Traders appeared to be fatigued as the market slumped into the pre-Christmas close. Holiday parties, trays of food and probably an occasional alcoholic beverage took precedence over trading stocks.

Market Statistics

For a quiet day in the markets there was a very busy economic calendar. Jobless claims came in at 420,000. That was lower than the prior week by 3,000 claims BUT last week was revised up by 3,000 claims from 420,000 to 423,000 so in reality there was no change. However, more than 20 states reported a decrease in claims of more than 1,000. It was still a good report as we wait for that first dip under 400,000. Unfortunately beginning in January we should see an increase in claims as holiday workers head back to the unemployment lines.

The Consumer Sentiment survey posted another small gain to 74.5 from 74.2 in the prior reading. This was slightly below the 74.8 to 75.0 analysts were expecting but still a gain. The final reading for December was a +2.9 point gain over November.

Consumer Sentiment Chart

Personal income surprised analysts with a spike to +0.3% when estimates were for a gain of +0.1%. Spending rose +0.4%. This was down from +0.7% in October but still above the trend. Service sector spending was the highest since May. The savings rate declined to 5.3% as spending forced consumers to dip into their savings. This is bullish because it means consumers are feeling better about the future if they are willing to dip into their cash hoard. This was the fifth consecutive month that spending was a draw on savings. The savings rate has not been below 5.3% since August 2009.

The PCE deflator, the indicator of real inflation at the consumer level, saw prices rise by only +0.1% after being unchanged for four months. Inflation is nonexistent and the lowest on record back to 1960. Income will rise again in 2011 thanks to the social security tax cut. This will flow billions of dollars into the economy because this will immediately increase the net pay on everyone's paychecks.

New home sales surprised everyone with a +5.5% gain in November to 290,000 annualized units. This is not really a home buying month so the news was positive for the markets. Months of supply declined from 8.8 to 8.2 months but homebuilder inventories are still at a 40-year low. Once regular buying returns to the prior rate of 1.3 million per year the price of home is going to rocket higher due to lack of supply. The median home price declined -2.8% to $212,700.

New home sales are still going to have an uphill battle in 2011. Realtytrac reported on Friday home foreclosure filings fell -21% in November. That is the lowest level in two years and is somewhat seasonal but it was also impacted by the slowdown by lenders while the robo-signing mess was being discussed. A total of 262,339 properties received a foreclosure filing in November.

Realtytrac said more than three million homes received a filing in 2010 and more than one million were repossessed by the bank. Today there are more than five million loans seriously delinquent but not yet in foreclosure suggesting 2011 could actually have more events than 2010. However, banks believe conditions will improve so they are working harder to avoid taking that next step from simply delinquent into foreclosure action.

The economic calendar for the last week of the year does not have any stand out reports. The big economic news is the following week with the national ISM and the NonFarm Payrolls. For this week the Richmond Fed Manufacturing Survey and Chicago ISM are the only reports likely to generate market interest.

Economic Calendar

After the market closed the Fed announced its balance sheet had grown for the eighth consecutive week to $2.41 trillion because of its purchases of treasuries in the QE2 program. This is a new record for the Fed but it is expected to grow to nearly $3 trillion before the program ends in June. Of the $2.41 trillion the Fed is holding a total of $1.007 trillion is U.S. government securities. The Fed also owns $1.008 trillion of mortgage bonds on Fannie, Freddie and Ginnie Mae.

Federal Reserve Balance Sheet

Retail sales were up +5.5% for last weekend compared to the same period in 2009. Consumers spent an estimated $18.8 billion. Foot traffic was up +3%. For those consumers running around trying to find that last minute Christmas gift it was stripped shelves and frazzled nerves. This turned out to be a good shopping season and stores sold down to the bare shelves in many cases. They did not load up on back stock in fear of having a lot left over. This is just about the right ratio of sales to inventory.

PC sales were slow but tablet sales were booming. New tech was hot but old tech, you know the stuff that was new six months ago, was left on the shelves. Technology is moving so fast the leading edge products have a very short shelf life before competitors have produced a new and improved generation of products. Apple's iPad may be the exception to the rule but only because the new Android tablets have not started delivering in quantity yet. I know of a major financial firm that gave everyone iPads for Christmas. Did you get electronics for Christmas?

