Odds of a Santa Claus rally seem to be fading with only two weeks left in the month of December. Concerns over Europe are weighing heavily on the market like a thick blanket of snow. Stocks experienced a three-day slide from Monday through Wednesday that left the S&P 500 down more than -3%. Semiconductor giant Intel (INTC) helped propel stocks lower with an earnings warning on Monday. Volume was very low all week except for Friday. Markets finally saw a surge of volume thanks to expiration of options and futures on Friday.

Market participants are cautious on the equities. Investors looking for a safe haven to put their money drove huge demand for U.S. treasury auctions this past week. The U.S. dollar also rallied as money searched for safety. The euro currency fell to an 11-month low on Wednesday thanks to a sharp surge in the dollar. This dollar strength had an impact on commodities. Gold produced a dramatic breakdown, falling below key support. The sell-off in crude oil weighed heavily on the energy and oil service stocks while boosting the airlines.

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

Daily chart of the Gold ETF (GLD):

Weekly chart of the Gold ETF (GLD):

One of the major stories this past week was the rating agencies. You may recall that back on December 5th the Standard & Poor's agency made headlines with their announcement they were placing all 17 euro zone nations on credit watch negative for a possible downgrading in the next several months. We had hoped that this threat might spur stronger action from the EU leaders at the December 9th summit. Unfortunately all of the credit rating agencies are very disappointed with the lack of action by the EU. The summit's new plan to make a plan strategy is falling on fallow ground.

I cautioned readers last week that the prospect for new credit rating downgrades threatened the market. This past Friday it was Fitch's turn to make headlines. The Fitch rating agency downgraded several U.S. and European banks on Friday morning. Fitch also released stinging remarks toward the situation in Europe. In their press release Fitch believes that "A comprehensive solution to the euro zone crisis is technically and politically beyond reach." They went on to say that without a solution and a credible financial backstop the situation will produce "episodes of severe financial market volatility" that will be especially hard on the troubled EU members struggling with significant debt problems. Speaking of troubled EU members Fitch put Spain, Italy, Belgium, Slovenia, Ireland, and Cyrus on credit watch negative for a possible downgrade in the next few months. Fitch also put France with its AAA rating on credit watch negative but said the time frame for a potential downgrade for France was a couple of years. If France gets downgraded it's going to cause a lot of problems for the entire EU system. As one of the largest and strongest members in the EU, France helps fund a lot of these bailout packages for smaller, struggling EU members.

Fitch wasn't the only credit rating agency casting a shadow across the markets on Friday. There was a persistent rumor that S&P might issue a downgrade somewhere in Europe on Friday after the closing bell. This rumor proved to be partially right only it wasn't S&P. It was Moody's. After the closing bell the Moody's rating agency downgraded Belgium by two notches from Aa1 to Aa3 and placed them on credit watch negative for future downgrades.

Another story on Europe, somewhat under the radar, was the ECB's new loan program. The ECB is offering three-year loans to European banks at just 1%. Currently banks can bring assets rated at A- to the ECB and receive cash. The theory right now is that EU-area banks are taking this 1% cash and buying short-term bonds from these struggling countries like Spain and Italy with yields in the 3% to 6% range, which allows them to pocket the different.

The ECB can't legally bailout the struggling EU countries. Market pundits are calling this a backdoor bailout since it allows European banks to buy these higher-risk bonds and drive yields down. It's being suggested that the ECB is going to lower the rating requirements on potential collateral to less than A-. If that happens then the European banks can bring more questionable debt to the ECB for cash to buy more questionable debt from countries like Spain and Italy. What could possibly go wrong with this plan, right? At the moment it seems to be working since bond yields have been quietly falling this past week. Global markets have been keying in on EU-area bond yields (mostly Italy's) as the barometer for investor sentiment on Europe. I want to remind you that the EU is racing against the clock. The area has more than one trillion euros worth of debt that needs to be rolled over in 2012. If they can't get bond yields down by the early part of 2012 then many of these countries will not be able to afford to pay interest on this debt. If this trick works then maybe the ECB has found a way to temporarily solve the EU crisis.

