Stock market volatility remains elevated. The Dow Jones Industrial Average gained more than 900 points with a huge bounce off its Monday morning low (Feb. 2nd) through Friday's intraday high. Big cap indices like the S&P 500 and the NASDAQ composite also produced significant rebounds. This market-wide bounce lifted the SOX semiconductor index to a +2.8% gain for the week. Transports rose +3.2%. Housing stocks rallied +4.1%. Banking stocks soared +6.8%. Biotechs were the odd group that failed to participate with the biotech index down -2.6% for the week.

Oil and energy stocks were big performers with the oil index surging +5.2% and oil service stocks rocketing +8.3% last week. That's because crude oil prices were racing higher with a +8.8% gain in the last week and a +20% gain in just the last seven days. We have seen the biggest two-week rally in oil prices in the last 17 years (percentage basis). That's impressive when you consider that oil inventories inside the United States surged +6.3 million barrels to 413.1 million. That puts our inventory +15.4% from a year ago levels. U.S. oil inventories are currently setting at an all-time high (since records started in 1982). This news did spark some profit taking in oil midweek but the sell-off didn't last.

Economic Data

We had a lot of economic data to digest last week. The latest reading on factory orders showed a -3.4% drop in December following a -1.7% drop in November. The ISM manufacturing index dipped from 55.1 in December to 53.5 in January. The ISM non-manufacturing (services) index inched higher from 56.5 in December to 56.7 in January. Numbers above 50.0 suggest growth for both indices.

Unfortunately the ISM data is suggesting the U.S. is also seeing deflation accelerate. The ISM manufacturing index is comprised of several components. One of those components is the ISM prices index, which dropped from 38.5 in December to 35.0 in January. This is the third month in a row we've seen prices decline. Deflation now sits at the highest level in the U.S. since October 2008.

We are seeing similar deflation issues in commodity demand. Last week I mentioned the Baltic Dry index hitting multi-year lows. This index measures prices to rent a dry bulk container ship. Today the Baltic Dry index has fallen to new 30-year lows. This is a sign that global demand for commodities is very low and falling. It's hard to see global economic growth when demand for basic goods has crashed.

Chart of the Baltic Dry Index:

Albert Edwards, an analyst at Societe Generale, made headlines last week when he warned that deflation in the U.S. is a significant threat. He believes that eventually deflation will be so serious that the stock market will be "ripped to smithereens".

In other economic news we did see significant growth in the labor market. The nonfarm payrolls (jobs) report came out Friday morning. Economists were looking for +235,000 jobs in January. The Bureau of Labor Statistics said the U.S. added +257,000 new jobs last month. They also revised their 2014 numbers. The revisions for November and December last year added another +147,000 new jobs. November's is now +423K and December's is +329K. That makes the last three months the best three-month job gain in 17 years with an average of +336,000 new jobs. This is significant because it will influence thinking at the Federal Reserve, more on the Fed in a bit.

The minimum wage in 20 states increased on January 1, 2015. This helped boost the average hourly earnings, which jumped +0.5% in January. It's the biggest one-month surge since November 2009. The national unemployment rate inched higher. The government said that an additional 700,000 people were looking for a job last month. Their decision to look for a job adds them back into the workforce. This bumped the unemployment rate from 5.6% to 5.7%. Fears that the collapse in oil prices had fueled significant layoffs in the energy industry did not seem to show up or influence the jobs data.

Overseas Economic Data

Economic data overseas was very mixed. Japan said their manufacturing PMI inched up from 52.1 to 52.2. China's HSBC manufacturing PMI ticked lower from 49.8 to 49.7. The Chinese HSBC services PMI dropped from 53.4 to 51.8. Numbers above 50.0 suggest growth and below 50.0 contraction. The Chinese central bank cuts its reserve requirement ratio for banks from 20.5% to 19.5%, which is technically a form of easing monetary policy but it might just be a seasonal move to provide more cash ahead of the country's annual Lunar New Year holidays.

There has been growing speculation that China could join the global currency war. China's economy is currently growing at the slowest pace in more than 20 years. Its relatively new government is probably desperate to stimulate their economy. They may decide to jump into the global race to devalue their currency (a race the U.S. is currently sitting out). We are less than 40 days into 2015 and we've already seen eight central banks cut interest rates in an effort to fuel economic growth. Why would China not jump on the band wagon?

