The S&P may have rallied for +6% in December but it managed to post a gain of only .47 for the last week. All the December gains came in the first week.

Market Statistics

In the graphic above note the highlighted changes for the various indexes last week. For most of them it brings an entirely new meaning to "flat." The S&P closed at 1258 once again and a loss of .24 for the day. The fund managers did an excellent job holding the indexes at resistance and near the highs for the year. The Dow gained +11% for the year, S&P +13% and Nasdaq +17%.

The Nasdaq finished its best December since 1999 with weakness as the large caps like Apple, Google, Netflix and F5 Networks accelerated their declines. Friday's market action was not an indicator of market strength because the volume was the lowest day of the year at 3.6 billion shares. However, the weakness in techs is a warning for January.

There was nothing in the limited economics for Friday that would have negatively impacted the market. The ISM for New York rose +10 points to 495.7 to the highest level since the index began in 1994 and grew at the fastest pace in six months. The NY-ISM has been rising steadily since July 2009.

The recovery in New York City is clearly progressing at a faster rate than the rest of the country although the Chicago ISM was also strong this week. NYC has seen 63,000 new jobs created in 2010 and has regained 38% of the private sector jobs it lost in the recession. The six-month outlook component rose from 71.9 to 75.2 and the current conditions component rose from 65.6 to 70.0. The city's housing market is improving rapidly with apartment and condo sales almost doubling since 2009.

Mayor Bloomberg is planning to cut 10,000 public workers in 2011 because of a lack of finances and this should slow private sector growth temporarily due to the loss of jobs.

For the first week of 2011 we have some serious roadblocks in the form of economic events. The first is the national ISM Manufacturing Index on Monday. The regional indexes have been posting some pretty strong gains but the consensus estimates for the national report are for only a minor improvement. If the ISM surprises to the upside it could give a boost to the market during the early January fund flows.

The second event is the FOMC minutes for the December meeting. Considering how divided the FOMC members have been recently it will be interesting to see how the conversations went in that meeting. If the divisions are becoming wider will that impact the fate of the QE2 program? Did the Fed discuss canceling the program? Does the Fed see the economy improving or inflation starting to rise? There are dozens of other questions and most will probably go unanswered but this is still a critical event hurdle we have to get past.

The ISM Services on Wednesday will not be as critical as the ISM manufacturing on Monday but it will be closely watched.

The big event is of course the Non-Farm Payrolls for December on Friday. The consensus estimate is for a gain of 125,000 compared to the disappointing gain of only 39,000 in November. Some analysts are expecting a much higher number. Morgan Stanley is expecting a gain of +160,000. These higher estimates may have prejudiced the market and anything even in the consensus range could be a disappointment. I am afraid we could have another month under 100,000. I believe that would be a real disappointment BUT it would be a bad news, good news event. A bad number means the Fed will continue QE2 and possibly add to it down the road. The market can deal with slow job growth because it keeps the Fed in an accommodating bias for a longer period. That does not mean we won't see some volatility in the market after the announcement.

I see next week's reports as a wall of worry the bulls will be happy to climb as long as there are no seriously negative surprises.

Economic Calendar

Stock news was pretty limited on Friday since there was nobody around to report it or listen to it. Imax shares rallied on a rumor in London's Daily Mail news that Sony (SNE) might be preparing to offer $40 for IMAX. The paper also said Disney (DIS) might be interested in buying the movie chain. IMAX shares spiked from $27 to more than $32 on the rumor but declined to close at $28 after various analysts said the deal was not likely.

Imax Chart

The Daily Mail also started a rumor on Tuesday about a BHP offer for APC. Since the sources are never disclosed I guess they can get free advertising by making up acquisition rumors on slow news days. The APC rumor first surfaced in September. BHP is sitting on a pile of cash and wants to expand its deepwater oil exploration. When the Horizon exploded BHP had two rigs under contract in the Gulf and Anadarko had three. Since the new rumor on Tuesday various analysts have said the deal would make sense for BHP but the rumored $90 price was not even close to what would be required to take out APC. Bank America said the base case value for Anadarko was $110 and that did not factor in the recent gains in oil prices and recent drilling discoveries. APC shares rose again on the continued discussion about an acquisition but gave back most of its gains at the close.

Anadarko Chart

Positive economics and year-end fund flows caused a monster short squeeze in crude on Friday. The current January contract rallied from an overnight low of $89.05 to an intraday high of $92.06. The shorts were setting up for a new years decline and were caught off guard once again. Crude closed at $91.40 and right at resistance that held for more than a week.

