It turned out to be a rocky week for the U.S. stock market. Concerns over the EU's weakest members continues to plague the market both here and abroad. Fed Chairman Ben Bernanke made his semiannual appearance before congress this past week. Economic data was mixed. Earnings season began with stronger than expected results. Yet it was the debt ceiling debate that seemed to garner most of the headlines. By the closing bell on Friday the major averages were down more than -2% for the week.

The problems started last Monday with concerns surging over Italy's debt and worries the country might follow Greece in need of a bailout. Markets around the globe were selling off and the dollar was rising versus the euro. Four days later a very motivated Italian government managed to pass significant austerity measures in an effort to assuage fears over their fiscal strength.

On Wednesday Mr. Bernanke gave his testimony before congress. He mentioned the potential for QE3 and the market saw an intraday rally. This helped push the dollar lower while gold soared to a new all-time high. The very next day with Bernanke before the Senate he seemed to back away from any QE3 talk and stocks sank again.

Last week also saw the latest GDP data out of China with +9.5% growth last quarter. This seemed to soothe fears that the country might see a hard landing as it tries to slow down growth. There were some analysts that felt this was actually too slow and that China needed double-digit growth to handle their population's migration from the fringes into the major cities. Elsewhere in the world the EU released their results for the European bank stress tests. The test results showed that 82 of the 90 banks tested passed. Those that failed only needed 2.5 billion euros worth of capital. Most analysts were skeptical of the results, since many were expecting north of 25 billion euros worth of capital needing to be raised.

One of the biggest topics of the week was the ongoing debt ceiling debate between democrats, the republicans, and the White House. The lack of progress on a deal has the markets worried they may not reach one in time. Both Moody's and Standard & Poor's put the U.S.'s triple-A credit rating on watch for a possible downgrade.

Alcoa, Google, J.P.Morgan, and Citigroup were the biggest earnings headlines last week. Alcoa missed by a penny but beat on revenues. GOOG, JPM, and C all beat the estimates. GOOG saw a massive rise of almost $70 on Friday in reaction to a terrific quarter. Yet JPM and C saw their intraday gains fade. Citigroup closed on its lows for the week.

In economic news the results were mixed. The Consumer Price Index (CPI) for June fell -0.2%. Economists were only expecting -0.1%. The New York Empire State manufacturing survey rallied from -7.8 in June to -3.8 in July. Numbers under zero still represent contraction. Analysts were looking for a bounce back into positive territory in the +7 area. Unfortunately, this is the first time in more than 24 months that the Empire State survey has produced back to back negative readings. The Consumer Sentiment readings for July were also a disappointment. Sentiment sank from 71.5 in June to 63.8 in July. These are the lowest levels in over a year. Normally analysts try to correlate falling consumer sentiment levels with falling consumer spending. Consumer spending accounts for almost 70% of the U.S. economy.

A week ago I had cautioned readers that the market was still overbought and due for some profit taking. While the action was bearish last week so far that's what it looks like - profit taking. The S&P 500 broke down under what should have been support near 1320 and near its 50 and 100-dma. Yet the selling could not break technical support near the 50% retracement of the rally off its June lows. The S&P 500 should have additional support at 1300. If the 1300 level fails then the 1280 area is next and this bill be bolstered by the rising 200-dma. A breakdown under the 200-dma would be very bearish for stocks. I also want to point out that the weekly chart is reason for concern. The S&P 500 could be forming a bearish H&S pattern.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

After three weeks of big gains the NASDAQ finally succumbed to some profit taking with a -100 point drop at Thursday's low. The NASDAQ managed a bounce from its 50 and 100-dma but the short-term trend is still down. We don't know yet if the NASDAQ is stuck in a massive 2600-2900 trading range or if it too is building a bearish head-and-shoulders pattern. On a short-term basis the 2750-2740 area should offer some support. Beyond that the 2700 level is likely support.

Daily chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index:

The Russell 2000 index was off -3.2% for the week at its worst levels on Thursday. The small cap index seemed to find some support at the 100-dma but the short-term trend is still down. The $RUT might find some support in the 820-810 area but the chart is messy. On a positive note we do not see the same potential H&S pattern on the weekly chart but the $RUT still has a lower high. Right now the easiest answer is the small caps are just seeing profit taking after three weeks of big gains.

Daily chart of the Russell 2000

Weekly chart of the Russell 2000

The semiconductor stocks were big losers this past week. Earnings results and guidance from the likes of NVLS and MCHP sent the group plunging lower. The SOX has failed at its 50-dma and near resistance at 420. Now the index is testing support at its June lows. It's also nearing the long-term trendline dating back to 2009. It seems the path of least resistance for this key group is down. Plus the 50-dma just crossed under the 200-dma, which is normally a very bearish signal.

Daily chart of the SOX semiconductor index:

Weekly chart of the SOX semiconductor index:

We continue to watch the Dow Jones Transportation index. The group saw a sharp sell-off last week and fell through their 50-dma. Friday the sector seemed to find some support at its 100-dma. I am concerned with the weekly chart. The last three candles form a bearish reversal pattern. For the moment the long-term trend is still up. A close under that trendline of higher lows would be very bearish for the sector and the market as a whole.

Daily chart of the Transportation index:

Weekly chart of the Transportation index:

Looking ahead the economic calendar is pretty light. We'll see a lot of housing data. The biggest report is probably the Philly Fed report on Thursday.

- Tuesday, July 19 -
Housing Starts & Building Permits

- Wednesday, July 20 -
Existing Home Sales for June

- Thursday, July 21 -
weekly initial jobless claims
Philadelphia Fed manufacturing survey

This week is very busy with almost 300 companies reporting Q2 earnings results. There will be 14 of the 30 Dow components report and over 110 of the S&P 500 index reporting. Normally earnings announcements would dominate the headlines but the debt ceiling fight could steal the spotlight. August 2nd is the deadline to raise the debt ceiling or the U.S. is in a world of trouble. Officials want to reach some sort of compromise by July 22nd so there is time to get the necessary legislation passed prior to August 2nd. If we reach Aug. 2nd without a deal then odds are the country will continue to pay the interest on its bonds to avoid a technical default and just not pay something else (maybe shut down non crucial government services?). Unfortunately, we would probably end up losing our triple-A credit rating, which would cause us plenty of pain with higher interest rates.

Right now I am market neutral. One down week does not make a trend and we were expecting some profit taking anyway. Bigger picture the market's upward momentum has stalled and the major indices could be forming a bearish head-and-shoulders top formation. This week's earnings results will be crucial. Do the better than expected numbers continue to roll in? What will the general trend for guidance be? Are corporate executives still cautious or do they see a stronger second half?

I am still under the belief that a debt ceiling deal will get done and that right now we are merely watching an epic game of brinksmanship from both democrats and republicans. However, there have been some comparisons to the TARP deal. The first time congress tried to pass the TARP deal the vote failed and the market plunged sharply. I suspect that if we do not reach a debt deal by the necessary deadlines we could see the U.S. markets cascade lower as investors seek the safety of cash.

Therefore it seems that the safest bet today is to just step back and watch. If anything I would suspect that volatility might spike as we get closer to the informal July 22nd deadline for a debt deal. Nimble traders may want to consider some short-term calls on the volatility index (VIX) but that's just a speculative bet. If you are compelled to launch new call LEAPS positions then I would definitely keep your position size small both to limit your risk and have some cash available just in case we see a better entry point at lower levels in a few weeks.

- James