Looking at Europe the Eurozone said their manufacturing PMI was unchanged at 51.0. Germany's manufacturing PMI slipped from 51.0 to 50.9. France's fell from 49.5 to 49.2. The Eurozone services PMI rose from 52.3 to 52.7. Germany's services PMI improved from 52.3 to 54.0. Numbers below 50.0 suggest economic contraction and above 50 mean growth. Another sign that Europe is struggling with deflation is the latest Eurozone PPI data, which saw prices fall -1.0% month over month. This was worse than expected and followed a -0.3% drop the prior month. The year-over-year reading slipped from -1.6% to -2.7%.


One of the major stories last week was Greece and how its new anti-austerity government is butting heads with all of its European counterparts (i.e. creditors). Last Tuesday German Chancellor Angela Merkel warned everyone that negotiations with Greece would likely take months. Of course that could be a challenge given the major deadlines Greece faces in February. On Wednesday the European Central Bank (ECB) dealt a blow to Greece by declaring Greek government debt as unacceptable collateral for loans from the ECB. On Thursday German Finance Minister Wolfgang Schaeuble met with Greek Finance Minister Yanis Varoufakis but the meeting failed to produce any significant results. It was so contentious that Varoufakis said the two could not even agree to disagree.

The situation intensified on Friday when the EU gave Greece a new deadline of February 16th to apply for new bailout loans. The current bailout agreement expires after February 28th. After the 28th the country will be bankrupt and quickly run out of cash (you could argue they are already bankrupt). Last week also saw Standard & Poor's downgrade Greece's credit rating to B- (junk status) and they kept the country on watch for potential downgrades in the future. The S&P analysts are worried that Greece could face bank runs and capital controls.

Greece is a small country of about 11 million people that is about 1% of the Eurozone's GDP. Currently their debt is so large the country will never be able to pay it back (more than 250 billion euros). The new Greek government was voted into office to end the Troika-mandated austerity and renegotiate their debt structure. So it seems unlikely they would cave into Europe's demand. Meanwhile the Troika (EU, ECB, and IMF), led by the Germans, doesn't want to throw more money at Greece but they don't want Greece to leave the Eurozone either. If Greece refuses to play the Troika's game then the country will be in default. The Greeks will either leave or be kicked out of the Eurozone.

Leaving the Eurozone is probably the only real solution for Greece. That way they could re-launch their own currency, devalue their debts, make their exports more competitive, etc. However, such a move would probably be extremely rough on the country and its citizens. If Greece leaves the Eurozone it also paves the way for other troubled countries to leave the Eurozone and then the unity of the financial region would be seriously destabilized.

Greece and its upcoming February deadlines will remain front page news for the global markets for the foreseeable future.

Major Indices:

The S&P 500 index delivered a +3.0% bounce last week. The rally struggled near its short-term resistance in the 2,060-2,065 range. The recent seesaw pattern would suggest it's time for stocks to retreat again.

If this rally continues the 2,080-through-2,100 zone is also overhead resistance. Meanwhile support appears to be the 1,980-1,990 zone. A breakdown below 1,980 would probably signal a drop toward 1,900. Year to date the S&P 500 is down less than -1%.

chart of the S&P 500 index:

The NASDAQ also rebounded higher and posted a +2.3% gain for the week. It too struggled with resistance near its recent highs. The 4,800 area remains overhead resistance while the 4,500 region is still support.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index delivered the biggest gains among the major indices with a +3.4% advance last week. The breakout above short-term resistance at 1,200 is encouraging. Now the $RUT is only about 15 points away from a new all-time high. If the $RUT can breakout to new highs it would be very bullish for the broader market.

chart of the Russell 2000 index

Economic Data & Event Calendar

The pace of economic data slows down this week. There are no market-moving reports to watch. The Q4 earnings season is also slowing down. The events this week may be political. The Eurozone finance ministers will meet on February 11th and the main topic is probably Greece and if the Eurozone wants to kick them out. On February 12th is the EU leader summit. They will most likely concentrate on terrorism following the recent attack in Paris. There will probably be a lot of talk about Ukraine as well.

