The continued sell-off in crude oil prices was the main story for the market last week. Oil plunged -12.6% in the last five trading days to five year lows and is down about 50% from its summer 2014 highs. Energy and oil related stocks account for nearly 10% of both the S&P 500 and the Russell 2000 indices. Their weakness was a major anchor around the market last week as the Dow Industrials lost -3.7%, its worst week since 2011. The S&P 500 dropped -3.5% for its worst weekly performance since May 2012. The NASDAQ composite dropped -2.6% and the small cap Russell 2000 fell -2.5%.

It wasn't just the U.S. market either. Globally stocks delivered their worst weekly performance of the year. More than $1 trillion in value was wiped out across the world equity markets. You would think falling oil prices would be beneficial for transports but the transportation average dropped -3.4%. Not surprisingly the oil index was down. The OIX fell almost -9% last week. The oil service index was down -7%. Banks also had a rough week with a -3.7% decline. Meanwhile precious metals bounced with gold up +2.5% and silver soaring +4.6%. All this stock market weakness drove money into the safety of bonds. The yield on the U.S. 10-year note slipped to 2.0%. The 30-year bond yield has fallen to two-year lows at 2.76%.

It is worth noting that it's not just oil. Worries about deflation are rising as other commodities continue to drop. A lot of analysts watch copper since it is a widely used industrial metal. Falling copper demand suggest that economic activity is slowing. Copper managed a bounce last week but it is still trading near five-year lows. Iron ore and steel prices are falling. Coal appears to be in a non-stop march lower. Falling oil and natural gas prices make them more attractive and steals demand from coal (by the way, that hurts the railroads who transport a lot of coal). Even cotton is plunging with a drop from $2.00 to $0.60. We can lay part of the blame here on the U.S. dollar. As foreign currencies like the euro and yen weaken it pushes the dollar higher. Since these commodities are traded in dollars a rising dollar makes the commodities cheaper (you get more value per dollar).

Oil's Slide

Last week saw WTI crude oil fall below $60 a barrel for the first time since July 2009. Today crude oil is about $57.50 a barrel. It was about $108 a barrel back in June. Helping drive the price lower last week was both the International Energy Agency (IEA) and OPEC who both lowered their demand forecast for oil in 2015. You might recall that OPEC helped accelerate oil's decline recently when they decided to not cut production at their late November meeting (Thanksgiving day). This was mainly Saudi Arabia who is willing to see lower prices in order to gain market share and hurt their rivals.

Weekly chart of the U.S. Oil ETF (USO)

The Saudi's plan is already working. They want to see oil production in the United States decline (of course they also want to hurt other producers like Russia, Iran, etc.). The latest data showed that permits for new oil and gas wells sank from 7,227 to 4,520. We could see a significant pullback in new drilling activity in the U.S. if oil prices stay low.

Another facet of the oil price plunge is its impact on the banking industry. You may have noticed that banking stocks were down sharply last week. That's because the market is worried they could see an increase in bad loans from energy companies. A few years ago the U.S. oil exploration and production companies only had about $300 billion in debt. Today that number is over $1 trillion. With oil prices down almost 50% in the last few months that raises the risk of some of the smaller companies defaulting. Another risk the world could face if oil prices stay low is growing unrest in struggling oil exporters. Countries like Venezuela, oil producers in Africa, Iran, even Russia could face trouble as they all count on oil exports to pay their bills and fund their governments.

These countries are facing something of a prisoner's dilemma. If they all cooperate and reduce production then oil prices would rise and they'd all make more money. Unfortunately, this group (mainly OPEC) is notorious for not complying with their own quotas and production guidelines. Instead of cutting production to raise prices these countries will produce even more (if they can) because they need the money to pay their bills and hope to make up their lost revenue on more volume.

There is some speculation that the sell-off in oil could be nearing an end. There was a new story that China had chartered a record number of massive oil tankers because they're taking advantage of these depressed oil prices to stock up on their strategic reserves. The IEA expects that stock piling could be a major influence on oil prices next year.

