The ongoing trials and tribulations in Greece continue to be a wet blanket on the stock market. Readers were cautioned last week that without any distractions the market would focus on Greece. Yet in spite of growing worries in Europe the S&P 500 still managed to hit new seven-month highs on Thursday. Unfortunately escalating worries over the Greek situation produced a widespread sell-off on Friday. It was the worst one-day session for the markets since December. Overall profit taking was relatively mild. The S&P 500 lost -0.1% for the week. The NASDAQ lost -0.06%, the Dow Industrials fell -0.4% and the small cap Russell 2000 index dropped -2.1%. Gold followed the market lower as the U.S. dollar rallied off its Thursday lows.

Last week was relatively quiet for economic news. Federal Reserve Chairman Ben Bernanke spoke before the Senate Budget Committee on Tuesday but he didn't say anything new. The weekly initial jobless claims fell to 358,000, another move in the right direction. One of the biggest surprises was the big jump in consumer credit. It looks like Americans put Christmas on their credit cards with consumer credit surging to $19.3 billion in December. Economists were only expecting a number in the $9 billion range. Speaking of credit card bills, they might account for a drop in consumer sentiment. Friday saw the preliminary look at February's University of Michigan Consumer Sentiment numbers. Economists had been hoping for a breakout past the 75.0 level. Yet sentiment fell from 75.0 to 72.5. This was likely due to seasonal adjustments. It's not surprising. Consumers have to start making payments on their Christmas shopping spree in February so they probably feel a little poorer. Plus, we're looking at tax day coming up soon in April.

Elsewhere in the news the European Central Bank kept rates unchanged at 1.0%. This was a bit disappointing but the ECB did relax some of its collateral guidelines. There had been growing speculation that the ECB would loosen their collateral requirements to provide banks more opportunity to take advantage of the 1% LTRO money deal. The Bank of England also kept rates unchanged at 0.5%. The only surprise was an increase in the BoE's quantitative easing program by another 50 billion to 225 billion pounds. Meanwhile in Asia there were raised eyebrows over higher than expected inflation data with China's CPI rising +4.5% in January.

Major Indices:

The S&P 500 was down -1.1% intraday on Friday but traders bought the dip again and pared Friday's declines to -0.68%. After a week of very small gains Friday's nine-point decline was enough to break the five-week winning streak. If you look at the intraday 90-minute chart below you can see the S&P 500 is still trading inside its bullish channel. You can also note that a traditional 38.2% Fibonacci retracement of the current rally would mean a pull back toward the 1300-1295 area.

In a bull market environment (if we can call it that), corrections tend to be in the -3% to -5% range. A 3% pull back would be 1,311. A 5% pull back would be a dip to 1,284. Personally, I would focus on potential support near 1,320 and the 1,300 level for the S&P 500. If the index breaks down under 1,300 again it could mean a much bigger correction (-8% to -10%).

A decline from current levels would not be that shocking. The 1350 area has been overhead resistance for a while and stocks are overbought after a multi-week rally higher. Earnings season is winding down and we have growing concerns over Europe again. Seems like a good spot to expect a correction. If stocks surprise us with more gains we can look for potential resistance at its 2011 highs near 1,365.

Intraday 90-minute chart of the S&P 500 index:

Daily chart of the S&P 500 index:

The NASDAQ composite almost made it six weeks in a row. The index hit new ten-year highs on Thursday. You can see from the daily chart below that the NASDAQ is trading in a very narrow, bullish channel. After a move from 2518 to 2930 (+16.3%) Friday's profit taking was pretty mild with a drop toward the 2900 level and the middle of its channel.

Even though the trend is clearly higher you can see that the NASDAQ is very overbought here. A normal 3% pull back would mean a dip to 2839. A 5% correction would be 2780. That would be almost low enough to hit the 38.2% Fib retracement of the current rally, which would be 2775.

Can the NASDAQ grow more overbought? Absolutely, but everyday odds of a correction are growing.

Intraday 90-minute chart of the NASDAQ index:

Daily chart of the NASDAQ Composite index:

I warned readers last week that when the profit taking began the small caps would underperform. Sure enough the Russell 2000 underperformed the major indices with a -2.1% drop last week. Almost all of that was on Friday. The $RUT essentially drifted sideways Monday through Thursday. After a +17% rally from its mid December lows the $RUT is way overdue for a pullback.

