The U.S. stock market ran into some profit taking last week after a string of record highs for the S&P 500 index. The S&P 500 and the Dow Industrials snapped a three-week winning streak. News that the World Bank had downgraded their global growth forecast midweek helped spark the selling. This was followed by disturbing headlines of an Al-Qaeda aligned terrorist group winning several victories in Iraq. Suddenly Iraq is facing the prospect of civil war along Sunni-Shia religious lines and oil prices surged on fears that Iraq's oil production could be in jeopardy. Crude oil rallied to nine-month highs.

Energy stocks outperformed the broader indices thanks to strength in oil. Gold managed a bounce as investors looked for safe havens among rising geopolitical tensions. Meanwhile the World Bank reduced their global growth estimates for 2014 from +3.2% to +2.8%. They adjusted their U.S. growth estimate from +2.8% to +2.1% and they moved their China forecast from +7.7% to +7.6%. Overall the market pullback was not that bad. The NASDAQ composite and the small cap Russell 2000 both declined to short-term technical support at their rising 10-dma. The S&P 500 is less than 1% from its all-time high. There was no pullback in the semiconductor industry with the SOX index hitting its seventh weekly gain in a row, although only the last four weeks are worth noting.

Economic Data

The U.S. continues to see mixed economic data. Retail sales for May were a disappointment. Economists were expecting +0.6% growth but retail sales only rose +0.3%. Wholesale inventories for April grew more than expected with a +1.1% rise versus estimates of +0.6%. This followed a +1.1% jump in March. Wholesale inflation in the Producer Price Index for May slipped -0.2%. Excluding food and energy prices the core PPI declined -0.1%. This was below expectations.

We did see some improvement in the mortgage application numbers. Purchase applications rose +9.3% while refi applications bounced +11%. NFIB small business optimism survey beat expectations with a reading at 96.6. Yet consumer sentiment slipped. The preliminary June reading for the University of Michigan Consumer Sentiment survey came in at 81.2. This was below the final reading of 81.9 for May and June marks the lowest sentiment reading since March.

Overseas Data

In Europe the French said their industrial production improved +0.3% last month, which is up from -0.4% the prior month. Eurozone industrial production rose +0.8% for the month, which was better than expected. Germany said their wholesale price index inched down -0.1%. The Bank of England might raise interest rates sooner than expected. Instead of early 2015 it could be late 2014 when the BoE raises rates.

Japan said their industrial production fell -2.8% last month. Their core machinery orders dropped -9.1% versus a +19.1% the prior month. The Bank of Japan left their monetary policy unchanged. Data in China was mixed with industrial production rising +8.8% and retail sales in May rising +12.5%. Yet home sales in China plunged -11% in May.

Major Indices:

The big cap S&P 500 index lost -0.68% for the week. It's still up +4.8% year to date and only down 15 points from its all-time closing high of 1,951. I would still look for short-term support near 1920 and 1900 with additional support at the 50-dma near 1888. The 1950 level is probably short-term resistance if stocks rebound from current levels. Should the rally continue then the 2,000 mark could end up being tough round-number, psychological resistance to push through.

chart of the S&P 500 index:

The profit taking in the NASDAQ has been very mild with the index holding short-term support at its 10-dma. If this level fails then 4250 is the next area of support. The recent high near 4350 and the March highs near 4370 are overhead resistance. Last week's -0.25% drop in the NASDAQ reduced its year to date gain to +3.2%.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index retreated from resistance at 1180 to support near 1160 and its 10-dma. Actually Friday's intraday low was 1154.33. Technically, last week's pullback is a 38.2% Fibonacci retracement of the rally from 1120 to 1180. The $RUT looks poised to bounce from current levels but that will depend on headlines over the weekend and Monday morning. Year to date the $RUT is down -0.2%.

The 1140 and 1120 levels should be support. 1180 and 1200 are overhead resistance.

chart of the Russell 2000 index

Economic Data & Event Calendar

We have a relatively quiet calendar this week. However the Fed meeting midweek could be a market mover. Not only will the FOMC announce their decision on interest rates but Federal Reserve Chairman Janet Yellen will hold a press conference. The Fed will also release their economic projections. Analysts do expect the Fed to reduce their QE asset purchases again.

After the World Bank reduced their forecast last week will the Fed reduce their forecast as well?

Not listed on the calendar is the Russell rebalancing. The Russell 1000, Russell 2000, and Russell 3000 are widely followed indices. The new weightings, deletions, and additions could definitely move individual stocks. You can view the changes here. The changes will take place on Friday, June 27th.

