The stock market survived the latest EU summit and ended the week on a positive note. The prior three weeks had been extremely volatile and stocks stalled Monday through Wednesday with the S&P 500 churning in a 20-point range while investors waited for news from Europe. Investors turned nervous on Thursday with the market down -2% only to see equities rebound when the EU didn't dissolve on Friday. Forgive me for being a little cynical here. Once again EU leaders have agreed to another vague plan to save the euro experiment. All they succeeded in doing was kicking the can down the road another three months (they hope). The S&P 500, NASDAQ Composite, and Russell 2000 indices all ended the week right underneath resistance and their multi-month trendline of lower highs.

One of the biggest headlines of the week came out on Monday. The Standard & Poor's rating agency placed all 17 euro zone nations on creditwatch negative for a potential downgrade in the coming months. This should have spurred EU leaders to stronger action. S&P said they will review the latest agreements from Friday's summit, which might delay any downgrade. Given the lack of any true progress from the EU on Friday, what do you want to bet that we see Standard & Poor's issue new downgrades before the end of the first quarter of 2012?

Meanwhile the European Central Bank (ECB) lowered interest rates by 25 basis points on Thursday. That was in-line with expectations but markets were unnerved by news that the decision to lower rates was not unanimous and that the ECB's economic outlook had turned more cautious. I don't see why that was a surprise. How could their economic outlook improve with so many of the EU nations are bordering on recessions? People are hoarding cash. Greece is seeing a run on their banks as average citizens have been pulling money out for months (wouldn't you?). You have multiple nations focused on austerity, which means less government spending, less economic activity, higher unemployment. I am not arguing that these EU nations should not be cutting their government spending but the natural effect of austerity reforms is less economic activity. If caution from the ECB wasn't enough the European Banking Authority's latest stress tests were unveiled on Thursday, adding more concern for the major European banks.

The major economic reports out last week were mixed. The U.S. ISM services index for November fell to 52.0, which was below expectations but remains in growth territory. Factory orders for October dropped 0.4%, which was generally in-line with estimates. The weekly initial jobless claims dropped to 381,000, which was better than expected and definitely a move in the right direction. Consumer sentiment for December rallied 3.6 points to 67.7, which is the highest reading since summer. Overseas the latest CPI and PPI readings on inflation in China both declined, which was better than expected.

The biggest event was Friday's conclusion to the latest EU summit. There was a lot of expectation going into this event. Some were expecting new treaties to be drafted. Many believe that this debt problem in Europe is not going away until the ECB steps up as the lender of last resort but the new ECB President said this week that won't happen. So what did the EU leaders agree to on Friday? It appears they've all agreed to stricter rules on tighter fiscal regulations, automatic penalties if individual governments don't comply with the EU standards, and an agreement to kick start the European Stability Mechanism (ESM) that will begin in July 2012 instead of in 2013. What is really surprising is that they actually got 26 of the 27 EU nations to agree to this new accord. The United Kingdom was the only nation that refused to play along (the U.K. is not part of the 17-nation euro zone, with the common euro currency).

The problem is that the EU didn't enforce the rules they already had on deficits. How will the enforce these new penalties if governments don't follow these new stricter rules? Now each of these 26 countries are going to have to approve of these new changes and then come back for a vote in March. What are the odds that each nation is going to approve this new agreement? It's only been a couple of days since Friday's conclusion to the EU summit and there are already multiple countries voicing concerns over the new changes.

Unfortunately the EU doesn't have a lot of time. There is more than one trillion euros of debt coming due in 2012. Over 500 billion euros of that is due in the first six months of the year. If the EU doesn't come together quickly then the bond market could force the issue with rising interest rates. Italy and Spain's interest rates are still uncomfortably high and yields on French 10-year bonds have been rising as well. If bond yields get too high then these countries can't afford to roll over their debt. Italy is already in the danger zone. (cue music for Kenny Login's "Highway to the Danger Zone")

Major Indices:

After churning sideways in a 20-point range (1245-1265) the first three days of the week the S&P 500 dropped toward 1230 and its exponential 200-dma on Thursday's decline. The market looked poised for a new correction lower only to see stocks rebound on Friday on EU headlines. This index remains under resistance at its simple 200-dma and the 1265 level. It's also still under resistance at its multi-month trendline of lower highs dating back to the July peaks (see chart).

