The stock market divergence continues. The S&P 500 index, the Dow Industrials, and Dow Transportation average hit new all-time highs last week. Yet the small cap Russell 2000 index fell to -10% correction levels on Thursday. Meanwhile U.S. bonds hit new highs for the year and yields plunged. Commodities like oil, silver, and gold all posted gains for the week while banking stocks underperformed (-1.7%).

Last week started out strong. Big gains in Asian markets on Monday helped fuel a bounce in U.S. stocks. Investors were bullish on the election results in India. China suggested they might allow more foreign investment. Unfortunately investor sentiment seemed to change when the S&P 500's rally stalled at the 1900 mark. The SALT conference in Las Vegas was making headlines in the financial media. Reporters were blaming Thursday's market sell-off as a Tepper Tantrum after Wall Street celebrity David Tepper, founder of the extremely successful Appaloosa Management hedge fund, issued cautious comments.

When asked about the stock market Tepper said, "there's times to make money and there's times not to lose money. This is probably you're supposed to think about preserving some of your money...I think you can still be long, but I think you're supposed to have some cash now." Tepper also said, "I am nervous. I think it's nervous time."

Art Cashin, director of floor operations for UBS at the NYSE, also shared some insight to the market's weakness on Thursday with his comments, "We're living in a five-year paradox here. Things like GDP, the macro numbers, have not lived up to what the market was doing. And the market has done what it's done simply on earnings. And through financial engineering we've gotten the earnings up." Cashin claims that market participants are worried that the European Central Bank does not have the tools it needs to handle the slowdown in Europe. The phantom of deflation seems to be looming larger these days.

Economic Data

Most of the economic data last week was negative but there were a few exceptions. The New York Empire State manufacturing survey surged from 1.3 in April to 19 in May. The survey hasn't been this high since 2010. Small business optimism continued to move higher and hits levels not seen since 2007, before the financial crisis. U.S. jobless claims fell to 297,000 for the week, which is the lowest level since May 2007.

The Philadelphia fed survey slipped from 16.6 in April to 15.4 in May. U.S. industrial production dropped -0.6% in April after March was revised higher from +0.7% to +0.9%. Consumer confidence dropped in May. Analysts were expecting a gain but the University of Michigan consumer confidence survey slipped from 84.1 to 81.8. Analysts blamed rising food costs and gasoline prices on the slide. Retail sales also came in below expectations. Economists were hoping for U.S. retail sales in April to rise +0.4% but the data only showed a +0.1% gain. March retail sales were revised higher from 1.2% to 1.5%.

There was some positive news from the railroad traffic numbers. The 12-week moving average for rail traffic hit highs not seen since 2011 with a +8.5% surge. The increase in rail traffic in April 2014 was the 53rd consecutive month of increase. Rising rail traffic is normally a bullish sign for the economy. Another bullish development is rising demand for trucks. The latest data showed that demand for trucks hit an eight-year high.

While most of the world seems worried about deflation the U.S. saw a bump in inflation. The wholesale inflation gauge, the Producer Price Index (PPI), rose +0.6% in April. The year-over-year increase hit +2.1%, which is the biggest one-year gain since March 2012. The consumer level inflation gauge, the CPI, surged +2% in April, marking the largest one-month increase since July 2013.

Elsewhere the U.S. residential market continues to slide. April housing starts surged +13.2% but almost all of the gain was due to multi-family permits. Single-family (home) permits were down -3.2% from a year ago. The NAHB homebuilder sentiment survey dropped from 47 in April to 45 in May. This is discouraging since we are supposed to be in the middle of the Spring-summer selling season.

If we boil down all of the economic data there is a growing sense of concern that the Q1 GDP growth estimate could be revised lower, possibly -0.5%. It would be the first time the U.S. has seen negative quarterly growth since Q2-2009. Nearly everyone has been expecting the U.S. economy to see this huge snap back rally in Q2 following a dismal Q1 due to the unusually cold winter. Unfortunately the current pace of Q2 data is not showing any big bounce in economic activity.

Overseas Data

Europe is slowing down. Growth appears to be vanishing across the continent. The latest Eurozone GDP quarterly estimate was +0.2% growth, below expectations. Eurozone GDP has only improved +1% from the first quarter of 2013. Germany, Europe's largest economy, is still growing with its latest GDP estimate at +0.8%, up from the prior quarter's +0.4%. Yet growth in France, Italy, and Portugal has stalled. Finland has fallen into recession. Fear of deflation in Europe is surging.

