the U.S. market. That way we can use the pull back as a new bullish entry point.

Overall the mood on Wall Street is improving pretty fast. More and more firms are raising their 2011 yearend targets and/or raising their expectations for U.S. GDP growth. This is encouraging and the positive attitude could be contagious. My market bias remains very bullish although short-term stocks look a little overbought and due for a pullback. We want to buy the dip when it happens. My concern is that money managers might start chasing stocks higher and we won't see a big enough dip! I want to warn readers not to chase it. If you are a short-term trader then you have more flexibility but we're buying LEAP options with multi-month time frames. Stay patient and wait for your entry point. Of course that entry point may end up being a breakout higher (depending on the stock you're following).

- James