Economic and Event Calendar

- Monday, June 16 -
New York Empire State manufacturing survey
U.S. industrial production for May
Eurozone CPI data

- Tuesday, June 17 -
Housing starts and building permits
Consumer Price Index (CPI)

- Wednesday, June 18 -
FOMC meeting
Fed Chairman Janet Yellen press conference

- Thursday, June 19 -
Weekly Initial Jobless Claims
Philadelphia Fed survey

- Friday, June 20 -
(nothing significant)

Additional Events to be aware of:

July 3rd, U.S. markets close early
July 4th, U.S. markets closed for holiday

Looking Ahead:

This past week the markets were rattled by increasing violence in Iraq. An Al-Qaeda splinter group called the ISIS (a.k.a. ISIL) has been sweeping through the central north region of the country. This looks like it could split the country into another civil war drawn along the Sunni-Shia religious divide.

The ISIS are hard line Sunni Muslims. The Iraqi government and most of southern Iraq is Shia Muslims. The Shias and Sunnis have been fighting each other for 1,000 years. The ISIS' recent victories and news they were headed south to march on the Iraqi capital of Baghdad was followed by new headlines that Iran was sending military forces to help Baghdad fight the terrorists. Iran is a Shia Muslim country. In contrast, Iraq's southern neighbor, Saudi Arabia, is mostly Sunni Muslism. Iraq is sandwiched in the middle with the northern most tip of the country controlled by the Kurds.

Oil prices surged on this growing violence for fears that Iraq's oil production could be at risk. It has taken years but Iraq's oil production has been steadily growing and they account for over half of OPEC's new production growth. Iraq currently produces about 3.5 million barrels of oil a day. If something were to happen to that production the reaction in the oil markets would be sharp. We could see oil jump another $20-25 a barrel if Iraqi production is damaged.

At the moment it seems unlikely that Iraq's oil industry is in trouble but war is hardly predictable. The U.S. does not want to send in troops. Washington has been talking about helping with air strikes and drone attacks. Unfortunately that means we have to pick sides. It doesn't matter what side we pick (Sunni/Shia) it will be a lose-lose situation for us. What we do not want to see is Iran gain any more control of Iraq but Washington doesn't want hardcore Sunnis taking over either. There has been speculation that if the violence continues we could see Iraq breakdown into three separate countries. One controlled by Sunnis, one by Shiites, and one by the Kurds.

Investors focus on the price of oil because it impacts our economic growth. Estimates suggest that every $10 rise in oil prices shaves off -0.2% of our GDP. Every dollar rise in crude oil pushes gasoline prices up about 2.5 cents. Right now the U.S. national average for gas is about $3.65 a gallon. Once we get over $4.00 a gallon it starts having a very negative impact on consumer spending, which is a majority of the U.S. economy.

Since we are on the topic of energy, the price of natural gas could be rising for Europe soon. Ukraine and Russia have been negotiating on natural gas prices. Last year Russia was charging Ukraine $268.50 per 1,000 cubic meters of gas. Russia was giving Ukraine an export-duty break (discount) because of Russia's lease on their very important naval base in Crimea and because Ukraine had a pro-Russia president.

Things changed this year after Ukraine kicked out the old president and Russia invaded Crimea and annexed the peninsula (along with its naval base). Russia raised the price on natural gas to $485.50. That means all the gas that Russia had already delivered to Ukraine was now worth about $2 billion. With a $2 billion unpaid bill Russia was demanding that Ukraine start pre-paying for all future natural gas deliveries. This was important to Europe because 30% of their natural gas comes from Russia and half of that runs through Ukraine pipelines.

The two sides have been going back and forth on a new price with the EU trying to help broker a deal. Russia offered a 20% discount at $385. The EU moderator offered $326, which Ukraine is willing to pay. Yet it seems the two sides are at a stalemate and the deadline for Ukraine to start pre-paying for natural gas is Monday, June 16th. The Ukraine Prime Minister has already warned its government to prepare for Russia to cut off natural gas supplies.

This entire negotiation has been tense because fighting between Ukraine forces and pro-Russian rebels in eastern Ukraine continues today. Just a couple of days ago these pro-Russian rebels shot down a jet, killing all 49 people on board. Then there is a new story that three Russian T-64 tanks have crossed into Ukraine territory.

The stock market has a lot of headlines to digest. Thus far stocks have managed to climb this wall of worry. The slope might get too steep for the bulls if the situation in Iraq and Ukraine continue to deteriorate. Keep in mind that in spite of all this news so far the S&P 500 is only 15 points away from its all-time high. It's not like anyone is panicking but investor sentiment can change quickly.