The European Central Bank all but promised some sort of stimulus or QE program at their June meeting but markets are worried the ECB doesn't have the right tools to combat the problem. Interest are already close to zero. They could launch a negative interest rate program and charge banks for holding their reserves but such a program hasn't been proven to be very effective. The EU does not have a single, consolidated bond market like the U.S. so any QE program would be challenging to implement.

Japan offered some positive economic data last week with industrial production growing +0.7% month over month, which was better than expected. Japan's Q1 GDP estimate came in at +1.5% for the quarter. It was the best growth reading since Q3 2011. Unfortunately the worry is this sudden spurt of growth was a temporary surge in consumer spending as people rushed to buy items before the new sales tax took effect. Thus they likely pulled forward a lot of business from Q2 and Q2 numbers will likely disappoint.

China helped fuel the stock market's rally last Monday when regulators hinted that they might loosen limits on foreign investment in public Chinese companies. The impact was short lived. Plenty of economist are worried about China's slowdown. The latest data on China's electricity usage confirms the slowdown with consumption slowing to +4.6% growth. That's down from +7.2%.

China is also dealing with the aftermath of its illegal drilling in Vietnam waters. I mentioned last week how China had moved its brand new deep sea oil drilling rig into the Vietnam's area of the South China Sea. There have been constant clashes between Chinese and Vietnamese ships surrounding the rig. Public sentiment in Vietnam has turned from frustration to anger. Vietnamese protests of China's incursion into their waters have turned into riots with at least 21 dead. Now China is trying to get some of its citizens out of Vietnam.

Ukraine-Russian Conflict

Worries over Russia potentially invading Ukraine seem to have cooled a bit this past week. After last weekend's vote for independence the eastern Ukraine cities of Donetsk and Lugansk both declared their independence and Donetsk immediately asked to join the Russian Federation. Meanwhile the back and forth sanction exchange between Russia and the West continued. Russia said they will no longer allow U.S. astronauts to travel on their Russian rockets to the International Space Station starting in 2020. Russia also said they would no longer sell Russian rockets to the U.S. effectively halting the U.S. military's ability to launch new satellites. Speaking of satellites, Russian President Putin claims he has moved Russian troops away from the Ukraine border. Yet U.S. satellite show no such pullback has occurred.

It was disclosed that Russia dumped a record-setting $26 billion in U.S. treasuries in March. That brings Russia's total U.S. bond portfolio to less than $100 billion, the lowest levels since the Lehman Brother's crisis. Russia could be pulling their money out of U.S. treasuries in anticipation of further sanctions where the U.S. might freeze Russian assets in their custody. April will likely show more selling.

Ukraine is scheduled to hold presidential elections on May 25th. Russia has promised not to interfere. However, Russia plans a massive military drill on the Ukraine border on May 25th.

Major Indices:

The S&P 500 index hit 1900 for the first time in history last week. It promptly reversed. We have been expecting 1900 to be potential round-number, psychological resistance. The index dropped from resistance at 1900 to toward technical support near its 50-dma. With the bounce on Friday the S&P 500 pared its losses to just -0.03% for the week.

The overall picture has not changed much with the S&P 500 virtually unchanged for the week. Another new high and traders still buying the dips. A significant close above 1900 could spark a wave of short covering. The index appears to have support at 1860, 1840 and the 1800 level.

chart of the S&P 500 index:

The NASDAQ composite managed a +0.4% gain for the week. It was the only major index to close positive. This tech-heavy index appears to be churning sideways. The 50-dma and 100-dma are overhead resistance. meanwhile the 200-dma, near the 4,000 level, should be support. A breakthrough either area could spark a big move. Odds are it should see a breakout, one way or the other, from this narrowing consolidating within the next two weeks.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index ($RUT) was the worst performer last week with a -0.39% decline. At its worst levels on Thursday the index was down -10% from its 2014 highs. That's considered correction territory.

The February low was 1,082. Thursday's low was 1,082. It's not a surprise to see a bounce there. I would not be surprised to see the $RUT rebound back toward the current trend line of lower highs. That likely means a bounce toward the 1120-1140 range.

