The stock market's Santa Claus rally has fizzled. Bulls ran out of breath after the S&P 500 tagged new record highs on Monday, Dec. 29th. The holiday shortened week saw the S&P 500 decline -1.46%. That puts the 2014 gain at +11.4%. The NASDAQ ended 2014 with a +13.4% gain. Overall a pretty good year. However, the Chinese Shanghai Composite soared +53% in 2014 while Argentina's market rallied +59% last year. On the flip side Greece's stock market dropped -29% while Russia's market plunged -45% in 2014.

Stocks experienced relatively widespread profit taking with nearly every sector posting losses. The housing industry seemed to be the only group with a minor gain for the week. The U.S. dollar continues to climb and just had its best year (2014) since 2005 thanks to the Fed ending QE while Europe and Japan turning on stimulus to support their economies. Against the six major currencies the U.S. dollar rallied +12.8% in 2014. This dollar strength is pressuring commodities lower. Gold is down again and closed at $1,189 an ounce. Silver followed suit with a drop to $15.78 an ounce. Crude oil slipped to its lowest levels since May 2009 with a decline to $52.81 a barrel. The yield on the U.S. ten-year bond ended at 2.1%.

The most probably explanation for the market's weakness this past week is profit taking, especially on Friday's decline. It's a near year. Investors can sell last year's winners and postpone paying taxes on the trade until 2016. This scenario might continue to play out over the next few days.

Economic Data

U.S. economic data was mixed. The Chicago PMI data snapped a four-month streak above 60 with a drop from 60.8 to 58.3 in December. Numbers above 50.0 suggest growth. Construction spending in the U.S. came in worse than expected with October's number revised up from 1.1% to 1.2% but November's number coming in at -0.3%.

The national ISM manufacturing index saw a drop from 58.7 in November to 55.5 in December. This is a six-month low but it's still the 19th month in a row that the ISM manufacturing index has come in above 50.0 (suggesting economic growth).

Overseas Economic Data

The story in Europe was focused on two things: The ECB and Greece. European Central Bank President Mario Draghi has been promising to launch some form of quantitative easing in the Eurozone for months. It looks like the ECB is finally ready to start. Europe is fighting the looming shadow of deflation as the euro currency dropped to its lowest level in four years. Draghi confessed to a German newspaper that deflation remains a risk. The ECB is scheduled to have an interim meeting on January 7th and then again on January 22nd. The best bet is the ECB might act at the January 22nd meeting.

The other big story was Greece. The country is edging closer and closer to committing financial suicide. The Greek parliament saw its third vote to approve Prime Minister Karolos Papoulias' president candidate fail. In response Papoulias dissolved the parliament and that forces snap elections to be held on January 25th. Right now the risk is that the country's citizens are so fed up with the current situation that they could elect the radical Left-wing Syriza party. If elected Syriza plans to leave the Eurozone and likely default on all of Greece's prior promises of austerity and bailout agreements.

By leaving the Euro it would allow Greece to reinstate the drachma as their currency. Using the drachma they could devalue their currency to make their country more competitive and reduce the value of their debts. The challenge is that an immediate exit, without the cooperation of the Eurozone, could cause a lot of instability in Europe. European markets saw a lot of volatility as this story unfolded last week.

The backdrop for all of this last week was a reminder that the Europe region is still slowing down. Spain, Italy, France, Britain, and the Eurozone all reported their manufacturing PMI data last week and they all declined. Germany said their manufacturing PMI was flat. Meanwhile bond yields across most of Europe are multi-year if not all-time lows. The yield on the German 10-year note is down to 0.5%. The yield on the 5-year German bund actually dipped into negative territory (-0.1%) on Friday.

China is also dealing with slowing growth. The China HSBC manufacturing PMI improved from 49.5 to 49.6 but it's still in negative territory under the 50.0 mark. The official China PMI data dipped from 50.3 to 50.1 in December. This is a one-year low. There is a growing camp of analysts that believe China will add more stimulus to reenergize their economy in 2015.

Major Indices:

The S&P 500's +11% gain in 2014 marks the index's sixth year in a row of positive gains. It's the third year in a row of double-digit gains. The Wall Street Journal raised the caution flag over the market's valuation. Over the last ten years the S&P 500 has traded with a forward P/E of 13.2. It just ended 2014 with a forward P/E of 16.4 (compared to 2013's 15.4).

