The stock market's year of the dragon (2012) rally continues. The S&P 500 index is up three weeks in a row and up four out of the last five weeks. Equities failed to crash after Standard & Poor's downgraded nine EU countries a week ago Friday. Oddly enough the euro currency began an oversold bounce that lasted almost all week before fading on Friday. Short positions in the euro remain at record high levels. We're currently in the middle of Q4 earnings season. Stocks have been able to shrug some of the high-profile misses. Volume has been low all week but that hasn't stopped the rally. The S&P 500 index is up 4.5% year to date. The small cap Russell 2000 index is up +5.9% and the NASDAQ is up +6.9%.

Daily chart of the FXE euro ETF:

Money managers seem to have a much more optimistic outlook for the economy and the market for 2012. A recent Bank of America survey showed that the number of fund managers that were overweight cash had fallen from 35% in December down to 27% in January. Unfortunately data from TrimTabs continues to show retail investors pulling money out of the equity markets.

There were a number of economic headlines last week. Analysts are expecting China's government to try and spur their economy after the Q4 GDP estimate came in at +8.9%. That's still a healthy number but it's the lowest level in over two years. The International Monetary Fund (IMF) announced plans to raise its lending capacity by up to $1 trillion. Meanwhile the World Bank revised their 2012 and 2013 growth expectations lower to 2.5% and 3.1%, down from 3.6% and 3.6%, respectively. Elsewhere in Europe the latest German investor confidence reading rose to its highest level on record. Investors seemed to ignore the S&P downgrade as Spain saw a healthy bond auction with yields falling.

In the U.S. the New York Empire State manufacturing survey came in better than expected at 13.5. The December existing home sales data also came in better than expected at an annual pace of 4.61 million units. Housing starts were not quite as strong and slipped to an annual pace of 657,000 when economists had been expecting 673,000. The Philly Fed survey improved from 6.8 to 7.3 in January but analysts had been expecting a bump to 10.0.

Inflation data in the U.S. was tame. The Producer Price Index (PPI) fell -0.1% while the core PPI rose +0.3%. Expectations had been for a rise of +0.1% at both levels. The Consumer Price Index (CPI) was unchanged and the core CPI rose +0.1%. Economists were expecting both to rise +0.1%. Meanwhile another positive was the weekly initial jobless claim data that plunged to 352,000 compared to estimates for 385,000. This is the lowest reading since 2008.

Major Indices:

The S&P 500 has delivered an impressive run with a +4.5% gain for the year thus far. The move is even more striking when you consider the S&P 500 is up +9.1% from its mid December low near 1205. Stocks have been able to slowly chew their way higher, rising past multiple layers of resistance. This past week saw a breakthrough the key round-number resistance level at the 1300 mark leaving the index at six-month highs. Would you believe that six months ago the market was focused on the debt-ceiling fight in Washington. Many were expecting our borrowing costs to rise and have a hugely negative impact on the U.S. economy. Yet just the opposite happened. In the last six months the yield on a 10-year bond has fallen from 3.0% to under 2.0%. For those of you who don't trade bonds that is a big move.

On a short-term basis the S&P 500 looks overbought. While there is support at the simple 10-dma near 1300, any significant correction could pull the index back down toward the 1280 level. If stocks can maintain this bullish momentum then investors are going to start aiming for the 1350 area, which could be major resistance for the S&P 500.

Daily chart of the S&P 500 index:

The tech-heavy NASDAQ has seen an even bigger move with the index up +10.4% from its mid December low (2523). The fact that shares held up so well on Friday in spite of a huge -8.3% earnings-induced plunge in shares of Google (GOOG) is a positive sign. Although the NASDAQ may not be able to dodge a bullet twice if Apple (AAPL) also disappoints investors.

Naturally, after a +10% rally in five weeks the NASDAQ looks overbought. There might be some short-term support near 2740 but I'd focus on the simple 10-dma as potential support. I've put a Fibonacci retracement tool on the chart below just in case the market does see a significant pull back. You can see where the Fib retracement would be. There is tons of resistance in the 2800-2860 area so further gains might be harder to come by. The problem lies with all the investors that are hoping and praying that the NASDAQ gets back to its 2011 highs so they can just get their money back.

Daily chart of the NASDAQ Composite index:

The small cap Russell 2000 index has produced a similar gain with a +10.7% rally off its Dec. 19th close near 708. The $RUT's breakout past resistance near 760, its simple 200-dma and the 770 level is all very bullish. Yet the small caps probably need a correction as well. A dip back toward the 760 area with its simple 200-dma would probably be healthy. If stocks continue to march higher then we can look for likely resistance near the 800 level.

