Friday was a new two-year high for the Nasdaq, S&P, Russell, Wilshire 5000, NYSE Composite and the Dow Transports. Only the Dow itself failed to keep pace.

Market Statistics

Helping push the markets higher was a stronger than expected Consumer Sentiment report for December. The headline number jumped to 74.2 from 71.6 in November. This is the highest level we have seen since June's 76.0 reading. The summer decline ahead of the elections appears to have ended and sentiment has surged +6.5 points in just the last two months.

The rebound in December was due to a strong increase in the present conditions component from 82.1 to 85.7. This is the highest level for that component since January 2008. The expectations component rose from 64.8 to 66.8. Consumers appear to be pleased with the outcome of the election. I wrote last month I expected a large spike once the election was behind us. Once the tax compromise is passed I expect another large spike. Consumers are always happy about keeping more of their own money and not being faced with the incredible shrinking paycheck.

This was good news for the market. As consumer sentiment improves market sentiment will improve.

Consumer Sentiment Chart

On the negative side the budget deficit for November was -$150.4 billion. That was a 25% increase over November 2009 and the largest November deficit on record. Revenues were up +12% but outlays increased by +18%. The government's fiscal year begins in October and for the first two months the deficit has totaled $290.8 billion. The government is projecting a $1.3 trillion deficit for the entire year or 9% of GDP.

After a week of limited economics the coming week has a full calendar. Leading off will be the FOMC meeting on Tuesday. That will be the highlight of the week and although there will be no change in rates the Fed is expected to update the status of the QE2 program. The dollar is rising along with bond yields and that is exactly the opposite of what the QE2 program is supposed to accomplish. Some analysts believe the Fed may halt the program, stretch it out or scale it down in the face of improving economics. Late Friday the NY Fed said it would spend $105 billion in QE2 treasury purchases next month. That is right inline with their announced targets so there appears to be no slacking off yet. This makes the Tuesday announcement of critical performance.

Following the FOMC announcement in importance are the two price indexes. The Producer Price Index and the Consumer Price Index will show how much inflation or lack of inflation is currently working its way through the system. Next up is the first of the regional Fed manufacturing reports with the Philly Fed Survey. The Philly Survey is seen as the best correlation to the national ISM two weeks later.

Jobless Claims will be also be closely watched as the numbers continue to trend lower and closer to the high 300,000 range. That first week with a jobless claims number starting with a three will be very market positive. Jobless claims have not been under 400K since June 2008. The weekly high was 674,000 in March 2009. The low for this cycle was 410,000 two weeks ago.

Economic Calendar

Bonds continued to sell off with yields on the 10-year approaching six-month highs on expectations lawmakers will eventually reach a compromise on the tax deal. Add in the spike in consumer sentiment and the improvement in the recent regional surveys and bonds are not looking like a safe haven any more.

Pimco, the world's largest bond fund, is raising its forecast for U.S. growth next year as policy makers pump in a "massive amount" of stimulus into the economy, according to CEO Mohamed El-Erian. Pimco raised their estimates for growth to the 3.0-3.5% range from 2.0-2.5%. JP Morgan raised their estimate to 3.5% and Morgan Stanley raised estimates to 4% from 2.9%.

The trade deficit narrowed by 13% in October to $38.7 billion and smaller than the lowest estimate of 78 economists surveyed by Bloomberg. It was also the smallest deficit since January. Exports were the strongest since August 2008 because Mexico and China bought record amounts of U.S. products.

Edward Yardeni said in an interview on Friday his 2011 year-end target is between 1400-1500 because of improving global fundamentals and expected earnings on the S&P of $100 in 2011. He made the point that calculating the future of the S&P is easy with an even $100 in earnings. If you believe the S&P at the end of a robust 2011 should have a PE of 17 or 18 then the S&P would be 1700-1800. (17 x $100 earnings) He did not go that far in his predictions but left the door open for observers to pick their own number.

He also reminded everyone the third year of a presidential election cycle has averaged a 20% gain since 1962. There are various political reasons for that trend that I won't go into here. That historical trend along with the post recession rebound could produce a surprising rally in 2011.

One of the big market movers on Friday was GE with a 3.5% gain because they raised their dividend for the second time this year. GE raised their dividend by 17% from 12-cents to 14-cents. Personally that is about as exciting as a week old newspaper but there are people who get excited about those kinds of increases.

Shortly after GE announced its dividend increase Honeywell said it was raising its annual dividend +10% from $1.21 to $1.33 per share.