The 800 level is probably round-number, psychological support but a 38.2% Fib retracement of the rally would mean a dip toward 785. A typical 5% pullback would mean a dip toward 789.

Intraday 90-minute chart of the Russell 2000 index

Daily chart of the Russell 2000 index

The rally in the semiconductors is meeting resistance with the SOX index pausing at a prior trend line of support. The transportation average is flashing a warning signal with a breakdown under one of its trend lines of support. That's not to say a pull back in the transports would not be healthy but they could be a leading indicator that the market is tired and about to correct.

Weekly chart of the SOX semiconductor index

Daily chart of the Transportation Average

The economic calendar is a bit busier than last week. The major reports to watch are Empire state survey and Philly Fed survey. Plus the PPI and CPI data on inflation. I suspect the FOMC minutes will be a non-event given all the air time Mr. Bernanke has had recently. Of course all of these reports will be overshadowed by any progress or lack thereof in Greece.

- Tuesday, February 14 -
January retail sales
Import/Export prices
Business inventories for December

- Wednesday, February 15 -
New York Empire State manufacturing data
Industrial production & Capacity Utilization
FOMC minutes from the last meeting

- Thursday, February 16 -
Weekly Initial Jobless Claims
Housings starts & Building permits
Producer Price Index (PPI)
Philly Fed survey

- Friday, February 17 -
Consumer Price Index (CPI)

The Week Ahead:

Two weeks ago the markets were ignoring Greece and its failure to make any progress negotiating with private sector investors on its debt restructuring. Yet this past week concerns over Greece have escalated. The EU members that are paying for Greece's bailout are demanding stricter regulations on Greece's budget cutbacks. That should not be a surprise. Greece has a terrible track record when it comes to implementing prior austerity measures.

This past week it was big news when Greek politicians approved significant cut backs on Thursday, which sparked new riots and strikes across the tiny nation. That wasn't enough. The Troika (EC, IMF, & ECB) wants the new budget cuts written into Greek law, they want thousands more Greek government jobs cut, and they want a drop in the minimum wage. The Troika is also asking for an additional 325 million euros in budget cuts before they approve the next tranche of bailout money.

Unfortunately this process is tearing the Greek government apart. Several leaders and cabinet members stepped down in protest. Greek Prime Minister Papademos has a tough week in front of him. EU regulators want these additional budget cuts approved by Wednesday this week. Of course the challenge here is a looming deadline in March where Greece has to pay a $14 billion debt payment.

Expectations that Greece will stay in the Eurozone are dropping. The Fitch rating agency expects Greece will default even if they do get the next bailout payment. Two more analysts raised their estimates that Greece would leave the Eurozone to 50% in the next 18 months. That might be a bit optimistic. It seems like the EU members who are writing the checks for this bailout have suddenly decided that they don't want throw any more money at this deal if all they're doing is delaying the inevitable.

If you are Greece you have to ask yourself, is it better to just default and suffer two or three years of chaos and depression before finding a new equilibrium with your own devalued currency, or is it better to stay in the eurozone and suffer super strict austerity measures and a massive debt load for the next 10 to 20 years. Readers of this column know we are expecting Greece to default eventually. The question is a matter of when.

The bigger question I keep asking is what happens after Greece leaves the eurozone? What stops Portugal, Ireland and Spain from giving up, defaulting on their debt obligations, and trying to start over? Let's not forget about Italy, with the biggest debt load in the EU. On Friday Standard & Poor's downgraded 34 of the 37 Italian banks they rate. S&P believes that risks are rising for Italy's ability to roll over its massive debt load. The country has to refinance hundreds of billions of euros worth of debt this year (113 billion euros worth just in the first quarter this year).

This coming week the focus will be on Greece's ability to get these new budget cuts passed by its very divided government. We also want to keep in mind that the ECB is going to launch another round of its cheap 1% three-year LTRO loans in late February, which should be seen as a positive for the European banking system and will likely have a soothing affect on the global stock markets.

Currently my outlook on the U.S. market is bullish but short-term the market looks poised for a pullback. Corrections are a normal part of market cycles. There are plenty of investors looking to buy the dip. The wildcard is Greece. You could argue that a Greek default has already been priced into the market but when it actually occurs the market will probably see a sharp knee-jerk reaction lower. No one is expecting a default this week or even this month but it's a dark cloud on the horizon that won't go away.

- James