Crude Oil Chart

Analysts are starting to upgrade their estimates again for 2011 because of the recent spike in crude prices. The former CEO of Shell is predicting $5 gasoline by 2012 but that is far enough away nobody is paying attention. Closer to home is gasoline expert Fred Rozell who predicts 15 states including Alaska, Hawaii, Connecticut and Rhode Island will see gasoline prices top $4 by Memorial Day. An extra dollar per gallon will cost the average consumer about $750 more per year for gasoline. That is not the end of the world but it is a serious psychological barrier. $3 gasoline causes pain at the pump and drivers begin to consciously add less gas to the tank and start worrying about their excess driving. Over $3.50 and that starts to seriously impact demand but $4 gasoline will probably put the country back into recession.

Fortunately I don't see it by Memorial Day or any day in 2011. Crude inventories are still 9% over the five-year average and the hype about increased demand in the U.S. is just that, hype. It really has not happened yet. I believe we will see prices over $100 in 2011 but not on a permanent basis. That is coming in 2012 but hopefully we will get there slowly so consumers have a long time to grow accustomed to the slowly rising price.

Borders Group Inc (BGP), the second largest U.S. bookstore chain, declined sharply losing -22% after saying it delayed payments to some publishers while trying to avert a liquidity crisis. The company warned earlier this month it was in talks to refinance and might violate its credit agreements in Q1 if negotiations fail. The company said there was no guarantee its efforts would be successful. If the refinancing fails the chain may face a "liquidity crisis" in Q1 and may no longer qualify as a going concern. That means bankruptcy or liquidation.

Since bookstores are normally flush with cash after the holidays the timing of this warning raised some serious alarms. Borders is attempting to raise cash by closing stores and selling off properties and other assets. Borders has posted losses for three consecutive quarters. At the end of October the company had $350 million in debt and $23.1 million in cash. As of Dec-9th the company had -$15.3 million in working capital. Having negative working capital means they don't have enough money to pay their bills. The chain's largest investor, William Ackerman at Pershing Square Capital Management said on Dec 6th they would help Borders fund a bid to acquire Barnes and Noble. It sounds like they need to fund working capital first before taking on another liability.

Borders Group Chart

One of the problems confronting Borders and Barnes & Noble is the massive acceptance of the Kindle. Analysts believe Amazon has now sold more than eight million kindles. Amazon reported last week the kindle has become their best selling product of all time even topping the Harry Potter record holder from 2007 titled "Deathly Hallows." Amazon won't say how many Kindles it has sold but it sold 2.5 million of Deathly Hallows just in the quarter in which it was released. Amazon has repeatedly said it now sells more e-books than all other books combined. Daniel Dilger, from AppleInsider, believes Amazon will sell 4.5 million Kindles in Q1-2011 alone. Barnes & Noble joined the back patting party last week saying their Nook reader was now their best selling product of all time and they were also selling more e-books than paper books. With this kind of e-book acceptance it is going to be tough to continue operating brick and mortar stores. Turn out the lights Borders, your party is over.

For tech investors next week is going to be the perfect storm with a whirlwind of tech news from the Consumer Electronics show in Las Vegas. This is the biggest show of the year and the place where everyone will showcase their new products. At last year's show the iPad was just a rumor and had not been announced. Apple is expected to have sold 14 million in 2010 and could double that in 2011. However, the competition is really heating up.

With sales like that they make a big target for other manufacturers. The major vendors will be displaying tablets with 7, 9, 10 and even 12-inch screens. Some will use the Palm operating system in the case of tablets from Hewlett Packard. Microsoft is rumored to be showing off their new line powered with a new Windows operating system. RIMM is expected to display working copies of its Playbook. Of course the biggest contingent will be the Android powered devices of which there will be dozens in any format imaginable.

Motorola is expected to show off a 4G version for Verizon running the Android OS and probably the biggest competitor to the iPad. Motorola needs a big win so hopefully they will hit a home run here. In a teaser video Motorola put out a week ago they compared the iPad to the Rosetta Stone. A historic breakthrough in technology but still an antique. Video Link

LG is expected to show off the world's largest 3D TV at 72 inches and the smallest 3D in a portable unit. The big chip companies are in an all out battle for the hearts of these new tech devices. Caris and Co., claims Intel is producing chips for 18 tablets, Nvidia 14, Texas Instruments 6 and Qualcomm 5. Reportedly the cost for the core processors has declined to $35-$40 but on the way to $25 each. Intel stand to gain the most since every low powered tablet needs a high-powered bank of servers somewhere to supply all the computing. What Intel loses in PC sales to tablet devices it will gain in those server chips. The other chipmakers only focus on the device chip not the server chips.

If this is January 1st you know there has got to be a historical recap somewhere in the commentary. It is obligatory like mistletoe at a college New Years Eve party. There was a wide range of performance between the winners and sinners on the Dow. With Caterpillar gaining +69% and Hewlett Packard losing -18% it was a stock pickers market. Note that three of the top four losers are big cap tech stocks. Even with those stocks losing ground the Nasdaq managed to post a healthy gain of 17%.

