Schizophrenic ~ "experiencing or maintaining contradictory attitudes, emotions, etc."

That's one of the informal definitions of schizophrenic on and it certainly seems to apply to the stock market. From November 11th to the end of Thanksgiving week the S&P 500 index plunged -8.3%. This past week the same index rebounded +7.4%. These extremely sharp moves are hard to trade. Unfortunately for traders most of this week's gains were fueled by super strong opening spikes, fueled by short covering on Monday and Wednesday.

Last week started off with a bang in Europe. Hope for a new eurozone "fiscal pact" to bring stability to the EU region on Monday launched big gains for the European markets. Plus there was hints that the IMF might be trying to find a way to lend money to Italy. The rally stalled a bit on Tuesday but stocks posted another gain. Then a parade of positive news sent stocks soaring on Wednesday morning. The big headline was a coordinated effort by six central banks including the Federal Reserve and ECB to provide more liquidity to Europe's struggling banking system. China announced they were lowering their bank reserve requirements, which suggested they were less worried about inflation and more concerned about keeping their growth at a strong pace. This was positive news after nearly a year of China trying to tap on the brakes to slow down their economy.

The good news on Wednesday kept coming with the ADP report and the Chicago PMI. The ADP employment report showed a jump of +205,000 jobs in private payrolls compared to estimates for only +125,000. The Chicago PMI rose from 58.4 in October to 62.6 in November. Economists had been expecting a decline. All of this positive news fueled huge gains on Wednesday with the S&P 500 index surging almost 52 points, the NASDAQ rallied nearly 105 points and the Dow Industrials were up almost 500 points.

The ADP numbers offered hope for positive news on Friday's nonfarm payroll data. The November jobs number came in at +120K, which was generally in-line with expectations but the Labor Department revised October's number from +80K to +100K and revised September's jobs number from +158K to +210K. The unemployment report, calculated off the Household survey, fell from 9.0% to 8.6%. Unfortunately a large part of that move was due to 320,000 workers giving up on their search for a job so they were no longer counted as part of the work force.

Additional economic data this past week was a disappointing new home sales data for October, which came in at an annual pace of 307,000. November's same-store sales numbers from the retailers were mixed in spite of all the Black Friday hype. The U.S. ISM manufacturing data improved from 50.8 in October to 52.7 in November, which was better than expected. Yet China's PMI manufacturing data fell from 50.4 in October to 49.0 in November.

Major Indices:

Is it a coincidence that the S&P 500 index rallied off the 50% retracement of its October move higher? The answer is probably "yes" but the November 25th close at 1158 offered a nice line-in-the-sand for traders to bet against. I cautioned readers that any rebound might end up being just an oversold bounce. Unfortunately we've moved from oversold with the -8.3% drop to overbought with last week's +7.4% surge. You'll notice that the rally has stalled exactly at resistance near its trendline of lower highs. The S&P 500 also has potential resistance at its simple 200-dma near 1265.

Now a breakout from here could definitely fuel more short covering. If the S&P 500 can rally past 1265 then the next hurdle is 1285 and then 1300. On the other hand, stocks could see some profit taking after such a big one-week move. The 1220 and 1200 levels are short-term support.

Daily chart of the S&P 500 index:

The NASDAQ composite has seen an equally impressive bounce (+7.5%) for the week. Now the index is resting under its simple 200-dma and a trendline of lower highs. The 2600 level might offer some short-term support but if stocks retreat I would expect a dip toward the 2550 area. Should the NASDAQ manage to break the trend of lower highs then we're looking at a potential run at its 2011 highs.

Daily chart of the NASDAQ Composite index:

The small cap Russell 2000 index delivered a +10% bounce off its 61.8% Fib retracement (see chart). It looks like the $RUT has broken through a trendline of lower highs but it's still struggling with the exponential 200-dma as resistance. Small caps used to benefit from big gains in January and it became so dependable that market watchers called it the "January effect". Then investors started front running the move and the January effect started happening earlier and earlier until small caps were seeing big moves in December. If this market rally continues I would expect the small caps to outperform. Just look for likely resistance at its October high and the simple 200-dma. The 700 level is probably short-term support.

Daily chart of the Russell 2000 index

I would also keep an eye on the transports and the financials. Traditionally the market cannot sustain a rally without support from both sectors. The Dow Jones Transportation average has rallied right back to resistance near the 5,000 level and its simple 200-dma. Meanwhile the XLF financial ETF has seen a strong bounce last week (+9.5%) but it's still struggling with a long-term trend of lower highs, thanks to ongoing worries over Europe's potential risk to U.S. banks.

Daily chart of the Dow Jones Transportation Average

Weekly chart of the XLF Financial ETF

This week the U.S. economic calendar is a lot lighter but these events will be overshadowed by headlines in Europe. Monday's headlines will be dominated by any word from a meeting between German leader Angela Merkel and French leader Sarkozy. They are meeting in Paris to argue over how to handle the debt crisis and hopefully present a united front in the EU summit on Friday. The new austerity-focused Greek government will vote on their 2012 budget on Wednesday. If the budget doesn't pass then they may not get the next round of bailout funds. The ECB will release their next interest rate decision on Thursday and most are expecting the new ECB President to lower rates again. Meanwhile there is growing concern that China could be facing a tough time to avoid a hard landing as their economy slows. The Chinese CPI/PPI inflation data will make headlines on Thursday. Friday will hold the umpteenth EU summit as leaders wrestle with how to solve their toxic debt problem.

- Monday, December 5 -
Factor Orders for October
ISM Services for November
Germany's Merkel & France's Sarkozy meet in Paris

- Wednesday, December 7 -
Greece votes on its 2012 budget

- Thursday, December 8 -
Weekly Initial Jobless Claims
Wholesale Inventory data for October
ECB interest rate decision
China's CPI/PPI data released

- Friday, December 9 -
Michigan (consumer) Sentiment for December
EU Summit

The Week Ahead:

As you might expect the week ahead will be dominated by news from Europe. Any progress on some sort of solution will lift stocks and any setbacks will spark new selling efforts. There is a risk that Spain could see its credit rating downgraded again but that's not necessarily surprising. There have been worries over the last few weeks that France might actually lose its AAA credit rating, which would be very bad for the EU region since France is a major part of any rescue package for the struggling EU members. The calendar above outlines the events to watch. Of course you'll also want to keep an eye (or ear) open for news on European bond yields. Italy's 10-year yields are still in the 7% range. Spain and France have seen their bond yields creep higher as well. Any significant spike higher in bond yields will spook investors and could spark another sell-off.

It is worth noting that seasonally the month of December is traditionally a bullish time of year for stocks. The first week of the month typically sees a rally with the normal influx of mutual fund inflows being put to work. Then later in the month you'll normally have mutual fund and hedge fund managers chasing stocks as they try reach for performance or window dressing their portfolios for the end of the year. This is your traditional "Santa Claus" rally. Then there is the retail investor that could decide to put part of their yearend Christmas bonus to work in the stock market. I say "could" because the volatility in this market could just as easily scare them away.

Another thing to keep in mind is the next FOMC meeting is December 13th. There has been slow but growing expectation for some sort of hint at a new QE3 program to help stimulate the U.S. economy. If China's economy is starting to slow down and now Europe's economy is slowing down, then the Fed might try and preemptively rev the U.S. engine to keep it from slowing down too.

Last week's bounce in the market is encouraging but until the major indices breakthrough their trend of lower highs, then the path is technically still lower. I remain very cautious when it comes to launching new positions. If you do choose to put money to work in the market I would keep your position size small to limit your risk.

- James