If the S&P 500 can breakout past 1265 then we are probably looking at a run towards the October peak near 1290 and likely the 1300 level. A rally past 1300 sets up for a move into the 1320-1340 zone. On the other hand, if stocks retreat then the S&P 500 is looking at potential support near 1220 and 1200 again.

Daily chart of the S&P 500 index:

The NASDAQ composite has also been struggling with multiple trendlines of lower highs. Thursday's close under 2600 and its simple 50-dma looked pretty ominous. Friday saw a +1.9% bounce but this index remains under resistance, including the simple 200-dma. A close over 2675 would be encouraging but the 2700 level could be another obstacle for the bulls. A breakout past this resistance could set up for a run into the 2820-2850 zone.

Daily chart of the NASDAQ Composite index:

The action in the small cap Russell 2000 index is similar. What's different on this chart is the clear resistance at the $RUT's 150-dma on the daily chart (black moving average). A breakout past this level could set up for a nice run back into the 800-850 zone. I've also listed a 90-minute interval intraday chart. Here you can see the Thursday's pull back almost completed a 38.2% Fibonacci retracement of the most recent rally.

Normally the small caps tend to perform well in December and January but they're going to have to break this trend of lower highs first.

Daily chart of the Russell 2000 index

Intraday chart of the Russell 2000 index

Investors still want to watch the transportation index. Currently the Dow Jones Transportation average is hovering under resistance at its 200-dma and the 5,000 level. A close past 5,070 would negate what currently looks like a potential double top pattern.

Daily chart of the Dow Jones Transportation Average

We have a relatively busy week for economic data. The big headlines to watch are CPI, PPI, and Philly Fed survey. The biggest event is probably the FOMC meeting on Tuesday. It's the last FOMC event for this year. No one is expecting any changes out of the Fed but there is the possibility that the Fed hints at QE3 in 2012.

- Tuesday, December 13 -
Retail Sales for November
Business Inventories for October
FOMC interest rate decision

- Wednesday, December 14 -
Import/Export Prices for November
OPEC meeting

- Thursday, December 15 -
Weekly Initial Jobless Claims
Producer Price Index (PPI) for November
Industrial Production
Capacity Utilization
Philadelphia Fed Survey

- Friday, December 16 -
Consumer Price Index (CPI) for November

The Week Ahead:

If we are lucky it would be nice to see headlines out of Europe diminish for a few days. Maybe there will be a post-summit lull and we can see the market move without so much EU-inspired volatility. Unfortunately that is not likely to happen. Investors will still be watching EU-region bond yields, specifically Italy, for any changes in the health of the EU. There is always the ever-present danger of another credit downgrade for any of the struggling EU members. Bigger picture it looks like this most recent summit may has given EU leaders another two or three months before the situation heats up again.

Closer to home investors might want to worry about corporate earnings. They were overshadowed by news out of Europe but there were some earnings warnings this past week. Analysts have been lowering their Q4 earnings estimates. On average this year's Q3 earnings were up +17.9%. While Q4 earnings estimates have fallen from +17% down to +10% over the last few months. There is reason to worry. Both consumers and governments are cutting back on spending in Europe and China has seen a minor slowdown as well. Given the large number of global companies in the U.S. this pull back is going to have an impact. Of course it's possible that as earnings estimates continue to fall it will allow for an earnings season of positive, better than expected surprises that fuels a Q1 rally in stocks.

We only have three weeks left for the year. Traditionally December is one of the most bullish months for stocks. Over the past 80 years the S&P 500 index averaged a +1.4% gain in December. The S&P 500 closed Friday at 1255. Currently J.P.Morgan has a 1350 year-end target. That's looking pretty optimistic at this point. Other targets are 1270 (Credit Suisse), 1250 (Goldman Sachs), and the average among the top 12 firms is 1278 (source: Birinyi Associates). The market could still see a Santa Claus rally fueled by fund managers chasing performance for their year-end statements.

Investors may want to stay neutral on the market until we see a breakout. Fortunately there is a very clear buy signal, which would be a close over 1265 on the S&P 500.

I would stay cautious on launching new positions and keep position size small when starting any new trades.

- James