In stock news Crocs (CROX) lost 5% after their second C-suite office defection exit in less than a year. Crocs CFO Russell Hammer announced he was resigning on December 31st to join another company. Crocs CEO John McCarvel said they were searching for a replacement. McCarvel became CEO back in February when John Duerden resigned after one year. Having a revolving door of officers is not confidence building for investors. They always wonder what the outgoing officers knew that the public does not know.

Bed Bath and Beyond (BBBY) rallied +5% after blowing past estimates with earnings of 74-cents. Analysts had expected 66-cents. Revenue was also higher than expected and the company won several upgrades from analysts.

Chart of BBBY

Retailer Jo-Ann Stores (JAS) spiked +32% to $60 after investment firm Leonard Green & Partners LP said it was taking them private for about $1.6 billion. That is $61 per share. This is another in a recent string of deals. J Crew agreed to be purchased by the same firm and TPG Capital for $3 billion. Gymboree Corp agreed to be acquired by Bain Capital for $1.8 billion. Leonard Geen also purchased a 9.5% stake in BJ's Wholesale Club and is considering taking that company private. They also have investments in Neiman Marcus, The Container Store, David's Bridal, Whole Foods Market and Sports Authority. Looks like they are building quite a retail conglomerate.

Jo-Ann Stores Chart

Crude oil prices rallied +$1 to $91.50 on colder weather, declining inventory levels, a decline in the dollar and comments from Libya and the CEO of Gulf Oil. The closing price was a new 26-month high and appears to be setting up for a run to $100. Colder weather for the last week prompted expectations of increased demand for heating oil this winter. Stronger economics suggest business and consumer demand for crude products should increase in Q1 and all next year. The normal end of year inventory reductions for tax reasons are being interpreted by the investing public as increased demand rather than an accounting maneuver. The Libya National Oil Corp chairman told Reuters in Cairo "I think current oil prices are reflecting the situation in the market, which is a well balanced market. It is fair to say the price is about right, but I still think it needs to improve a bit more. About $100 would be a fair price for the time being." He is one of OPEC's most hawkish members.

Speaking at the same meeting the Kuwaiti oil minister said on Saturday, "the global economy can withstand $100 oil." He said the market was well supplied and the fundamentals were balanced. The oil minister from Iraq also told Reuters $100 was a fair price. The Qatar oil minister said OPEC will not raise production before June because the market is well supplied. It seems OPEC is intent on talking up the price.

OPEC does not appear to be concerned the high prices could crimp demand and push the global economy back into recession. They don't have any plans to officially discuss a production change until they meet again in June. Saudi Arabia is trying to gently talk down the price by repeating the $70-$80 is a fair price mantra but so far it is having no impact. That comment was repeated by Saudi's oil minister again this weekend. Some analysts expect Saudi to quietly begin pumping more oil to oversupply the market and lower prices. That would take 30-60 days to have any impact.

The CEO of Gulf Oil was asked on Thursday his expectations for prices. He expects oil over $100 in January and said there was a 25% chance of a new high over $147 by Memorial Day. His company operates oil terminals and distributes about 250,000 barrels of oil per day to 3,500 gas stations. He said high prices were a problem because at any time there was more than two million barrels in transit through their pipelines to those 3,500 stations. High prices cause demand destruction and the flow of products backs up into the distribution system.

I personally believe we will see $100 early in 2011 and possibly $125 by year-end but I don't see $147 again until mid 2012. The impact of prices on the global economy is so great OPEC will eventually raise production. This is not 2008 when they were pumping at 100% capacity. They have excess capacity today. How much capacity is under continuous debate but they do have some excess capacity. They need to dip into it soon or we will be looking at another global recession about two years before it is due.

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Remember Elaine Garzarelli? She was the analyst that correctly predicted the 1987 market crash. Elaine has thirteen indicators she follows and she claims they are at the most bullish level in a decade at 71% positive. Above 65% is a buy signal, below 30% is a sell signal. Before the 1987 crash they declined to 9% prompting her to make her famous market crash prediction.

