Stocks rallied again. The U.S. market is up four weeks in a row and poised to mark one of its best monthly gains on record. Investors continue to ignore bearish economic data and focus on positive headlines. It was a rocky week with big swings both directions but headlines out of Europe drove the market higher. Strength overseas weighed heavily on the U.S. dollar as both the euro and yen currencies rallied against the greenback. This helped fuel big gains for commodities. The stock market strength also drove the volatility index (VIX) to new two-month lows and a breakdown from the VIX's 30-47 trading range.

Currently the S&P 500 index is up +13.6% for the month of October but it's up +19.6% from its October low near 1,074. The NASDAQ composite is up +19.0% from its October intraday low. The small cap Russell 2000 index is up +26% from its October low.

chart of the U.S. dollar ETF (UUP):

chart of the Gold ETF (GLD):

chart of the Copper ETF (JJC):

Economic data last week was mixed. The S&P/Case-Shiller 20-city housing price index for August was bearish. Home prices fell -3.8%, which was worse than the -3.5% estimate. Another bearish report was the Conference Board's consumer confidence index for October, which came in worse than expected at 39.8 compared to estimates for a drop to 46.0. This contradicts the final October reading for the Consumer Sentiment data, which rose to 60.9 compared to the initial October reading of 57.5. Durable goods data showed a -0.8% decline in the headline number and a +1.7% gain minus the transportation component. Economists had been predicting -1.0% and +0.4%, respectively. Two of the most bullish reports this past week was a positive reading in China's PMI manufacturing survey done by HSBC plus the final estimate on the U.S. Q3 GDP data, which came in at +2.5%, which was better than the +2.3% estimate.

Europe & Greece

Naturally Europe was the main driving force behind the market's volatile moves. Early last week there were fears that there would be no progress made at the EU summit. This was especially true after the EU finance ministers postponed their Wednesday meeting. The EU summit continued without the bankers and leaders from all 27 EU members did meet on Wednesday. I was very surprised that Wednesday's session was not more negative for stocks. As of the close on Wednesday we had little in the way of details or confirmation of any significant agreements. It seemed that crucial details for the EU's rescue package would likely get postponed until November.

Everything changed on Thursday. Suddenly the market had some numbers it could hold on to. EU leaders said they would try to reduce Greece's debt burden with a 50% haircut as long as it was voluntary. The EU would recapitalize the banks and inflate the EFSF rescue fund to $1.4 trillion. This news fueled a significant amount of short covering and stocks delivered a very strong session. The major indices rallied to new two-month highs. The euro currency surged against the dollar.

chart of the euro ETF (FXE):

The general consensus among market pundits was that the EU's decisions had taken the worst case scenario off the table. Plus, it had kicked the can down the road well into 2012. Yes, I said kick the can. Europe's problems are not solved. Far from it. ECB President Trichet, currently on his way out the door before his successor takes over in November, acknowledged this in an interview this weekend. Even if an immediate default by Greece has been postponed the EU still has to worry about Italy and Spain as potential default candidates (they are the main reasons behind the EU's plans to boost the EFSF).

Major Indices:

The S&P 500 index has surged past resistance at 1250, 1260 and its simple 200-dma. The next stop looks like resistance at 1300 except that the market is very short-term overbought. A +20% rally in less than four weeks is just not normal. I'd like to think the 1260-1250 level will hold up as support but I can't say that with any confidence. A normal 38.2% Fibonacci retracement would mean a dip back toward the 1210-1200 area. I don't necessarily think the S&P 500 will dip that far in the immediate future but it's not out of the question. I suspect that if the 1260 level fails as support then the S&P 500 is probably looking at a dip toward the 1240 area.

Daily chart of the S&P 500 index:

2nd Daily chart of the S&P 500 index:

The NASDAQ composite has rallied +19% from its October lows near 2300. The breakout past 2700 and its simple 200-dma is certainly bullish on a technical basis. Yet the index looks overbought given the big gains. If the market does see a correction I would watch the 2600 area to act as support.

Daily chart of the NASDAQ Composite index:

The small caps have been big winners. The Russell 2000 index is up +26% from its October low. This past week produced a breakout past its late August highs and past resistance at its 100-dma and exponential 200-dma. My concern now is that the $RUT has stalled at long-term resistance near 760. I cautioned readers last week that the $RUT could rally toward the 760-770 area. If the stock market does see a correction I would look for support near 720 and if that level fails then the 700 level or its 50-dma.

