It proved to be a disappointing week for stock market bulls. Concerns over Greece, economic data in the U.S. and a round of bearish earnings numbers helped undermine investor confidence. Stocks managed a bounce off their Tuesday lows but the rebound stalled, which produced a three-week trend of lower highs and lower lows. The market's major indices look like they are in jeopardy of breaking their longer-term bullish trend of higher lows.

The situation in Greece has graduated from the back burner to front and center again. The country's debt was downgraded again. This time by the Fitch rating agency to junk bond status. Of course this really shouldn't be a surprise. Investors have been growing more and more concerned that Greece will default on its debt. Readers of this newsletter know we've been expecting that Greece will eventually default on its debt or see some sort of restructuring of its debt, which is merely a nice way of saying "default". Restructuring usually means bad news if you're a debt holder. It was always a matter of when, not if Greece would default.

Sure, sure, you've heard all of this about Greece before, right? Do you remember the firestorm over Greece and its bailout a year ago? This past week the yield on a Greek 10-year bond surged to 15.8%. This is more than 100% higher than its yield a year ago. That's telling you investors are demanding big payouts to hold this debt because they're worried the country will default.

It's not really about Greece. It's about the structure and safety of the EU and euzo-zone. If Greece defaults or chooses to leave the euro zone what does that mean for Portugal and Spain. Spain is the real worry because their economy and debts are so much larger than Greece. There are a lot of very important European banks holding massive amounts of debt for Greece, Portugal and Spain. We're going to hear more about Portugal and Spain soon. Both countries need to roll over significant amounts of debt in the next several weeks. The total is about 20 billion euros worth of bonds. If the debt auctions don't fare well it will pour gasoline on the fire for Europe's debt worries.

Weakness in Europe's debt markets will send the euro currency falling, which will boost the dollar. Normally a rising dollar is bearish for commodities. On a positive note falling commodities should mean less inflation here at home. After a week of churning sideways the euro already looks poised to resume its down trend and the U.S. dollar is poised to resume its up trend. While I'm on the subject of Europe this past week saw some concerns about the growth rates in Germany, which is Europe's largest and arguably strongest economy. Here at home the parade of economic data has been distressing. The Philly Fed survey seems to be imploding. A month ago the Philadelphia Federal Reserve index dropped from 43.4 to 18.5. This week the same index plunged from 18.5 to 3.9. Economists had been expecting a minor drop to 17.5. This is a HUGE drop in just two months.

Meanwhile the data on the real estate industry is not improving. Spring is here. New and existing home sales should be improving. That's not the case. Existing home sales fell from an annualized pace of 5.09 million units to 5.05 million in April. Analysts had been expecting a rise to 5.23 million. Housing starts are also struggling. April housing starts came in at 523,000, which was down from the prior month's 585,000 and well below expectations. Building permits were also declining and came in at 551,000. The new home sales data for April comes out on Monday and economists are looking for 300,000.

On top of the disappointing economic news were some earnings misses. Retailers Aeropostale (ARO) and The Gap (GPS) were making headlines. ARO reported earnings inline, missed on the revenue number and then guided Q2 lower. GPS managed to beat estimates by a penny, but then issued a warning for the second quarter. The negative headlines overshadowed the earnings beat by rival Abercrombie & Fitch (ANF) who delivered a profit 15 cents better than expected. ANF's revenues were above estimates and margins were also significantly higher. The retail sector could see more profit taking if investors start to worry about the consumer. Currently the RLX retail index is only down -3.6% from its all-time high set just two weeks ago.

Last weekend I warned readers to watch the 1330 and 1320 levels on the S&P 500. Last Monday's close under 1330 looked bearish and Tuesday saw a drop under 1320 before the market produced an intraday bounce. Now the bounce has stalled and the S&P 500 has a three-week bearish trend of lower highs and lower lows. If this trend continues then we're probably looking at the S&P 500 falling to its 100-dma near 1313-1315 and if that level fails then a drop to the 1300 level. If you're feeling optimistic then you can argue the S&P 500 is forming a bull-flag consolidation pattern only without much of a flag pole. If a reversal higher occurs then a move past the 1345-1350 zone could spark some short covering and send us back toward the early May highs.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ Composite has been a lot more volatile. The breakdown under 2800 saw a drop toward technical support at its 100-dma. Now the oversold bounce is already stalling. It looks like the NASDAQ is ready to slip lower again. If the 100-dma fails then it could see a plunge toward the 2700 area. I will repeat my comments from last week. A close under 2700 would look ominous for tech stocks.

Daily chart of the NASDAQ Composite index:

What worries me is the breakdown in the small cap Russell 2000 index (also evident in the IWM Russell 2000 ETF below). Three weeks ago the $RUT produced a bearish reversal pattern. Stocks have continued to slip since then. This past week saw the $RUT (and IWM) break its trendline of higher lows. If we see the $RUT close under its 100-dma it could be forecasting a much more significant correction lower. Right now the short-term trend is down!

Weekly chart of the IWM (Russell 2000) ETF:

This coming week is full of economic reports. New home sales and pending home sales will shed more light on the real estate sector. Personal income/spending and the Michigan Sentiment numbers for May will highlight the consumer. The durable goods orders and the second estimate on the Q1 GDP will focus on the economy.

Overall I don't see a lot of changes from my comments last weekend. Once again the U.S. markets will be held hostage to the situation with Europe's PIGS countries and the strength or weakness in the euro and dollar. The U.S. market lacks leadership. Small caps look poised to underperform as investors look for safety in large cap blue-chip names. Yet if the market accelerates lower even the blue chips will fall, albeit to a lesser degree.

I will steal a comment from Jim in the OptionInvestor newsletter. Investors are in a "why buy" period on the calendar. Earnings season is over. We're in the worst six months of the year (remember the sell in May strategy) and we're facing the prospect of slow, summer doldrums. Economic data seems to be suggesting a slowdown in the U.S. economy. Europe is slowly losing its grip on the Greece situation. I heard someone refer to the meltdown in Greece is like watching a car crash occur in super slow motion. Plus, if that wasn't enough, we have a dark cloud of uncertainty surrounding the U.S. markets when QE2 expires at the end of June, which is less than six weeks away. The one thing the stock market hates the most is uncertainty. You could say the market is lost and looking for direction again. This could be a pivotal week as stocks decide to bounce and resume the up trend or fall and break the up trend. There is always the chance stocks churn sideways and postpone the decision (up or down) another week.

I am suggesting a defensive, step back and watch mindset. I would not rush to buy the dip this week.

- James