She said we should take a lesson from Japan and their QE program. When they implemented the program aggressively to lift themselves out of their recession the Nikkei rallied 50%. The second time they did it aggressively the market rallied 80%. When they stopped QE the market declined 50%. She claims QE does not specifically help the economy but it always spikes the stock market. With the Fed facing another six months of QE2 Elaine says this is the best time to buy stocks in the last decade. Let's hope she is right.

TrimTabs CEO Charles Biderman does not agree with Elaine but he does agree as long as QE2 is underway the markets will go higher. Biderman claims the money flows do not support a retail investor rally. He said the current fund flows are institutional investors reallocating funds in defensive mode. Bonds are going down in price and the current worry over potential municipal bond defaults is driving bond investors back to equities.

Month to date in December bond funds have seen outflows of -$15.5 billion. This compares to inflows of $273 billion year to date. The tide is turning but it has a long way to go. U.S. equity funds have seen inflows of +$16.7 billion in December compared to outflows of -$41.2 billion year to date. International equity funds saw inflows in December of -$8.5 billion compared to +$84.3 billion for the year.

Biderman said QE2 has not yet convinced retail investors to buy stocks. The Fed is removing an asset class from the market and that forces institutional investors to buy stocks. As long as QE2 is in operation the market should continue to rally.

He said TrimTabs.com had done the same municipal bond analysis as Meredith Whitney but did not draw the same conclusions. He is not calling for a big default cycle but warned there are problems. States and municipalities have a $200 billion annualized shortfall on bond debt payments and without a Federal bailout they will be unable to make their debt payments. You can't fire that many people or cut services and budgets that far that quickly. Maybe QE3 should be muni bonds.

Biderman explained why he is bearish on the market once QE2 ends. In 2008 consumer take home pay plus money taken out of real estate totaled $7.0 trillion. Since most consumers spend what they have the majority of this money went out for living expenses and investments. In 2010 the decline in income received has ended and stabilized at $5.9 trillion per year. That is an annual shortfall of $1.1 trillion dollars consumers no longer have to spend on living expenses and investments. Obviously the category coming up short is the investment side since utility bills and car insurance payments tend to be higher up the priority list. Consumers are still taking money out of investments to pay for bills because 18% of the U.S. is unemployed or under employed. Until take home pay begins to rise he does not believe the market will see a retail investor rally. He pointed out between 2003-2008 40% of the jobs created came from real estate. What sector is going to supply 40% of any new jobs in 2011-2012? That economic boost is gone at least for the time being so he believes the market will struggle once QE2 is over.

The one thing feeding the market is the decline in bonds. The bond bubble of 2010 is evaporating and that money is flowing into equities. The decline in the dollar is making equities more attractive and the rise in interest rates is making bonds less attractive. We are facing a classic asset allocation rally as long as the Fed is in control.

Chris Johnson of Johnson Research said the QE2 environment in the U.S. was pulling money back from international funds. Money in international ETFs was starting to come back to the U.S. to capture the gains from the QE2 rally. When the dollar is depreciating you want to be in dollar denominated assets that are going up in value like U.S. stocks. Being invested overseas in that environment exposes you to currency risk as well as stock risk.

While almost every analyst is expecting a strong market in 2011 most believe the market is due for a pullback in January. Katie Stockton, Chief Market Technician at MKM Partners, said although stocks are overdue for some short-term weakness there is a silver lining. She wrote in a research note, while the S&P and most of its components are technically overbought, the index's ability to forge higher is a "phenomenon that is characteristic of strong and sustainable uptrends."

The S&P has risen +6% in December and +24% since the July lows. There were 3,400 new highs on the NYSE so far in December. Bullish investor sentiment is nearly 60% and clearly bearish by contrarian standards. The VIX hit a new nine month low on Thursday. By any measure we are watching what some would call irrational exuberance but there is still a lack of real conviction by the bulls.