With corporations currently holding nearly $2 trillion in cash many analysts believe half of the companies in the S&P will raise their dividends in 2011. With nearly 50 S&P companies already yielding near 5% the outlook for equities is much better than bonds.

I warned you on Thursday night we were expecting economic news and a possible rate hike out of China on Friday and Saturday. The news was not good. China's consumer prices rose +5.1% driven by higher costs for food. That was well above the 4.7% consensus by analysts. It was also significantly higher than the 4.4% rate in October. Producer prices rose by 6.1% and a full point over estimates. Industrial output rose +13.3%, also stronger than analyst estimates. Retail sales jumped +18.7% and fixed asset investments rose by 24.9% year to date, also higher than expected. Their trade surplus was $22.9 billion. (That compares to our trade deficit of $38.7 billion) Broad money supply or M2 rose by 19.5% and the fastest gain in six months. M2 has risen +55% over the past two years and yuan denominated loans have risen 60% to 47.4 trillion yuan from their low in November 2008. China wants to limit that to 7.5 trillion yuan in 2011.

China responded to these exploding numbers by raising the reserve rate another 50 basis points and the sixth time they have raised the rate this year. This will pull another $53 billion out of banks and into the government account. Chinese economists were meeting on Saturday and they were expected to announce an interest rate hike in addition to the reserve hike. As of 6:PM Saturday there had been no announcement. One prominent Chinese official said in a speech China could not afford to raise rates because it would attract too much money to the country and push inflation higher. China is already under fire for its strong currency and raising rates would only make it stronger. This should be an interesting decision by Chinese officials.

They need to do something or they are going to flame out. I can't even comprehend an 18.7% jump in retail sales in November. The U.S. is expecting a +1% increase when sales are reported on Tuesday. Chinese auto sales spiked +27% in November to 1.7 million vehicles. Think about that number. Sales for the year have already reached 16.4 million vehicles with 18 million expected by year-end. Streets are becoming so crowded some cities are rationing license plates. In Shanghai the available plates are sold by auction and prices average $6,000 or more.

When reporters on TV talk about the growth in emerging markets and the boom in China I don't think the majority of listeners actually understand how fast they are growing. Those numbers above are simply astounding. More than anything else it brings home for me the rapid approach of peak oil. A country growing that fast is ramping up its consumption of crude products by numbers we can only guess at. Officially oil demand in November was reported to have increased +9.4% in China but I expect it was more. Just adding 1.7 million vehicles a month is a monster increase in fuel demand. If each one of them ONLY burned 5 gallons per week that is an increase of 202,000 barrels of gasoline per week. Next month you add another 1.7 million vehicles and so on. You would think eventually gasoline consumption would go down because the cities will be so gridlocked with cars nobody will be moving. They don't have the systems of lights and interchanges we have in America. Analysts believe China will have 200 million passenger cars by 2020 from less than 85 million today. There are 199 million vehicles of all types in China today and that is expected to double. Add 200 million vehicles in ten years and what does that do to oil demand?

China understands this problem and they are spending a fortune to delay it. A person in one of five pilot cities can buy a 150,000 yuan ($23,000) electric car for about 80,000 yuan ($12,121). The central government will give them a 60,000 yuan subsidy and the local government will donate another 10,000 yuan. China wants to have five million electric cars on the road by 2020 to cut down on the amount of oil they are going to need. Sorry guys but doing the math on that last paragraph still puts you in a heap of trouble. 85 million cars today going to 200 million by 2020 for an increase of 115 million and only 5 million are going to be electric? That is a drop in the proverbial bucket for cutting oil demand.

I am going out on a limb here and predict they will have far less than 200 million cars because peak oil's arrival in 2014 is going to make gasoline so expensive nobody in China will be able to afford to drive. Peak oil is going to be a game changer and produce the mother of all global recessions and it will be here before you know it.

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In stock news Tenet Healthcare (THC) turned down an offer from Community Health (CYH) of $6 per share or $7.3 billion including debt and called the offer inadequate. Shares of THC rallied +55% to $6.65 as the biggest percentage mover in the market. Tenet then started trash talking Community Health in an effort to prevent a higher offer. Tenet said it had serious concerns about Community Health's ability to integrate and operate a business like Tenet and then meet its own guidance for 2011 given Community's slowing growth. (ouch) Tenet sent a letter to Community saying they were worried about Community's debt levels, excessive leverage and risky capital structure. Tenet evidently thought by highlighting certain questionable items in the Community closet the board might not be so ready to up the ante for Tenet.