Daily chart of the Russell 2000 index

Additional indices I would keep an eye on are the transportation average ($TRAN), the semiconductor index ($SOX) and the financial ETF (XLF). The $TRAN has risen to new six-month highs thanks in part to a pull back in oil prices and expectations for ongoing improvement in the economy. Meanwhile better than expected earnings results and positive comments about growing demand have fueled a big spike higher in the semiconductor sector. The $SOX actually looks very short-term overbought and due for some profit taking but thankfully the new trend is bullish. The financials have been able to rally higher in spite of some hiccups in the recent rash of earnings announcements. The XLF just recent broke out past resistance near $14.00 and its simple 200-dma.

Looking ahead we have a number of events to be aware of. The biggest event of the week looks like the two-day FOMC meeting. No one is expecting any changes to interest rates on Wednesday but there has been a growing expectation for some hint of QE3 from the Fed. Yet with the U.S. economy continuing to slowly improve and little will power for more easing in Washington that expectation may be misplaced. TrimTabs believes that money managers have been buying stocks on the expectation that the Fed will announce QE3 this quarter (either Wednesday or in March).

Looking at the economic headlines the Q4 GDP estimate on Friday could be a market mover. Yet market direction will likely be determined by headlines out of Europe. Many were expecting Greece to have some sort of deal done with PSI by Monday. If we can ignore Greece for a moment then the major events will likely be earnings reports. Apple Inc. (AAPL) reports earnings on Wednesday but they won't be alone. This week has a huge number of corporate announcements. I'm talking hundreds of companies are reporting. If there was a week to sell the news then this might be it.

- Monday, January 23 -
expectations for a deal between Greece & PSI
EU finance ministers meeting

- Tuesday, January 24 -
two-day FOMC meeting begins

- Wednesday, January 25 -
FOMC meeting ends, rate decision released
Bernanke holds quarterly press conference
pending home sales

- Thursday, January 26 -
Weekly Initial Jobless Claims
Durable goods orders
New home sales

- Friday, January 27 -
(advance) Q4 GDP estimate
Michigan Sentiment for January (final)

The Week Ahead:

Let's talk about Greece for a moment. If you're reading this column then you already know that Greece has been struggling with negotiations concerning the 50% haircut on its sovereign debt. Greek officials need to hammer out the details with private sector investors (PSI) and get it done and signed or they will not qualify for the next bail out installment loan. The challenge is that Greece has a March 20th deadline to make a 14.4 billion euro debt payment and they don't have the cash. Unfortunately it takes days and weeks for all the paperwork for deals like this to get done. Many were expecting that Greece would capitulate to its investors just to get the deal done. Yet as of Saturday it looks like negotiations have broken down again. What we do not want is the hedge funds that own CDS swaps on their Greek debt to call them due since it could start a domino effect and everyone else starts executing their CDS deals, which would wreak havoc on the banking system. Thus, what looked like might be a bullish boost for Monday could end up being a bearish event if there is no deal by Monday.

Potentially offsetting any negatives from Greece is China. After the lowest GDP reading in ten quarters the Chinese government could be ready to stoke the fires of economic activity again. The Chinese spent three years trying to cool off their overheating economy and engineer a soft landing. Now it seems they have been successful and they're trying to turn things around again. Last month the People's Bank of China (PBOC) cut bank reserve ratios for the first time in years. Normally when the PBOC makes a move with reserve ratios it is a series of hikes or cuts and not just a one-off event. China just injected 353 billion yuan ($55 billion) into their banking system on Friday in preparation for the Chinese new year holiday coming up. Now analysts are expecting that another bank reserve-ratio cut is imminent, which frees up capital for banks to lend out.

It's definitely going to be another interesting week. The breakdown in Greek negotiations is bearish for Monday. We'll have to wait and see if China makes any moves over the weekend. Meanwhile there is the potential for a sell-off following the FOMC meeting on Wednesday if the Fed doesn't deliver something positive. While all of this is going on there will be a deluge of earnings data. The volatility index (VIX) has been plunging as the market makes new relative highs but volatility for individual stocks is likely to soar as traders react to earnings news.

The market's trend is bullish but stocks seems short-term overbought here. It's probably time for a pause or a pull back. I would not rush out to launch new positions. Let the market come to you instead of chasing it higher.

- James