The bears are pulling their hair out over the slow melt-up and even the bulls are starting to express cautionary fears. You have to wonder if everyone believes something is true does that make it true? Unfortunately no. We all know the quote, "the market can remain irrational far longer than investors can remain liquid." In the bears case today that is quite true but the bulls will soon get their turn in the woodshed.

The general consensus is for a 5% to 7% correction in January. Most analysts recommend taking profits early and then looking for an opportunity to get back in on the dip. The long-term view has not changed so any January dip should be considered a buying opportunity.

Insider selling is normally seen as a good indicator of market direction. In October/November the ratio of insider selling to buying was strongly bearish at better than 30:1. Insiders sold nearly $6.5 billion in stock. That ratio has fallen to 15:1 in December and under 15:1 is considered bullish. There is always an imbalance to the sell side because of company grants of stock and options. However, the lower the ratio the more bullish the outlook for the markets. One analyst believes the selling tapered off in December because of tax considerations. Employees are waiting until January and the beginning of a new tax year to ratchet up selling again. Since this stock/option grants are a good way for workers to make up for that $1.1 trillion shortfall in payments I described earlier I would expect that selling ratio to return to those high levels. However, the Fed's QE2 program has a stronger impact on the market than insider selling so this is just a data point not a signpost of a change in market trend.

Santa Claus Rally? While the inexperienced reporters on the web have been calling the gains of the last week a Santa Clause rally the actual definition of that rally is the last five days of the year and the first two days of the next year. It has nothing to do with the week we just had except traders tend to anticipate the official Santa rally and buy in advance.

Another market saying goes like this, "When Santa fails to call, bears will roam on Broad and Wall." On average since 1969 the S&P has gained +1.6% during the Santa rally. On years when the S&P loses ground during that period it tends to continue lower in January. Nothing is ever a guarantee of market direction but it does not hurt to be watching out for trends to repeat.

The S&P 500 moved over 1250 on Tuesday but failed to extend its gains. We can put all the qualifications on the market you want like low volume, over extended, etc. The key point is a slowing of the advance. It "feels" heavy. Obviously the growing number of analysts calling for a January correction are generating a serious headwind and rightfully so. It would be silly to expect the market to simply continue higher even with the Fed greasing the wheels.

Since December first the S&P has only had two decent decline days. There needs to be a decent bout of profit taking before investors will put more money to work. It is simple market mechanics and it does not take a trader with 20 years of experience to figure it out. That is why the gains last week were muted and why they will probably be muted next week "IF" there are any gains at all. There is still the potential for some window dressing but I think they will be trying to maintain 1250 rather than push the index higher.

Initial support is 1240 and barring a serious news event that should hold until year-end. Resistance is any level over Thursday's close at 1256. We are at resistance and any gains will be solely news driven.

S&P-500 Chart - Daily

If technicals mattered in this market the S&P completed a reverse head and shoulders move last week with an upside target of 1248. Thursday's close at 1254 was slightly over that target level and exactly where you would expect a failure. However, after the three weeks of consolidation in November we may be immune to a failure at the H&S target. These patterns don't normally fail at the target but experience a bout of volatility before continuing.

The S&P also has strong resistance at 1300-1310 from August 2008 and from the Fib retracement of the 2008 market drop. If the index does continue higher into year-end I cannot conceive of a move over 1300. I think the odds are better we will see a range bound market over the next week that sets up for a temporary decline in January.

S&P Chart - Weekly

The Dow has been hampered by low volume and extremely low volatility. The Dow has now stretched its string of low range days to 15 where the range was less than 100 points. You have to go back to 1996 for a streak this long. The trend is bullish but despite the new highs there is a tremendous lack of conviction. Far too many investors are afraid we have come too far, too fast and they are right. Those that are buying are doing so reluctantly. This lack of conviction is slowly being overcome by a desire to not miss out on the continued gains.

Dow Chart - Daily

Dow Chart - 90 Min

The weekly Dow chart shows a textbook respect for the 200-week average with a nice retest of the 200W as support after the breakout in November. This continuation pattern would be a clear long-term breakout signal were it not for the strong resistance at 11700. In our current low conviction environment I seriously doubt we can move through that level without another dip to allow those buyers still waiting on the sidelines to join the party. An eventual break over 11750 would be a very strong bullish confirmation and we could hit 13000 very quickly from there as money managers race to dump bonds and move into stocks.