Economic Data

We did not get a lot of economic data in the U.S. but what we did see was generally positive. Retail sales from October were revised higher from +0.3% to +0.5% and the November reading came in above expectations at +0.7%. Looks like the consumer is doing okay after all.

Speaking of the consumer, the latest consumer sentiment number for December soared five points from 88.8 to 93.8. This is the highest reading since July 2005 and significantly above expectations. The expectations component rose from 79.9 to 86.1.

Meanwhile the wholesale look at inflation in the Producer Price Index (PPI) dropped -0.2% thanks to a sharp drop in energy prices. The energy component dropped -3.1% while gasoline fell -6.3%. The core-PPI, which excludes energy, was unchanged in November.

Overseas Economic Data

There were a number of headlines overseas. The Eurozone industrial production number rose +0.7%, up from +0.2%, and above expectations. The latest Eurozone Sentix Investor Confidence survey improved from -11.9 to -2.5, which was also above estimates.

Germany said their industrial production improved +0.2% from a month ago. Unfortunately their imports in November plunged -3.1%, which is the biggest decline in almost two years. Exports dropped -0.5% compared to a +5.5% gain the prior month. Elsewhere France made headlines when the Fitch rating agency downgraded France's credit rating from AA+ to AA.

Greece was back in the news. The country was granted a two-month extensions on meeting its bailout requirements. Almost immediately the Greek Prime Minister called for new presidential elections. Investors are worried that the party that wants to secede from the Eurozone might win and that sparked a -20% drop in the Greek stock market. Bond yields for a Greek 10-year note soared to about 8%. Normally a yield of 7% or higher for a sovereign 10-year bond is a major warning signal to investors. In contrast money continues to seek safety in German bonds and the yield on the 10-year German note sank to a record low of 0.627%.

Economic data out of China was mixed. Their latest retail sales data showed sales up +11.7%, which was slightly ahead of expectations. Yet their industrial production came in at +7.2%, which missed expectations. Most of the headlines out of Japan were negative. Japan's Q3 GDP estimate was revised down from -0.4% to -0.5%. Japan's core machinery orders plunged -6.4%, down from +2.9%. The latest Japanese household confidence survey dropped from 38.9 to 37.7 when analysts were expecting a rise. They did see their industrial production number improve +0.4% for the month.

We will hear more about Japan this coming week. Prime Minister Shinzo Abe called for new elections a few weeks ago. The election for the Lower House will be today (Sunday, December 14, 2014). It is expected that Abe's LDP party will win. If they do not win it would be very negative for Japan and could spark selling pressure in stocks around the globe.

You can read more about the Japanese election here. It looks like Abe's party did win: Shinzo Abe's coalition wins big in Japan, amid very low voter turnout

Major Indices:

I've been warning readers that the market was overbought and due for a pullback. Honestly I wasn't expecting such a sharp pullback in the middle of December. This month is historically bullish for equities. Not surprisingly the S&P 500 did find support near the 2,000 mark, which is also bolstered by the 50-dma.

I would expect an oversold bounce on Monday. However, if the S&P 500 breaks down under 2,000 then the next support area could be the 1975-1980 zone. Below that the 1950 level is likely support as it will be underpinned by the 200-dma.

Last week's drop in the S&P 500 (-3.5%) brings the year to date gain down to +8.3%.

chart of the S&P 500 index:

The sell-off in the NASDAQ (-2.6%) cut its 2014 gains to +11.4%. Thus far the pullback has been pretty mild. I would expect a dip toward 4600. Below that the 4500 level is probably round-number support. The NASDAQ could see a significant pullback and still keep its long-term up trend. Although I would really start to worry if we saw the NASDAQ close below 4500.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index has spent the last six weeks consolidating sideways in the 1150-1190 range. If we see a breakdown below the 1150 area it could portend a much deeper decline ahead. There is a cloud of moving averages all converging in the 1140-1150 area. If you look real hard the consolidation over the last few weeks almost looks like a bearish head-and-shoulders pattern, which would forecast a drop toward 1100.

