U.S. stocks on Friday suffered their first setback after six straight days of gains, but the damage wasn't severe. No news appeared to precipitate the decline, so chalk it up to light profit-taking.

In the Friday session, the Dow Jones Industrial Average lost 0.2%, the Standard & Poor's 500 Index lost 0.1%, the tech-laden Nasdaq Composite Index lost 0.2%, and the Russell 2000 lost 0.2%.

For the week, the Dow gained 1.7%, the S&P jumped 2.6%, the Nasdaq surged 3.1% and the Russell zoomed 4.1% – a picture-perfect ladder of increased risk-taking.

There wasn't any indication that investors were stampeding for the exits on Friday as breadth was mixed and volume lighter than Thursday's session. According to Lowry Research Corp., buying power dropped two points while selling pressure increased just one point. It looks like the bulls stopped to catch their breath, providing the bears with a perfect opportunity to cause trouble.

 The fact that bears didn't take advantage of the opening should be taken as evidence that sellers are either unwilling – or are unable – to mount any kind of resistance here as the major indexes trade near their rally highs. But never count them out: Remember, complacency is always winners' worst enemy.

At the sector level, industrial and material stocks were the strongest on Friday, posting gains of 0.3% and 0.1%, respectively. We continue to see lots of activity in energy and materials stocks. Highlights included a 3.4% rise in oilfield service provider Schlumberger Ltd. (NYSE: SLB) and a 4.1% rise in Vulcan Materials Co. (NYSE: VMC). Laggards included bank and utility stocks.

In my Strategic Advantage newsletter, our new position in the SPDR S&P Metals & Mining (NYSE: XME) exchange-traded fund (ETF) was helped by a 7.6% rise in component Cliffs Natural Resources Inc. (NYSE: CLF). We also saw big moves overseas for global steel producers like ArcelorMittal (NYSE ADR: MT) and Mechel OAO (NYSE ADR: MTL). As one of the most direct plays on a global recovery in manufacturing, early signs of strength in the steel sector indicate that big institutional traders are putting long-term money back to work.

Earlier in the week, I told Strategic Advantage subscribers about how the S&P 500 faced overhead resistance at the 50% retracement line as drawn from the October 2007 highs to the March low. Well folks, the smaller, tech-oriented stocks in the Nasdaq vaulted over this level last week in an awesome showing of strength. The index has now returned to the same levels that prevailed last September in the wake of the Lehman Brothers Holdings Inc. (OTC: LEHMQ) bankruptcy.

Considering the relative strength of small caps this week, high-beta assets are in vogue as the riskier indices perform the more conservative ones. Subscribers have exposure to international small-caps through two high-octane regional ETFs. A broader ETF that is less risky is the SPDR S&P International Small Cap (NYSE: GWX) ETF.

Key ETF stats: Volume averages 156,000 shares per day; the trailing 12-month Price/Earnings (P/E) ratio is 13.4; the dividend yield is 2.6%.

Our bottom line continues to be the same as it has been the past five months: A new bull cycle is under way. There will be bumps along the way, including 3% to 10% multi-day and multi-week corrections, but we expect prices to rise for at least another six months, and most likely much longer.

Merrill Lynch is Bullish on America – Again

Merrill Lynch Chief U.S. Equity Strategist David Bianco last week published a big 65-page report that loudly proclaimed a new price target of 1,200 on the S&P 500. Bianco gets to that level by putting a P/E multiple of 17 on his 2010 earnings per share (EPS) estimate of $70. As this big document was passed around brokerage offices and Wall Street trading desks – carrying a title that called the S&P 500 index "overlooked and undervalued" – it was just the thing to get those speculative juices and animal spirits flowing. For such a broadly disseminated piece of research, it's probably no coincidence that its release came with a new rally high for stocks.

Now, I've never been really interested in exact estimates for what is truly in inexact art. And the quality and veracity of sell-side research is spotty. But Merrill's report was an impressive piece of work. Let me share some key takeaways with you.

The most important point in Bianco's opinion – which I share – is that a weak economic recovery is actually better for stocks than a strong one. A weak recovery will force policymakers to hold down interest rates and keep taxes low. Bianco believes that the combination of low short-term interest rates along with higher long-term rates is "of much greater benefit to banks than a rapid U.S. recovery."

Another takeaway is that U.S consumer spending will not be leading us out of the recession. Instead, Bianco is looking for "late-cycle" sectors of the economy like infrastructure, commodities, and exports to be the first to recover. And, finally, Bianco finds that compared to prior recoveries, we're currently tracking the historical median. So while other commentators will proclaim that we've come too far too fast, history shows that we're right on target.

Let's take a look at the key events in the markets last week.

The Week in Review

Monday: Markets were closed for the Labor Day holiday.

Tuesday: The U.S. Federal Reserve reported that consumer credit fell by $21.6 billion in July, compared to the consensus estimate of a $4 billion decline and June's decline of $10.3 billion. The drop was the sixth in a row and the largest drop in record.

The bears grabbed jumped this as terrible news, but a Deutsche Bank AG (NYSE: DB) study finds that drops in consumer credit have historically occurred after recessions have ended, not while they are taking place. Part of the reason might be that in the deepest, darkest time of economic malaise people hunker down and conserve liquid assets – not unlike the cash hoarding we saw in the banking sector.

Wednesday: The Federal Reserve's latest Beige Book of economic conditions across its 12 districts pointed to continued economic stabilization thanks to the government's Car Allowance Rebate System (CARS), popularly known "Cash-for-Clunkers." As a result, the Richmond, Atlanta, Chicago, and Minneapolis districts reported increases or planned increases in auto production – which will provide a desperately needed boost to the U.S. manufacturing sector in the current quarter.

And, in an early sign that the U.S. jobs market is firming – particularly good news at a point when concerns about a "jobless recovery" remain very high – eight districts reported a "slight pickup" in demand at temporary staffing firms. Temp demand is commonly looked upon as a leading indicator for labor demand.

Thursday: The U.S. trade deficit worsened to $32 billion in July from a previous deficit of $27 billion. That will be a drag on third-quarter gross domestic product (GDP). The drop was the result of a spike in non-oil imports led by automobiles and consumer goods.

In other news, the U.S. Census Bureau reported that American household income fell at its sharpest rate since recordkeeping began in 1947. Median income dropped 3.6% to an inflation-adjusted $50,303 – a return to the level that prevailed in 1997. 

Friday: The University of Michigan's Consumer Sentiment Index rose to 70.2 for September versus the consensus estimate of 67 and a previous reading of 65.7. According to Haver Analytics, September's result was the 42nd-largest rise out of the last 380 monthly changes. The current conditions sub-index jumped from 66.6 to 71.8 – its second-highest increase in the current recession/recovery cycle.
Let's take a look at the key events to watch this week.

Events to Watch This Week

Monday (today): No major economic or earnings releases. 

Tuesday: We will get an update on inflation with the release of the latest Producer Price Index numbers as well as new retail sales numbers reflecting the cash-for-clunkers program. 

Wednesday: Another inflation reading, this time from the Consumer Price Index. We will also get an update on Industrial Production for September.

Thursday: New housing starts will likely have increased as the inventory of new homes continues to shrink.

Friday: Quadruple witching as September index options, future options, stock options, and stock futures all expire. The Dow Industrials have been up in five of the last six September expiration sessions – rising for the last four consecutive sessions.