Stock Market Rallies Into Halftime

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 |  Includes: DIA, IWM, QQQ, SPY
by: Wall Street Sector Selector

By John Nyaradi

U.S. stock markets close out first half of 2012 with a big last day

U.S. stocks jumped on Friday in response to the latest European Summit in Brussels with the Dow Jones Industrial Average (NYSEARCA:DIA) jumping 2.2%, the Nasdaq Composite (NASDAQ:QQQ) gaining 3%, the S&P 500 (NYSEARCA:SPY) adding 2.5% and the Russell 2000 (NYSEARCA:IWM) climbing 2.9%.

The euphoria was driven by a perceived solution to the ongoing European debt crisis, and next week brings a holiday shortened week but one packed with important economic news. U.S. equity markets now find themselves facing yet another significant turning point as we turn the page to the second half of 2012.

On My Wall Street Radar

Click to enlarge

chart courtesy of StockCharts.com

In the chart of the S&P 500 above, we can see how Friday's rally took the index back above its carefully watched 50 day moving average and right back to resistance levels at the 1360-1370 level. Momentum had been waning but took a sharp turn north with Friday's rally.

Basically, the S&P 500 returned to levels seen before last week's "Euro dump," and so now the questions are whether or not the bulls can build on this rally or will it be another "one and done," post-Euro summit surge like so many we've seen before.

Click to enlarge

chart courtesy of StockCharts.com

A quick glance at VIX, the CBOE S&P Volatility Indicator, also known as the "fear index," gives a hint of what the most sophisticated options traders are thinking about today's situation. In this chart we can see how VIX declined right to and stopped at significant support levels in the 17 range. This is below its average of 20 and VIX remains in a bullish configuration with an upside price objective of 29, some 70% above current levels. Upside VIX means downside moves for equities, and so this chart indicates that the "smart money" still sees higher volatility/lower equity prices ahead. A break below current levels changes the picture, and so we'll be watching this chart closely as we move into the first days of the second half of this intense and hard fought game.

The Economic View From 35,000 Feet

Last week's big news, of course, was the outcome of the European summit where, once again, the region's leaders bought more time for their efforts to resolve the long running debt crisis. Markets cheered the reprieve and so now we'll have to see if the details of the deal will support the initial euphoria.

Already some cracks are starting to appear as the German Constitutional Court has to review the terms before Germany's President can sign off on the deal, and the European Stability Mechanism (ESM) has yet to be approved by several members of the European Union. And, of course, Friday's deal does nothing to solve the real problem which is that there is simply too much debt in Europe and not enough money to cover it with no new funds forthcoming from Friday's summit outcome.

This story isn't over yet by any means, particularly as many elements of the most recent deal won't be in place until late 2012, at the earliest. Also, let's not forget Greece, as over the weekend, Chancellor Merkel's government was hotly denying a Friday report that Finance Minister Wolfgang Schaeuble had stated that Parliament needed to prepare for a Greece going bankrupt and a subsequent departure from the European Union.

In other economic news, the Chicago PMI showed a slight gain but remains weak, Pending Homes Sales for May beat estimates and New Home Sales rose.

On the downside, Q1 GDP remained flat at a tepid 1.9% annual growth rate, weekly jobless claims stayed high and higher than expected, consumer spending and incomes are weak, the Richmond Fed manufacturing index dropped from +4 in May to -3 in June, a stunning decline from April's reading of 14 which clearly indicates a sharp slowdown in manufacturing activity in the central Atlantic region.

Finally, the June University of Michigan fell to 73.2, missing expectations and hitting the lowest level of 2012.

Earnings season kicks off July 9th with Alcoa (NYSE:AA) reporting, and so far, negative earnings outlooks have been the order of the day as the widening recession in Europe and slowdown in China takes a toll on companies' bottom lines. Overall earnings growth is continually being revised lower, and while analysts have notoriously poor track records, this earnings season will be particularly important as investors look forward towards the second half of the year.

This week brings light holiday trading mixed with important economic reports. On Monday we get Institute for Supply Management and construction spending, Tuesday bring motor vehicle sales and factory orders, Thursday highlights weekly jobs, ADP private employment and non-manufacturing ISM, and Friday brings the 900 pound gorilla with the June Non Farm Payrolls and Unemployment Reports.

Bottom Line: U.S. financial markets come to a significant turning point on both a technical and fundamental basis. Europe, earnings and economic reports will determine the short term direction and longer term trend, and we can never forget the ever present Federal Reserve. Expect more volatility as the bulls and bears take the field for the second half of 2012.

Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds and positions can change at any time.