Soon we will start to hear the financial media discuss the "January effect" and how small cap stocks tend to outperform the rest of the market in January.

chart of the Russell 2000 index

Economic Data & Event Calendar

This week we will see a few regional Fed surveys from New York, Philadelphia, and Kansas City. The main event is probably the last FOMC meeting of the year. No one expects the Federal Reserve to change interest rates so the focus will be on their statement. Right now market watchers are speculating if the Fed will alter their "considerable period" language that has been in their statement for a long time.

Economic and Event Calendar

- Monday, December 15 -
China's HSBC manufacturing PMI
New York Empire State manufacturing data
Industrial Production
NAHB housing market index

- Tuesday, December 16 -
Eurozone manufacturing PMI
Housing starts & building permits

- Wednesday, December 17 -
Consumer Price Index (CPI)
FOMC meeting
FOMC updates their economic forecast
Fed Chairman Yellen press conference

- Thursday, December 18 -
Weekly initial jobless claims
Philadelphia Fed survey

- Friday, December 19 -
Kansas City Fed manufacturing survey
Quadruple option expiration

Additional Events to be aware of:

Dec. 24th - U.S. markets close early (Christmas Eve)
Dec. 25th - U.S. markets are closed for Christmas

Looking Ahead:

Looking ahead the year is almost over. We have 11 and 1/2 trading sessions left in 2014. You only have 11 days until Christmas. Traditionally stocks tend to move higher in the second half of December. As we get closer to Christmas we're going to hear the financial media discussing our prospects for a Santa Claus rally.

I remain bullish on the U.S. Previously the drop in oil was seen as a blessing because lower oil meant lower prices for gasoline at pump. The less we pay for gas the more money consumers have to spend elsewhere. Yet last week the plunging price of oil was suddenly seen as a bad thing and instead of a blessing for consumers the drop in oil was a reflection of slowing economic activity overseas.

The markets already knew that China, Japan, and Europe were all slowing down so I fail to see why there were new worries about a slowly global economy. Falling gasoline prices are good for the entire planet's consumer spending. The U.S. economy is nearly 70% consumer spending. According to Stephen Stanley, Chief Economist of Amherst Pierpont, every penny that gas prices drop in the U.S. leaves a billion dollars in American's pockets. I heard this figure a few years ago when Deutsche noted back in 2010 that every one cent rise in gasoline equated to a drop of about $1 billion to $1.4 billion in consumer spending elsewhere.

In the last year the American consumer has been given a $62 billion bonus thanks to lower gasoline prices. Now imagine this effect multiplied around the world. Granted, Americans drive more than other countries, but it's still a positive stimulus for the global economy. Back in October we noted that lower gasoline prices could provide more than $1 trillion in stimulus around the globe. On the other hand all of the oil exporting countries will have less money to spend so their government spending will go down.

Believe it or not but Q4 earnings season will begin in a few weeks. Alcoa (AA) will unofficially kick off earnings season on January 12th. The next couple of weeks could bring some earnings warnings. We are hearing companies complain that the sharp rise in the U.S. dollar is hurting their sales overseas. The S&P 500 companies get about half of their revenues overseas so blaming the dollar could be a popular excuse in 2015.

Next year it could be a battle of investor ideas between the U.S. and the rest of the world. We do live in a global economy. If the rest of the world is slowing down economically how long can the U.S. keep growing? Can the U.S. really decouple from the rest of the world?

At the same time if the rest of the world is slowing down and regions like Japan and the Eurozone are devaluating their currency, that makes the U.S. look much more attractive. We already know that Japan's new stimulus includes buying foreign stocks and ETFs. Since the U.S. has the biggest and most liquid market we will be the beneficiary of that program.

The oil sell-off will eventually stop. I suspect that next year we could find some real bargains in the energy sector.

I'd like to think the market's -3% pullback this past week is a new entry point for bullish positions but investors may want to wait for a bounce. The average bull market lasts about 165 weeks long. The current bull market just hit 300 weeks old. That doesn't mean it's going to die any time soon. Bull markets do not come with an expiration date but we were due for a pullback.

Stocks go up. Stocks go down. That's normal life in a stock market. We just need to be patient when it comes to the right entry point.

~ James