The U.S. stock market celebrated the fourth of July a little early this year because there were plenty of fireworks on Wall Street this past week. A week ago it looked like the S&P 500 index might breakdown under key technical support at its simple 200-dma. Now five trading days later the major U.S. indices are all up between +5.5% to +6.5% and back in positive territory for the year. It was the best weekly performance in twelve months.

The bond market has been in rally mode for almost three months. That changed dramatically this past week. With the end of QE2 looming on June 30th there was a sudden multi-day sell-off as investors yanked money out of the bond market. It looks like a lot of that cash was funneled into equities. Combine this influx with some end-of-quarter window dressing and place it in front of a long holiday weekend and you get low-volume summer trading days that exacerbate the move higher.

Before we look at what happened in the markets lets quickly touch on some of the headlines and economic data that influenced trading. Early in the week the U.S. personal income numbers came in at +0.3% but spending was unchanged. This was actually a disappointment as economists were looking for more. Meanwhile the Greece problem was heating up but cooperation between Germany and France presented a unified front for the EU's stance on Greece's debt problems, which soothed investors' fears.

Pending home sales for May surged +8.2%, blowing away estimates for a -0.6% drop. A better than expected Richmond Fed manufacturing survey helped set a positive tone for the market. Investors were ignoring the photos and headlines of massive rioting in Greece and instead applauded news that the struggling country's parliament had passed the new five-year austerity program. This program was required by the EU and IMF before they would release the next round of bailout money to Greece. This vote was followed up the next day with a positive vote in parliament on the implementation plan.

Meanwhile the weekly initial jobless claims continue to disappoint. Last week these came in at 428,000, still higher than expected. This number has been consistently above the 400K level and doesn't bode well for the monthly jobs report due out this week. Fortunately we continued to see positive economic data from the manufacturing sector. The Kansas City Fed manufacturing survey reported a sharp rebound higher. Overshadowing this report was the Chicago PMI, which reversed higher. Economists had been expecting the Chicago area PMI to drop to 54.0 but the survey rose to 61.1.

The next day the markets focused on the U.S. ISM manufacturing index, which rose to 55.3 compared to estimates for a drop to 51.1. Remember, numbers under 50.0 indicate contraction and numbers over 50.0 show growth. Overall the balance of data for the week was much better than expected. This new show of strength in the U.S. is suggesting the soft patch in the economy could be on its way out. Many believe that most of the economic weakness in the second quarter was due to the supply chain disruptions in Japan. Thankfully the global impact from Japan's disaster should be healed at this point.

The stock market's reaction to this generally positive economic data along with the seasonal effects, the window dressing, and rotation out of bonds produced a huge move higher. The S&P 500 was up five days in a row and rallied through resistance near 1300, 1320, and both its 50-dma and 100-dma. Last week's rally also broke the intermediate trend of lower highs.

Optimistically this could be the start of a midsummer rally but we'll have to get past the June jobs report this coming Friday and we need to see strong numbers as Q2 earnings season begins. Naturally after such a big move some profit taking would be expected. It wouldn't surprise me to see the S&P 500 consolidate sideways for several days as investors wait for the jobs report and the first week or two of earnings data.

On the other hand, if the S&P 500 were to stall right here near the 1340 area and eventually roll over it would look like a huge bearish head-and-shoulders pattern that has taken more than six months to build. If this is an H&S pattern then a breakdown under the neckline in the 1260-1250 area would forecast a drop toward the 1150 area. I'm not making a forecast here. I'm just looking at possibilities.

On a short-term basis The S&P 500 could have support near 1320 and if that level fails then support near 1300.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

Naturally we see a very similar move in the NASDAQ composite. Technology stocks were some of the market's best performers last week. The NASDAQ's rebound pushed through resistance at 2700, 2750, 2800 and its 50 and 100-dma. The index is now closing in on resistance in the 2840-2850 zone. Of course the NASDAQ is very short-term overbought here and we should expect some profit taking. Hopefully it will find some support near 2750. Like the S&P 500 there is the chance that the NASDAQ is building a huge H&S pattern.