However, this offer puts Tenet in play and even with the 55% spike in the stock price analysts are betting there is another offer coming from somebody else. Offers tend to wake up the competition and trigger other offers. Raymond James said the Community offer was "grossly undervalued." Hospital operator Health management Associates was mentioned as a potential bidder.

Tenet Chart

Kindle sales are exploding and sales of real books are not. At least that is what Borders Group was saying on Friday. BGP posted a bigger loss than expected and a steep drop in sales. The company said it could face some credit issues if liquidity does not improve. Borders said traditional book sales were declining thanks to the proliferation of e-readers and electronic books. Odds are growing of a merger of Barnes & Noble and Borders as they combine to take on Amazon. Borders shares fell 11% on the news.

Green Mountain Coffee Roasters (GMCR) lost 10% on Friday after posting lackluster results and saying prior guidance was unreliable. A couple analysts came out in support of GMCR but they were less than convincing. Saying prior guidance was unreliable and then canceling future guidance is not particularly a confidence builder for shareholders.

Beckman Coulter (BEC) rallied +26% after saying it had retained Goldman Sachs to review offers. Apparently several private equity firms are interested in a firm that generates lots of cash and will see a significant increase in demand from the health care reform. Blackstone and Apollo are two of the companies interested in BEC. Charles River Labs (CRL) is also being pushed by two large investors to sell after receiving expressions of interest from PE firms.

National Semi (NSM) shares lost 8% after their disappointing earnings on Thursday night. Two of National's three largest customers placed healthy orders for holiday products but the third company lowered its orders. Everyone is wondering which phone company is the sick one. More than 25% of National's chips go into mobile phones. We know Apple is not having any trouble with sales so that narrows the field. I would think it is a toss up between Motorola and Nokia.

The (YOKU) IPO on Wednesday soared from its opening price of $27 to a high of $50 on Friday. It was a brief 15 minutes of fame. The stock closed well off its $50 high at $36.80 and a loss of $5 on the day as revelations about its business started going public. The company said it only made $30 million for the last nine months and at the highs of the day had a $5 billion market cap. It also disclosed the content on its website could be found objectionable by Chinese authorities. It appears people who thought it was a bargain three days ago found out that reality was very different.

Bernie Madoff's oldest son Mark, the one that turned him over to the FBI, committed suicide on Saturday because he could no longer endure the hostility directed at him by investors and the public. Mark was never charged with any crime and he and his brother repeatedly claimed they knew nothing of the scheme until their father broke down and confessed. Saturday was the two-year anniversary of the call to the FBI. Mark hanged himself in his apartment in New York. He left behind his wife and two kids ages 2 and 4.

Mark Madoff

The Nasdaq has posted gains for eight consecutive days but retail investors still don't trust the rally. There is still a high degree of denial even though five of the top six indexes have broken out to new multiyear highs. I don't know why it is so hard for people to accept the trend and the reasons behind it.

I had quite a few readers email me after Thursday night's market commentary. One of them, a subscriber since 1999 and a fund manager reminded me of the famous Jesse Livermore quote.

"It is not our duty as speculators to be on the bull side or the bear side, but upon the winning side."

That has never been more true. We can get ourselves all twisted up in knots worrying about the various things impacting the economy and end up watching the markets run away from us because we are distracted about what might happen instead of what is actually happening.

Another reader also a 10-year subscriber said this: Hi Jim, I have been a subscriber for a long time, and made good money. I get up every morning, look in the mirror, and say to myself, "You are one of the dumbest people in the market, and you have to work harder than anyone else today." It takes away the idea, that you are smart. Then just follow the damn trend, until, of course, its wrong.

Sometimes we try to over think what we are seeing. Some people apply conspiracy theories about market manipulation and some go to great lengths to make some technical chart pattern fit what they want to see. I guarantee you if you want to see a bearish pattern you can find one to fit. Likewise if you are bullish then all the patterns you apply are likely to be bullish.

If you want to know which way the market is going ask a 5-year old like my grandson. "Preston, is that chart line moving up or down?" They will look at you like your trying to trick them and then tell you what they see without their interpretation being colored by any knowledge of chart patterns. He will say, "grandpa that line is going up." Sometimes it is just that simple.

Lastly our bias is colored by what we hear in the news. For instance, U.S. equity fund flows have been negative 13 of the last 16 months. People have been scared out of the market. Repeating that in the news keeps people out of the market.

One more email: Jim, I wasn't playing the market for the first 5 months of this year... left a lot of money on the table... felt the same way RP did... didn't understand why the market was going up! If it wasn't for you and the staff at Option Investor/ I would still be setting on the sidelines. Thanks for your insightful, enlightening commentary.