Dow Winners and Sinners

On the index side of the market the Russell 2000 was the big winner and it is even more amazing when you consider it rose +25% in 2009. The Dow Transports are the second best and clearly a play on the recovering economy and the rebound in the airline sector. Drugs and healthcare ended up on the bottom of the pile because of the uncertainty that surrounded the passage of the new healthcare bill.

Index Winners

Most traders have probably already forgotten the rebound from the 2009 lows of 6470 on the Dow to the highs of 11,258 in April of 2010. That was a +74% rebound with two major corrections and four minor bouts of profit taking along the way. 2010 was off to a good start but a +74% gain was too good too last. The April Horizon disaster blunted the Dow's momentum when the energy stocks plummeted. Only a week or so later the momentum really began to slide when the May 6th Flash Crash knocked -1,000 points off the Dow in about 20 minutes.

The Flash Crash and the rising worry at the time about a second recessionary dip and new problems in the financial sector, killed investor sentiment and stock mutual funds saw outflows of billions over the months to follow. The low at 9,614 on July 2nd was a -14% decline from the April highs. After three aborted attempts to rally out of the lows the Fed set fire to the market on August 27th when they alluded to a new quantitative easing program after the elections. The low on the 27th was 9936. The high last week was 11,625 for a +17% rally since the end of October.

Dow Chart

When you look back at the Dow moves over the last two years it is hard to imagine we have had 20 consecutive days without a triple digit range on the Dow. That record goes back to 1996. Fund managers were able to hold the Dow over 11,500 for the last eight days without even a weak attempt at a sell off. All of that is about to change.

In my humble opinion there is no way we are going to get through next week without a triple digit move even if it is only intraday. There will be an abundance of year-end retirement contributions hitting the tape early in the week but there is also some big economic events and a lot of after tax profit taking waiting to occur. The timing of the profit taking is going to be the key. In some years the fund managers wait for the year end fund flows to dry up before they pull the exit trigger. Sometimes they wait for the first couple weeks of the earnings cycle in hopes of getting one more bounce before they exit. In years with big Q4 moves they tend to exit earlier in order to protect those gains.

The real key to the puzzle is not when the decline comes. The key is to be ready for a decline when it comes. That means keeping your stops tight and enjoying the view as long as it lasts.

I know most of the bears will be looking at a decline as vindication of their long term views and a return to "normal" given the state of the economy, the Fed's money policy and the high unemployment. I disagree with that view and I believe any January dip will be a buying opportunity.

The economic recovery is accelerating as we have seen in nearly every economic report over the last couple months. The October pause is behind us and all the regional Fed reports are rebounding strongly. Yes, "strongly" is relative but compared to the last three years these reports are strong. It may take a couple more years to completely recover and maybe three years to return to full employment but this is a journey. It is not something that happens overnight or over a couple quarters. We are recovering from the Great Recession. It is going to take a while. Recovering from the Great Depression took more than a decade.

Nearly all analysts expect the profits on the S&P to be a record in 2011. With any kind of PE expansion for a recovering economy the S&P could be 1450 or higher by year-end. The Morgan Stanley target is 1425 with highs above that but a cooling by year-end.

The financial sector is recovering. Bank lending has suddenly taken a sharp turn higher and analysts expect strong M&A activity in 2011 because of the new financial regulations. This will be positive for the market.

Home sales, to the surprise of many, are actually holding up in the late fourth quarter. Buying activity is increasing despite a rise in mortgage rates. The foreclosure cloud will remain over the market in 2011 but a very low inventory of new homes will help push prices higher. There is a lot of pent up buying power and I believe it will begin to be released in the spring. We won't see a return to a normal market until 2012 as employment increases but the trajectory for housing is up. The bottom is behind us and now there is the pressure to buy something before rates move much higher. The Fed QE2 program will slow their rise but buyers will want to jump back into the market before they go much over 5%.

The energy market will continue to strengthen. Crude prices will rise and fall but energy stocks should continue higher. There will be a flurry of M&A as smaller companies are gobbled up. It is getting easier to buy reserves than find them. As the global economic recovery accelerates the demand for oil will rise along with prices. By the summer of 2012 triple digit oil will be here to stay and under $4 gasoline a rare find. These trends will push energy stocks higher but weigh on the economic recovery. I only hope the rise in crude prices remains subdued throughout 2011 so the recovery has a change to solidify before the pressure of high oil prices returns.

Everything I have mentioned is a long-term outlook. The short-term outlook is a January dip as a buying opportunity. I have posted the historic January declines for the last ten years more than once but I am repeating it here once again. Despite bullish outlooks the market always seems to find an excuse to decline early in the year. It is not the end of the world. It is normal. As long as you plan for it you can profit from it.