If somehow the $RUT were to close above technical resistance at its 50-dma (currently near 1150) it could be bullish and likely spark some serious short covering. Likewise if we see the $RUT close below 1080 it would be bearish and could spark heavy selling pressure.

chart of the Russell 2000 index

Economic Data & Event Calendar

Ahead of us is a relatively quiet week for economic data but plenty of events. Former Federal Reserve Chairman Ben Bernanke is scheduled to speak on the U.S. economy on Monday. Monday will also see defense ministers from ten Southeast Asian nations come together as they discuss China's incursion into Vietnamese waters.

On Tuesday Russian President Putin begins a two-day meeting with Chinese leaders in Beijing. Many expect the two nations to sign a major trade deal with Russia exporting natural gas to China. On Wednesday the U.S. Federal Reserve will release their minutes from the April meeting. Elsewhere the Bretton Woods Committee will meet with speakers from the IMF, World Bank, and former Fed chairs.

The HSBC Chinese PMI data on Thursday could influence markets. April's reading was in contraction territory at 48.1. Thursday also marks the beginning of EU elections. British and Dutch voters will go to the polls to vote on the European Parliament. The rest of the 28-nation union will vote on May 25th.

The U.S. markets will be closed on Monday, May 26th for Memorial Day.

Economic and Event Calendar

- Monday, May 19 -
Ben Bernanke speaks on the economy

- Tuesday, May 20 -
Russian President Putin meets Chinese leaders in Beijing
JPMorgan Chase's annual meeting

- Wednesday, May 21 -
FOMC minutes from the last meeting
Bank of Japan policy update

- Thursday, May 22 -
Weekly Initial Jobless Claims
Existing home sales
European elections begin
HSBC Markit Chinese PMI data

- Friday, May 23 -
New Home Sales

Additional Events to be aware of:

May 26 - U.S. market closed for Memorial Day

Looking Ahead:

The bond market was a major topic for investors last week. I have been warning readers for weeks that a breakdown below the February lows could signal trouble for the equity markets. Bonds surged midweek and yields on the 10-year U.S. treasury briefly traded below 2.5%. These are six-month lows. The rally in bonds stalled near their October 2013 highs.

Worries over the global economy, geopolitical risk, and a desperate reach for yield are all likely factors pushing money into the bond market. The bond market is supposed to be "smart money" and if bonds are rising it likely means investors are afraid to own stocks. Equity bulls would argue that doesn't make sense with the S&P 500 and the Dow Industrials hitting new highs last week.

Investors should view this rally in bonds as an ill omen for stocks.

chart of the 10-year U.S. bond yield

Warning Signs

There were a parade of analysts offering warning signs for the market last week. Comstock partners warned that market internals continue to deteriorate with only 165 new highs this month. Margin debt remains at record highs. They contend that market valuations are at the highest levels and "exceeded only in 1929, 2000, and 2007."

Piper Jaffray issued a warning last week. They're concerned the S&P 500 index could see a 15 percent correction and drop into the 1,600-1,650 zone before finding a bottom. Long-time market bull, Ralph Acampora, also issued a warning. Acampora is worried the S&P 500 could see a -10% to -15% pullback between now and October. He said the Russell 2000, the NASDAQ, and the S&P midcap index could all drop -20% to -25% from their highs.

Michael Batnick, on The Irrelevant Investor Blog, noted the divergence between the small caps and the big caps. A few days ago Batnick wrote, "The Russell 2000's current 10% peak-to-trough decline (its first since November 2012) is small caps' 36th peak-to-trough decline of at least 10% since 2000, with an average decline of 17.1%. Of the first thirty-five corrections, every one of them were accompanied by large-caps also falling, until now (an average decline of 12.8%)."

The Stock Trader's Almanac noted that since 1949 there have been 11 bull markets that lasted an average of 1,770 calendar days with an average gain of +161.4%. The current bull market is 1,894 days (as of today) with a +180.5% gain. The current bull market in the S&P 500 has also gone an incredible 956 days without a -10% correction.

I continue to urge caution. There are pockets of strength in this market. However, they are unlikely to last if the big cap indices rollover. I will repeat Tepper's comment that "there is a time to make money and a time to not lose money."

There is always opportunity in the market somewhere. If you do initiate new positions I would start small to limit risk. If the market does see a correction you will wish you had some capital available to take advantage of the weakness. I would not be in a rush to buy dips since we don't know when the next dip fails to be bought and turns into something more painful.