I cautioned readers last week to look for support near 2,050. The low on Friday was 2,046. If the Friday afternoon bounce fails then the S&P 500 could be headed for the 2,000 area. Meanwhile the 2,090-2,100 zone is overhead resistance.

chart of the S&P 500 index:

The NASDAQ composite pared its 2014 gain last week but still closed up more than +13% for the year. I warned readers that a pullback near 4,800 would look like a potential bearish double top. That's what we are facing today. The NASDAQ did find short-term support near 4,700 on Friday. If that level fails then 4,650 and 4,550 could be the next levels to watch for support (see the Fibonacci levels on the daily chart below).

chart of the NASDAQ Composite index:

The yearend rally in the small cap Russell 2000 has stalled. The $RUT was due for a pullback. The fact that its bounced on Friday near its prior highs is potentially bullish. If the $RUT can close above 1,222, which would be a new record high, it would be a very bullish sign for the market. Don't forget the $RUT has an inverse H&S pattern that suggests a 1,340 target.

chart of the Russell 2000 index

Economic Data & Event Calendar

It's the first full week of the month and that means economic reports. The big report to watch will be Friday's jobs report. December's number could be volatile due to all the temporary workers hired for the holidays but it should be over 200,000 new jobs.

It's worth noting that the Q4 earnings season is about to start with Alcoa (AA) on January 12th.

Economic and Event Calendar

- Monday, January 05 -
Auto and Truck sales for December

- Tuesday, January 06 -
ISM services index
Factory Orders from November

- Wednesday, January 07 -
ADP Employment Change Report for December
ECB meeting (no interest rate decision)
FOMC minutes from the last meeting

- Thursday, January 08 -
Bank of England interest rate decision

- Friday, January 09 -
U.S. nonfarm payrolls (jobs) report for December
Unemployment rate
Wholesale inventory data

Additional Events to be aware of:

Jan. 22nd - ECB meeting
Jan. 25th - Greece Elections
Jan. 27-28th FOMC two-day meeting
Jan. 28th - FOMC policy update

Looking Ahead:

Not much has changed in the last few days. Most market participants have been on vacation for the yearend holidays. They should be back to work this week and that will bring an increase in volume.

The drop in crude oil and gasoline continues to make headlines. Oil sank to new five-year lows this past week. The price of gasoline in the U.S. has fallen a record-breaking 99 days in a row. The average price per gallon is now $2.23 but several states have prices under $2.00. I believe Oklahoma City has the lowest in the nation with several gas stations listing prices for unleaded in the $1.55-1.59 a gallon range.

Travel group AAA claims that the drop in gas prices in 2014 saved Americans about $14 billion. That's about $43.75 for every person in the U.S. AAA is now estimating that Americans could save up to $75 billion in 2015 if prices stay low. This should be a huge boost for the U.S. economy since nearly 70% of GDP is consumer spending.

The big picture outlook for the market is bullish. That's because the U.S. economy is entering 2015 with some positive momentum. We have low gas prices to fuel strong retail spending. We have low interest rates to help with business investment. The labor market gone from glacial growth to lukewarm growth. Investors are ignoring an economic slowdown in China, Japan, and Europe due to dovish central bank policies and the expectation for more stimulus for their economies. The one sour note might be strength in the U.S. dollar. Half of the S&P 500 companies' sales come from overseas and a super strong U.S. dollar could hurt business.

Additional issues to watch are Russia, ISIS, the U.S. Fed. Russia and its president, Vladimir Putin, are wounded animals. Their economy is crashing. Their main export oil has seen its price cut in half. There are concerns that Putin could spin the struggling economy into a narrative that supports more military conflict in Europe. ISIS remains a significant threat to the Middle East. Without the porous southern U.S. border I am surprised there hasn't been more terrorist attacks inside the U.S. It might be just a matter of time. Increase geopolitical conflict could unnerve investors.

Last but not least is the U.S. Federal Reserve. According to research done by Barrons, since 1955, every time the Fed started a cycle of raising rates the stock market sold off. If that wasn't bad enough the stock market continued to struggle until the Fed was done raising rates. Right now it is widely expected that the Fed will announce their first rate hike in mid 2015 or the second half of 2015.

~ James