Economic and Event Calendar

- Monday, February 09 -
(nothing significant)

- Tuesday, February 10 -
Wholesale inventory data

- Wednesday, February 11 -
Eurozone Finance Minister meeting

- Thursday, February 12 -
U.S. retail sales for January
Business inventory data
EU leader summit

- Friday, February 13 -
Eurozone GDP report
Import/export prices
University of Michigan Consumer Sentiment

Additional Events to be aware of:

Feb. 24th - Fed Chairman Yellen's semiannual testimony before congress.

Looking Ahead:

Earnings season is winding down. More than 70% of the S&P 500 companies have reported their results. About 65% have beaten Wall Street's earnings estimates. Unfortunately the majority have issued bearish or cautious guidance. As many pundits predicted the U.S. dollar, currently at multi-year highs, has seriously hurt profitability for a lot of companies.

Geopolitical Concerns

Geopolitical issues could once again become the market's focus. We already discussed Greece, which will be a major story this year. There also seems to be a renewed focus on ISIS/ISIL. When ISIS burned a Jordanian pilot alive this past week it seemed to rekindle the civilized world's disgust for these terrorists. The country of Jordan has launched a number of airstrikes at ISIS targets in response. The White House just released their 2015 National Security Strategy and in it the Obama administration confessed that the U.S. probably faces an unending war against ISIS and its affiliates.

The sad news is that situation, with ISIS, is unlikely to change much. Until there is a serious offensive to take them out, just airstrikes will not succeed. Michael Morell, formerly the deputy director of the CIA said it would take 100,000 ground troops to take care of ISIS but no one is willing to make that commitment.

Meanwhile the focus on geopolitics might turn towards Ukraine this week. We just heard on Friday that German Chancellor Merkel and French President Hollande rushed to Moscow to talk with Russian President Putin about the situation in Eastern Ukraine. The media was calling it a last-ditch effort to form a peace plan to stop the fighting. As of today it would appear that Merkel and Hollande's efforts did not accomplish anything.

There is speculation that if Greece does get kicked out or leaves the Eurozone they might find a friend in Putin. Greece would love someone with deep pockets to help them through the transition in leaving the euro. Russian would love an ally right in the middle of the Mediterranean.

Investors are Nervous

Investors are nervous and looking for safety. The global economy is slowing down. Europe is facing deflation. China is at its slowest growth in decades. Russia remains belligerent. Greece is on the verge of leaving the Eurozone. U.S. stocks are getting whipsawed back and forth. Right now investors want protection.

Bond yields across the major economies are at multi-year lows. Many in Europe are trading at all-time, historic lows. Countries like Germany actually have negative yields on their short-term bonds. Investors are so desperate for safety they are piling into big corporate debt too. This has driven some bond yields for big corporations in Europe into negative territory.

Last week Nestle's corporate bonds saw a negative yield. This has never happened before. Investors are so scared they're willing to pay a fee (negative yield) just to park their money somewhere safe. Other big European or multi-national companies are seeing a similar event with their bond yields near zero. Oddly enough there is this strange divergence. The German stock market is near all-time highs. With last week's bounce the U.S. stock market is not that far away from all-time highs.

Federal Reserve and Raising Rates

Another big story to follow over the next several weeks will be the U.S. Federal Reserve. Friday's better than expected jobs number and the wave of upward revisions will give the Fed more ammunition to raise rates sooner rather than later. Currently the Fed has promised to be "patient" and many market pundits are translating that word into at least two more Fed meetings before we raise rates.

So what happens when the Fed changes that language? Previously expectations were for the Fed to begin raising interest rates in the September time frame or the fourth quarter of 2015. Now there is suddenly speculation that the Fed might raise rates as soon as June. Atlanta Fed President Dennis Lockhart has already voiced his opinion suggesting the Fed could start raising rates midyear. Market watchers already know that once the Fed starts hiking rates the stock market usually dips. Historically stocks plunged about -5% on the first hike. The researchers at the Stock Trader's Almanac noted that the month the Fed starts raising rates the stock market has never closed in positive territory that month. Three months after the first rate hike stocks are normally down about -5%. Hopefully the Fed can communicate clearly that they are raising rates because the economy is so strong. That might be a challenging message to get across if the rest of the world is slowing down.

Stocks definitely look a lot better today than the did a week ago thanks to the widespread bounce. However, it's just a bounce back toward resistance. I wouldn't get too excited yet. I am still suggesting caution. Now if we see the major averages breakout then investor sentiment would change significantly and we might see money chasing after new highs.

~ James