The stock market's performance for 2010 was pretty good. The big cap S&P 500 index delivered a +12.7% gain for the year. The technology-heavy NASDAQ composite rallied +17%. Meanwhile the small cap Russell 2000 index outperformed them both with a +26% gain. Let's hope 2011 can keep up the pace.

Fund managers did a pretty good job of painting the tape at the end of the year. They held stocks near their highs so your year-end statements will look good. The question is, what will they do now that we're in a new tax year? We will answer that in a bit. First let's talk about last week. For the most part the economic data continues to come in positive with strong reports from the Chicago ISM (purchasing managers index) and the New York ISM. Yet in spite of this data the market continued to drift sideways, much like it did prior to Christmas. The best performers were some of the commodity and resource names thanks to weakness in the U.S. dollar. Copper is surging to all-time highs. Silver is hitting new 30-year highs. Gold is nearing its high. While short-term overbought; many believe the metals will continue to do well in 2011, especially if the Fed's QE2 keeps the dollar weak.

Looking ahead the market could see some volatility as traders react to more economic data. We have a busy week of data in front of us. Monday, January 3rd starts with the ISM manufacturing index for December and the construction spending numbers for November. The big event on Tuesday, the 4th, will be the FOMC minutes from the last meeting. Tuesday will also show us the Factory orders for November and the latest auto and truck sales figures. Wednesday we'll hear from ADP and their employment change report as a precursor for the government jobs report on Friday. Wednesday also brings the ISM services data for December. Thursday is the weekly initial jobless claims but unless these are wildly out of line they will probably be ignored since everyone will be focused on Friday. On Friday, January 7th, the big event for the week will be the December non-farm payrolls (jobs) report. Economists are expecting a gain of +132,000 jobs. In the report analysts are looking for private job growth to jump +142,000 (essentially the government is still shedding jobs and that's why the headline number will be less).

Technically not much has changed for us in the last week since the major indices spent the last five days moving sideways. The S&P 500 should still see some support around the 1245 area. If that level breaks then look for support near 1225 and its rising 50-dma. As you know I am expecting a correction in mid to late January. A normal -5% correction could pull the S&P 500 down toward the 1190 area. I would focus on support near 1200 or the 1175 areas.

Daily chart of the S&P 500 index:

The NASDAQ composite has been struggling with resistance in the 2670-2675 zone these last two weeks. Should the market manage an early January rally then look for a run towards the 2700 mark. You know how traders like big round numbers. A -5% correction from the 2700 level would be a pull back toward 2565. The NASDAQ may not dip that low since it has found support near its rising 40-dma in the past. Currently the 40-dma is nearing 2590.

Daily chart of the NASDAQ Composite index:

The SOX semiconductor index has broken out of its rising bullish channel but I wouldn't call it a breakdown, at least not yet. Chip stocks are moving sideways. We should expect a move up or down as soon as this week. A -5% correction in the SOX would be a dip toward the 390 level, near its rising 50-dma.

Weekly chart of the SOX semiconductor index:

We also want to look at the transportation sector. The Dow Jones transportation index has been consolidating sideways almost all of December. You can see how the consolidation has narrowed and it looks poised to breakout higher. If the breakout does occur it could boost the rest of the market. Profit taking in crude oil could certainly help the transports move higher.

Daily chart of the Dow Jones Transportation index:

Small caps have been some of the best performers in 2010. The Russell 2000 index has rallied over +33% from its late August lows. Now the upward momentum seems to be slowing. If stocks continue higher I would look for resistance near the 800 mark. If not, then look for a correction toward the 760 area. Since the small caps tend to be more volatile than the rest of the market it wouldn't surprise me to see a dip toward 740 or the rising 50-dma.

Daily chart of the Russell 2000 index:

I don't see any changes from my comments last week. Investors were happy to just run out the clock on the calendar as they waited for 2010 to end. We are now in a new year. Traders could be tempted to sell stocks now to lock in gains and put off worry about taxes until 2012. At the same time the first part of January could be bullish. Mutual funds will see a new inflow of cash and will need to put that money to work. Big investors are unlikely to put it in the bond market given the Fed's QE2 program. That means equities should remain in favor. There is no guarantee that the first week of January will be bullish. It really doesn't matter. Whether stocks start to see profit taking on Monday or two weeks from now the correction is coming.

The correction shouldn't be feared, at least not for us. We want to see a healthy pull back so we can load up on new positions as we look ahead into 2011. Right now I'm expecting that correction to begin in the middle to late part of January (two or three weeks from now). This will coincide with the onset of earnings season. That's the exciting part. We don't know yet how the market will choose to interpret earnings results. Significantly better than expected results and guidance for 2011 could alter our expectations for a pull back. Or the earnings news could merely post pone any profit taking. When the correction does happen I am expecting it to last two to four weeks (or more). Initially I would look for a -5% decline but the small caps will likely see a deeper pull back.

- James

Did you know you can get the Option Writer, LEAP Trader, Premier Investor and Couch Potato Trader newsletters for free with a year end subscription to Option Investor? Click here for details