Daily chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index:

We see the same moves in the small cap indices. It is encouraging to see that the rally was broad based and not just focused on the large caps. The potential for an H&S pattern isn't so clear in the small cap index or ETF. On a short-term basis the Russell 2000 ETF should find support near 82.00 and its converging 50 and 100-dma.

Daily chart of the Russell 2000 ETF (IWM)

Weekly chart of the Russell 2000 ETF (IWM)

I am still watching the SOX semiconductor index. Chip stocks saw their rally accelerate on Thursday and Friday. The SOX powered past resistance at 410 and its 200-dma but stalled at resistance near the 420 level. Plus the SOX has not yet broken the bearish trend of lower highs (see chart).

Weekly chart of the SOX semiconductor index:

One of the market's best performers last week was the transportation sector. The Dow Jones Transportation index surged more than +6% and set a new all-time closing high. This is very bullish. Dow Theory suggests we can't have a sustained market rally without the transports. Long-term the trend here is still very bullish. Short-term the transports are now overbought and due for some profit taking.

Weekly chart of the Transportation index:

Looking ahead the economic calendar will be dominated by the June non-farm payroll report on Friday, July 8th. Estimates are all over the place but consensus is about +85,000 jobs in June versus +83,000 in May. A better than expected jobs report could easily fan the flames for this new up-trend in stocks. It would not surprise me to see the market stall mid week as investors wait for the report. Due to the market holiday on Monday the ADP employment report, normally published on Wednesday, will come out on Thursday.

- Monday, July 4 -
U.S. stock markets are closed (holiday)

- Tuesday, July 5 -
May Factory Orders

- Wednesday, July 6 -
ISM Services index
Challenger, Christmas & Gray mass layoffs report

- Thursday, July 7 -
weekly initial jobless claims
ADP Employment report

- Friday, July 8 -
Non-farm payroll (jobs) report for June
Unemployment rate
Wholesale inventories

Now that the Greece problem has been kicked down the road another month and Q2 earnings don't start for another week, what will investors focus on? Odds are the market might turn its focus to the U.S. debt ceiling debate. Democrats and Republicans are still fighting over this. We have to have a signed agreement to raise the debt ceiling by July 22nd to avoid a default in early August. Technically we reached our debt ceiling weeks ago but through various accounting tricks the U.S. has been able to juggle its bills until August.

The final outcome will be a vote to raise the debt ceiling and it will get passed. The question is who will blink first? Will it be the Democrats or the Republicans? Many of the new Republicans were placed in office by the Tea Party movement with a focus to lower government spending and debt. There is going to be a lot of deal making and a lot of rhetoric hitting the airwaves over the next month. We might have two weeks of calm with investors focused on corporate earnings starting the second full week of July. Yet if congress can't come together and agree on a deal by July 15th you can be everyone will be focused on this issue the following week!

As long-term LEAPS traders what do we do now? The stock market just ended almost two months of declines with a violent move higher. The real issue here is earnings. The job report this Friday is important but we've seen a bad number before and the market didn't collapse. Hopefully the debt ceiling issue is just a circus sideshow that will eventually get solved. Now that we're seeing a sudden improvement in economic data the focus should be on earnings. While we will certainly see some bombs due to a worse than expected second quarter the investors and analysts want to hear guidance for the third quarter and beyond.

Traditionally, the market likes to peak in the second week of July and then slide lower into early October. Now that doesn't always happen and I've got a feeling it might not happen this year. Of course feelings don't count for much on Wall Street. What we do know is that stocks are short-term overbought. I am reluctant to chase stocks here at current levels. We don't know if the market will see any follow through higher, will it reverse lower again, or will it consolidate sideways?

I am suggest that we remain patient. We do not want to launch new bullish positions at the top of the right shoulder to a bearish H&S pattern (see my comments above). We're going to have to wait and see how the markets react to earnings news. A question to ask is, "did last week's rally save us from a deeper correction lower? or did it merely postpone the correction until earnings season?" I don't want to sound too bearish here. This past week has healed a lot of technical damage over the last month and my market view has improved significantly. There are plenty of stocks that are seeing a huge bull market. We just need the right entry point. Unfortunately today is not that entry point.

Enjoy your fourth of July holiday!

- James