Are you sitting on the sidelines paralyzed by fear the market could drop? What will it take to get you back in the game? I believe we have the greatest setup of this decade in front of us for the next 12 months. The global economy is recovering. The political picture has changed. Earnings are going to improve significantly. And, drum roll please, the Fed is going to guarantee a higher market six months from now. You have to decide if you are going to look back from S&P 1450 at the end of 2011 and be thankful you were a player or be frustrated because you waited on the sidelines for the crash that never came.

Don't get me wrong. The market is going to go up and it will go down. I just believe it will go up more than down and we could end up 20% higher or more a year from now.

I believe we are going to see some window dressing over the next three weeks as fund managers chase performance into year-end. There is always the possibility of a pullback once December 31st is behind us. That January/February portfolio shuffle is common but it is not to be feared but to be celebrated as a buying opportunity.

The S&P consolidated all week after the big gains from the prior week. Fortunately as the week progressed there were higher lows and higher highs until the shorts threw in the towel on Friday. Being a short has been a frustrating pastime recently. There were declines at the open both Wednesday and Thursday that were the perfect trap for a waiting bear. Neither had any follow through and the S&P closed at the high of the week.

Support is now 1225-1228, the level that produced resistance fear in the bulls last week. Now it is support with 1250 the next resistance target followed by 1270.

A reader asked me Friday if the market was showing a "cup and handle" formation and how reliable those formations are. They are actually one of the most reliable patterns and they are bullish.

S&P-500 Chart - Weekly

The S&P has broken over resistance at the top of the handle and has plenty of room to move before testing material resistance around 1270. There could be a psychological bump at 1250 since so many brokers have targeted that all year as the expected level at year-end. There could be some sell programs waiting there for an opportunity to take profits. Strong support is now 1200 and rising.

S&P-500 Chart - Daily

The Dow is showing the same handle but has not yet broken out. Money is still flowing out of the big cap techs/industrials and moving into small caps in anticipation of a continued rally in 2011. The Dow was only up .25% for the week but the Russell was up +2.7%. Any questions?

The Dow respected new support at 11,335 all week. Friday's 40-point gain was five times the total gain for the prior five days. I would like to think this was money moving into big caps but I believe it was the rally in financials and some late day short covering that finally pushed it higher.

The Dow needs a big news event to attract new money. The dividend news from GE was enough to give GE a +3.4% gain but not enough to energize traders to buy large caps.

With the FOMC on Tuesday I am not expecting any major Dow move until that is behind us.

Dow Chart - Daily

The Nasdaq finally broke through overhead resistance at 2625 and ran for a decent gain. For four days that resistance had held but the Nasdaq was still able to stretch its consecutive winning streak to eight days. For me this is almost a perfect chart. The Nasdaq gained +100 points in eight days. Slow, steady, low volatility, a perfect investors market.

Support should be 2620 and after eight days of gains there should be a buying opportunity in our immediate future as some event provides an excuse for profit taking.

Nasdaq Chart - 30 Min

Nasdaq Chart - Daily

On Thursday night I profiled the Russell's late day shortened range after 1:PM as an impending breakout. That breakout came right on schedule on Friday and exploded higher. The long string of green candles is as beautiful as a Picasso if you were long at the open in anticipation of that breakout.

The weekly chart on the bottom shows a nearly perfect C&H and the breakout. The next real resistance is not until 845-850 but I harbor no illusions that it will run that far without several pauses for profit taking. Personally I am just happy to see it over 760 and in uncharted territory for the last three years. There is a bull market in Russell stocks and three weeks left for money managers to window dress for year-end.

Russell Chart - 10 Min

Russell Chart - 30 min

Russell Chart - Weekly

In case there is any doubt, I am still bullish and in buy the dip mode until proven wrong. If China and the FOMC cooperate we may have to switch to buy the breakout mode but only as a last resort. The Nasdaq's eight-day streak has to end soon. Traders will find an excuse to take profits and that will be our opportunity to add to longs. Streaks tend to be self-defeating. Once they are identified everyone starts betting against them.

Even if China raises rates sharply I think the impact to our markets will be minimal. The expectations from the FOMC meeting are also already priced in after a week of consolidation. In either case it will probably take a highly unexpected action to produce a meaningful dip. Those of us hoping for a new dip are wishing for some news to give us a new entry point. The market is setting up for an extended run so be prepared in advance for any buying opportunity.

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Don't fight the Fed!

Jim Brown