Looking at the economic headlines last week the results were mixed. November retails sales were a bit disappointing in spite of strong Black Friday results. The November data on price inflation was mild. The PPI rose +0.3% with core prices rising +0.1%. Meanwhile the Consumer Price Index came in at +0.0% but the core CPI rose +0.2%. The New York Empire State manufacturing survey jumped to 9.5 in December versus estimates for 3.0. The Philly Fed survey soared to 10.3 compared to estimates in the 4-5 range. Another positive was the most recent weekly initial jobless claims that fell to 366,000. This was well below the estimate for almost 400,000 and the lowest reading since May 2008. Last week's FOMC meeting was a dud. The committee left rates unchanged in the 0.00% to 0.25% zone. That's not a surprise. The focus was on the FOMC's statement and investors were hoping for some hint at QE3 to soothe concerns over a struggling global economy. The FOMC statement proved to be disappointing. Meanwhile overseas we're hearing mixed data on export levels and manufacturing activity in China, which refueled worries about a slowdown there.

Major Indices:

The key levels in the S&P 500 last week were 1250, 1230 and 1210. The index failed at 1250 early on. The 1230 area was support on Monday but resistance on Friday morning. The index bounced twice near 1210 on Wednesday. Looking at the daily chart you can see how the index failed near its 50-dma on Friday morning. The S&P 500 currently has a two-week bearish trend of lower highs and lower lows. I would still expect a dip toward the 1200 level, which should be psychological support. There is a lot of potential resistance in the 1230-1260 zone.

The trendline of lower highs is near the 1250 level now and the simple 200-dma represents technical resistance near 1260. If the index breaks down under the 1200 level then we're looking at a drop toward 1180 or 1160.

Daily chart of the S&P 500 index:

Intraday chart of the S&P 500 index:

The NASDAQ composite is back under support/resistance at the 2600 level. The sell-off midweek did fill the gap from late November. Unfortunately the oversold bounce on Friday reversed. The path of least resistance appears to be down. I wouldn't be surprised to see a decline toward the 2500 area again. The 2650 area and the simple 200-dma could end up being tough resistance.

Daily chart of the NASDAQ Composite index:

Bulls were probably hoping we would see an early occurrence of the January effect in December this year with the small caps outperforming. That hasn't happened yet. The two-week consolidation in the Russell 2000 index has hit the 50% retracement of its latest rally. Overhead the simple 150-dma seems to be the technical resistance to watch. If the $RUT breaks support at 700 then it could be a quick drop back toward its November lows.

Daily chart of the Russell 2000 index

The economic calendar slows down a bit this week. There will be multiple reports on the housing market and home sales (not listed below). The big reports to watch will be the third Q3 GDP estimate on Thursday. On Friday we will see the latest Durable Goods orders but I doubt anyone will be paying attention that close to the Christmas holiday.

- Tuesday, December 20 -
housing starts and building permits for November

- Wednesday, December 21 -
exiting home sales for November

- Thursday, December 22 -
Weekly Initial Jobless Claims
Q3 GDP estimate

- Friday, December 23 -
Durable Goods orders

The Week Ahead:

Twas the week before Christmas and looking ahead I am concerned about the stock market. Investors are weary from concern over the situation in Europe. It started almost two years ago with Greece. Now the major rating agencies are upping the pressure on EU leaders to do something. The first and second quarters of 2012 could be fraught with credit downgrade landmines that might go off at any time to sink the equity markets. We don't know yet if the downgrade for Belgium on Friday night will have an impact on our markets. I doubt it will given the size of Belgium's economy but it does start Monday off on a sour note.

You already know that December is historically a bullish time of year for stocks but that's for the average December. There are always exceptions. We could still see some window dressing by fund managers as they face the end of the year in two weeks. This coming week would be the week for that to happen since so many professionals are on holiday the week between Christmas and New Years. At the same time we could see an increase in tax-loss selling. That's when investors dump their losing positions near the end of the year to offset any taxable gains.

Short-term I am neutral on stocks, especially if you're looking for long-term positions. A close over 1265 and the S&P 500's simple 200-dma would definitely improve the mood on Wall Street. If stocks continue to sink then nimble traders can look for possible entry points near the November and October lows but until stocks bounce that's an aggressive, higher-risk strategy.

Keep position size small to limit your risk and have cash on hand in case we do see an entry point in the next few weeks.

- James