Daily chart of the Russell 2000 index

Intraday chart of the Russell 2000 index

We have a very busy week for economic data. Now that the Europe situation has been put on hold the U.S. economic headlines are going to carry more weight. The key reports to watch are the Chicago PMI, the national ISM and ISM services indices, and of course the jobs report on Friday. Economists are expecting +105,000 to +115,000 new jobs in October. A better than expected number here could do a lot to keep this stock market rally alive.

One of the biggest events of the week is a two-day FOMC meeting that wraps up on Wednesday. No one expects the Federal Reserve to alter interest rates so the focus will be on the Fed's statement and comments on the U.S. economy. If that wasn't enough the Fed's decision will be followed up with a press conference by Fed Chairman Ben Bernanke. Thus far Bernanke has done a pretty good job cheerleading the economy but there is always a risk he says the wrong think and stocks tanks. Wednesday afternoon could be volatile.

- Monday, October 31 -
Chicago PMI (ISM) for October

- Tuesday, November 1 -
(National) ISM index for October
Construction spending
vehicle sales

- Wednesday, November 2 -
ADP Employment report for October
FOMC interest rate decision (end of two-day meeting)
Ben Bernanke press conference (after FOMC announcement)

- Thursday, November 3 -
Weekly Initial Jobless Claims
(national) ISM services for October
factory orders for September

- Friday, November 4 -
Non-farm payroll (jobs) report for October
monthly unemployment rate

The Week Ahead:

Looking ahead I suspect that traders could use any hiccup in the parade of economic data as an excuse to sell and lock in profits after a +20% bounce. Monday will probably be quiet as fund managers try to leave things unchanged for their fiscal year-end statements. Then the beginning of the month for November could be bullish as fund managers put new money to work. Only this time I wonder if they'll wait and hope for a pull back before buying stocks. I did mention that Wednesday could be volatile due to the FOMC meeting. I will point out that there was an increase in rumor activity surrounding a QE3 program by the Fed to help stimulate the U.S. economy. Since we've seen an uptick in positive economic news I seriously doubt the Fed is going to announce QE3 this week.

What does worry me is the November 23rd deadline for the "super committee" in Washington, which is charged with finding $1.2 trillion in spending cuts to reduce the deficit. This bipartisan group has to come up with a deal by Thanksgiving or there will be automatic cuts of $1.5 trillion. This "deal" to work together on reducing the deficit was crucial to getting the U.S. debt ceiling increase passed this past summer. The automatic cuts are supposed to be targeted at defense spending and entitlements and are said to be so deep that neither side wants this to happen. We'll have to wait and see how this plays out. With just over three weeks left I suspect we might get past this week without too many headlines. Yet the media frenzy could pick up significantly as we approach the final two weeks. This event could weigh on investor sentiment since Wall Street hates the unknown and no one knows how this is going to play out.

The good news tonight is that both the U.S. and Chinese economies seem to be showing some signs of improvement. The U.S. appears to be inching away from another recession while the Chinese appear to have engineered a soft landing for their red hot economy. I realize you've heard this before about China but it's been a constant on-again-off-again worry as economists and investors fret over how China tries to slow things down without throwing the global economy into a recession.

Plus, this past week actually produced some results out of Europe. Granted we still don't have a lot of details but this time the market doesn't seem to care. Two weeks ago EU leaders approve an eight billion euro loan to Greece, which postponed any default into 2012. Now the latest changes to the rescue fund, and a proposed 50% haircut on Greek debt should alleviate a lot of concerns. Just keep in mind that this is not a done deal. The 50% haircut on Greek debt is supposed to be voluntary. The bank recapitalization plan still has to iron out the kinks.

The market's trend is still higher but I strongly suspect we will see a market pull back soon once October ends and we roll into a new calendar month. A big portion of this move higher in stocks has been a chase for performance by fund managers. No one wanted to get left behind so portfolio managers were chasing stocks higher. Once their fiscal year ends on Monday they will all breathe a sigh of relief. Stocks could see some window "undressing" the rest of the week.

Strategy wise we can look to buy the dip but the challenge is knowing when to jump in. After a +20% rebound in the S&P 500 the pull back could be significant. Fortunately the November-December time frame is historically a very bullish one for stocks. Investors can focus on key support levels and wait for the market to test it or bounce before putting new money to work.

- James