Dow Chart - Weekly

The Nasdaq is a tough chart this weekend. The short-term move has extended well over recent support and the extension is very overdone. The potential for a January dip on the Nasdaq is very strong. That dip, when it comes, should build a base for the eventual retest of strong resistance from 2007. Those 2007 resistance levels at 2710 and 2825 should be difficult to break but once cracked they should provide a springboard for a very strong rally. A move over those levels would provide all the conviction needed for reluctant traders to jump back into the market.

Nasdaq Chart - Daily

Nasdaq Chart - Weekly

Moving over the 2825 level would put the Nasdaq at new TEN-YEAR highs. Those headlines could rekindle investor interest in the market and convince reluctant investors to move money from bonds, money markets and mattresses and back into stocks. This is not going to be an easy hurdle to cross even with the Fed pouring money into the market. Once crossed it could become a self-sustained feeding frenzy. I am sure you can imagine the daily headlines in the media proclaiming the new ten-year high.

Nasdaq Chart - Monthly

The Russell has been the most bullish index but it is also the most overextended. Money managers have expressed their confidence in the market for 2011 by shifting funds from large caps into the higher risk, higher return small caps.

The Russell has already surpassed its 2000 highs at 614 and is rapidly approaching the 2007 historic highs at 856. The tough resistance from 2008 at 760 should now be support for any January decline.

The Russell move is confirmation of fund manager sentiment. They do not appear to be worried about an impending correction and will see any dip as a buying opportunity.

Russell Chart - Weekly

Russell Chart - Monthly

The Dow Transports are seen as a leading edge indicator for the health of the economy. The transports exploded higher after the Fed leaked news of QE2 in August but then stalled in early December. They have been range bound in a very narrow 80 point range for the entire month while traders waited to see if holiday shoppers showed up at the malls. The transports are also fueled by the Nonfarm Payroll reports and the last report was not stimulative.

When the transports finally move over 5100 it should be a very positive signal investors are confident the economy is still improving.

I could see the transports dipping back to support at 4800 on any weakness in January simply because of the large gains that need to be turned into cash. I would be a buyer of the IYT ETF on a dip to that level.

Dow Transports Chart - 90 Min

Dow Transports - Monthly

For the coming week I am neutral. We could go sideways or begin heading lower in anticipation of a January decline. While nobody knows for sure what will happen in January the odds are good there will be some portfolio reshuffling once into a new tax year.

I believe any decline will be a buying opportunity. The bears will be telling us "the" big decline has begun but I think they will be wrong once again. Technicals don't matter to the market today. The Fed is pouring financial gasoline on the market and it will push the market higher. Don't fight the Fed.

On Saturday China raised interest rates a quarter of a point to 5.81% for the second rate hike in three months as it combats inflation. The deposit rate also rose to 2.75%. China's inflation rate rose to 5.1% in November and well over their target of 3%. China has been expected to raise rates for the last three weeks so this should already be priced into the market. The keyword there is "should."

When the market decides it wants to go down it will always find an excuse. It could be China's rate hike, hostilities in Korea or Moody's downgrade of Portugal's debt. It does not make any difference what reason is blamed for the decline. Just be prepared for it and plan to buy the dip. I would not buy the first down day because January dips tend to last a couple weeks or more. I printed this table of January declines last week and I am reposting it here for reference. By averaging the January high dates over the last nine years you get January 12th. This is the seventh trading day of the year in 2011 but there is obviously no guarantee the market will wait that long or even decline at all. Based on the trend over the last decade I would not bet against a decline.

New Year Declines for S&P

I hope everyone had a very merry Christmas and I hope you are looking forward to 2011 as much as I am. I expect a new bull market in 2011 thanks to the Fed and the recovering economy. I hope you choose to participate in that market and profit handsomely from it.

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Don't fight the Fed!

Jim Brown