Despite a weak Friday on the heels of a failed attempt by lawmakers at a solution to our fiscal cliff problems, our major indices enjoyed a solid week. Small caps led the rally, forging ahead another 2.93%. All of our indices rallied, however, with the NASDAQ, S&P 500 and Dow Jones also tacking on 1.67%, 1.17% and 0.43%, respectively.
Small cap strength tacked on to recent relative gains by the Russell 2000. We've discussed on many occasions the historical tendency for small cap stocks to perform well during the month of December and 2012 thus far has been anything but a disappointment. The following chart is a price relative chart between the Russell 2000 and S&P 500. It's fairly evident that small caps are leading their large cap counterparts:
This chart highlights the fact that the stock market tends to perform very well when the more aggressive Russell 2000 index is outperforming on a relative basis (green shaded area above). But when the Russell 2000 lags on a relative basis, it illustrates that market participants are not willing to accept the increased risk of owning smaller companies. That intolerance of risk generally spells trouble for equities.
Technically, the action last week was very bullish. All of our major indices negotiated the price resistance that could not be penetrated in the prior week on a closing basis. Increasing volume accompanied the move as additional sideline money and frightened shorts began buying. Market makers likely aided the bulls with their own buying as equities were up quite nicely heading into Friday.
That's when things turned interesting.
After the bell on Thursday, House Speaker John Boehner cancelled the vote on his "Plan B" proposal once he realized that he didn't have enough support amongst the Republican party to pass the bill in the House. Futures immediately tumbled on the news as market participants realized the greater likelihood of December 31st passing without a deal amongst lawmakers. The red futures carried over to the opening bell on Friday and the stock market was in selloff mode until mid-day when the bulls finally began to make their present felt.
The buying couldn't have started at a much better time technically. During any advancing market, pullbacks to test rising 20 day EMAs provide our first clues as to the strength of an advance. Solid markets normally bounce off such key support levels. Take a look at how the S&P 500 has defended this 20 day EMA support over the past several weeks:
Economic news was mostly mixed during the week. December Empire Manufacturing, housing starts, initial claims, leading indicators and Michigan sentiment all were reported worse than expected, while positive surprises came in the form of building permits, the final Q3 GDP reading, existing home sales, personal income and spending and durable goods.