The week before Christmas proved to be a bullish one for stocks. The market stumbled a bit on Monday the 19th as the world reacted to news that North Korea's dictator Kim Jong II had passed away. Market sentiment quickly reversed higher on Tuesday thanks to positive economic data overseas and a successful Spanish bond auction. Later in the week the U.S. markets eventually shrugged off news that the Q3 GDP estimate was revised down from +2.0% growth to +1.8%. The ECB launched a new funding program, which helped alleviate lending concerns in Europe but simultaneously alarmed market watchers at the large number of banks that needed help. Technology stocks lagged behind the market thanks to a disappointing earnings report from Oracle (ORCL) released on Tuesday night. By the closing bell on Friday the S&P 500 index had rallied +5.2% off its lows from Monday afternoon. For the week the S&P 500 is up +3.7%, the NASDAQ Composite is up +2.4%, and the small cap Russell 2000 index is up +3.5%. Year to date the S&P 500 is up +0.6%, the NASDAQ is down -1.2% and the $RUT is down -4.5%.

Economic data last week was mixed. The latest Q3 GDP estimate was a disappointment with an unexpected from +2.0% to +1.8% growth. Investors ignored the news as estimates for the Q4 are moving higher into the +3.5% to +4.0% zone. Helping fuel estimates for the fourth quarter was the durable goods report for November, which rose +3.8% compared to a -0.7% drop in October. Economists had only been expecting a rise of +2.0% in durable goods. Most of this move was fueled by a huge surge in aircraft orders. Home sales were making headlines. New Home sales in November rose +1.6% to an annualized paced of 315,000. It was almost a +10% jump from the same month a year ago. Another slice of good news was the falling inventory levels. Overall home sales continue to lag and 2011 might end up being the slowest year since they began keeping records back in 1963. Another positive report last week was the weekly initial jobless claims, which fell to 364,000. Economists had been expecting 380-390K.

Major Indices:

The S&P 500's +5% bounce is encouraging although doing so in a four-day time period suddenly makes the index look short-term overbought. The S&P 500 managed to breakout past resistance near 1230, 1250 and at key technical resistance at the simple 200-dma. Yet the rally paused right at early December resistance at 1265.

In a normal market, after a +5% bounce, I'd probably expect some profit taking ahead of us. Yet given our spot on the calendar there is a decent chance we could see stocks extend their gains. Volume is going to be low and that's going to allow for exaggerated moves and bulls currently have the momentum. If the S&P 500 can breakout pas resistance at 1265 then the next hurdle is the 1285 area and then 1300. It is worth noting that further gains will look like a bullish breakout from an inverse head-and-shoulders pattern. This H&S pattern appears to be forecasting a move toward 1350-1370. Chart readers might find it interesting that the Point & Figure chart on the S&P 500 is still bearish but a move past 1270 would produce a new triple-top breakout buy signal.

Daily chart of the S&P 500 index:

Intraday (2-month) chart of the S&P 500

The NASDAQ composite sank to new December lows on Monday at 2518 before surging on Tuesday to 2600. There was profit taking on Wednesday thanks to ORCL's earnings report but the NASDAQ bounced near 2550 and by Friday's closing bell the index was above resistance at the 2600 level. This tech-heavy index is struggling with a trend of lower highs and there is still technical resistance at its simple 200-dma overhead. If the NASDAQ can breakout past its 200-dma near 2661 and the December high near 2675 then we might see the index make a run toward the 2011 highs in the 2840-2880 zone.

Daily chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index:

The Russell 2000 index is up +5.6% from its lows on Monday near 708. The sharp four-day bounce has produced a bullish breakout past technical resistance at its 150-dma. This small cap index also appears to be on the verge of a breakout from an inverse H&S pattern. If that's true then the H&S pattern would forecast a rally into the 830-840 area. On a short-term basis the 750 level, the simple 200-dma near 763, and the late October high near 770 are all overhead resistance for the $RUT.

Daily chart of the Russell 2000 index

Two-month chart of the Russell 2000 index

The week between Christmas and New Years is a quiet one for economic data. The major reports in the U.S. will be the Consumer Confidence number and the Chicago PMI data. Yet the biggest event will probably be overseas. Italy will hold a three-year bond auction on Wednesday. Rates have been rising in Italy and they want to sell up to 8.5 billion euros of debt. If rates on this auction end up being too high or they don't sell the full amount then it will signal distress in the EU again and could spark new weakness in equity markets.

- Tuesday, December 27 -
Consumer Confidence for December

- Wednesday, December 28 -
Italy will hold a 3-year bond auction (8.5 billion euros)

- Thursday, December 29 -
Weekly Initial Jobless Claims
Chicago PMI for December

The Week Ahead:

"If Santa should fail to call, bears may come to Broad and Wall." is an old market maxim. Looking ahead at the last week of the year it would appear that the seasonal trends are in force. Historically the "Santa Claus" rally is the last five days of the year. It looks like Santa came early this year with a big bounce last week. Bulls currently have momentum on their side. Stocks could see a combination of window dressing for the end of the quarter with strong stocks getting stronger and tax loss selling with weak stocks getting weaker. Of course everything could change if Italy's bond auction on Wednesday doesn't perform well.

Looking out into the first quarter of 2012 the focus will remain on Europe but earnings results will be a factor. Here in the states we have a very slowly improving economy. Investors will be expecting good news out of corporate earnings that begin in about three weeks. If Q4 earnings results disappoint then it could get ugly for stocks. At the same time we're facing the rising likelihood of the credit rating agencies announcing significant downgrades in Europe in the first quarter. Meanwhile U.S. banks will be facing tougher stress tests.

Currently no one seems happy with the EU's latest plan to make a plan strategy. The EU zone needs to raise more than one trillion euros of debt in 2012. That will be impossible to do if rates don't come down. Italy alone has to raise 440 billion euros of debt in 2012 ($574 billion). Fortunately it seems that rates, outside of Italy, have been falling in Europe. The rumor is that EU banks are taking the 1% loans from the ECB and are using that money to buy short-term EU area bonds at more than 1% to pocket the difference. Pundits are calling it a backdoor bailout.

Technically the U.S. indices appear to be on the verge of a bullish breakout from an inverse head-and-shoulders pattern. Now these patterns are not 100% accurate but it's another factor in favor of the bulls.

I would stay cautious on launching new positions. That doesn't necessarily mean don't trade but if we see an opportunity I would be cautious on opening positions and would keep our position size small to limit risk.

- James