S&P January Dips

The S&P closed at 1258 again and just under initial resistance at 1260. Congratulations to the fund managers for a successful pin job. Despite the morning dip the range was an unbelievable four points. The lack of volume made their job easier and there was a weak attempt to sell the close but it was quickly stopped. I still see resistance in the 1280 range and real support at 1228. The S&P has interim support at 1240 but I believe that will not hold. I think it will be a speed bump but I expect to see 1228 again. That is the Fib retracement of the 2009 lows.

The RSI (Relative Strength) has been declining while the index moved sideways. This suggests a potential breakdown in the S&P. The Stochastics also predict weakness.

S&P-500 Chart - 90 Min

S&P Chart - Weekly

S&P Chart 60 Min

The Dow has two levels of decent support at 11,445 and 11,335. The initial sell cycle should find those levels as speed bumps that could contain the decline. However, if a real bout of profit taking appears I would expect much stronger support at 11,000 to be tested. I would seriously doubt that level to be broken. That would be a -5% decline and would not be damaging to market sentiment. It would be enough of a decline to attract new money from the sidelines and set us up for a new move higher.

Dow Chart - Daily

The Dow has literally flat lined and needs some electric shock therapy to wake it back up. The 20-day streak of low range days has not happened in over a decade. The PPO (Percentage Price Oscillator) is a slower moving indicator and a cousin to the MACD. I find the PPO signals to be cleaner than the MACD and the PPO has given us a lower high and the signal lines are on the verge of crossing to the downside.

The Money Flow Index is clearly showing a downward trend while the Dow is flat lining. This indicator compares the positive money flow to the negative money flow over a 14-day period. Clearly the flows are indicating a growing weakness.

Dow Chart - Daily

The Nasdaq has decent initial support at 2600 but odds are good we will see a retest of 2500. The Nasdaq big caps are showing far more weakness than the index and this is with some decent window dressing. Now that the window dressing is over we could easily see some substantial declines in those high dollar momentum stocks like Apple, Google and others.

A drop to 2500 would only be -5% and well within the historical norms for profit taking after a +26% gain in the last four months.

Nasdaq Chart - Daily

Nasdaq Chart - Daily

As you can see from the charts below the two biggest Nasdaq stocks already began to decline before December ended. Apple is the most vulnerable because of the hundreds of new product announcements at CES and Apple is not a presenter. They have elected not to participate in CES. Apple is the largest market cap stock on the Nasdaq at $296 billion so any serious decline in Apple will crush the Nasdaq.

Google has declined for the last six days and could continue that trend but there will be hundreds of new product announcements at CES and many of them will feature Google technology. Google could get a bounce from the news. Since most of those products are competitors to Apple the two stocks could go in opposite directions. Google's good news is Apple's bad news.

Apple Chart - Daily

Google Chart - Daily

The Russell was the big winner in 2010 with a +26% gain. This was on top of a +25% gain in 2009. This makes the Russell more susceptible to a larger decline on profit taking than the other indexes. The first target for support will be in the 760 range and prior resistance on the cup and handle breakout in early December. The secondary support target would be 700 and a -10% correction. A dip to that level would be strongly buyable and I can't see that level failing without some unexpected and disastrous news event.

Once the profit taking begins we need to watch the Russell closely for signs of a bottom. Fund managers will want to buy the weakness and the key is watching for a bottom. Once managers believe it is safe they will pile back into the Russell in hopes of another +25% year.

Russell Chart - 90 min

Russell Chart - Weekly

Russell Chart - Daily

The Dow transports have shown slightly more relative strength than the other indexes. Near term support at 5000 could be tested with only one seriously negative day. If any selling on the other indexes approaches those 5% levels I described above we could see the transports test 4800. A worry for the transports is the potential for the airlines to start issuing earnings warnings resulting from the holiday shutdown of thousands of flights. IYT puts might be a good move.

Dow Transports Chart - 90 min

In summary I expect a 5% to 7% decline in January. Year-end fund contributions could postpone it for several days but the anemic moves over the last three weeks are suggesting the decline will come earlier rather than later in the month.

This will be a buying opportunity. This will NOT be the beginning of a larger decline. (Famous last words, I hope I don't have to eat them.) The economy is recovering. The Fed is pouring cash into the market at the rate of $150 billion a month. Some of that will continue to slosh over into equities.

The ISM report should be positive. The FOMC minutes should put some Fed worries to rest rather than kindle new ones. The Non-Farm Payrolls should show a job gain. A big gain and the market will celebrate. A small gain and the market may not celebrate but I doubt it will decline because it means the Fed will be active that much longer.

However, whenever the market wants to go down it will find a reason. It may not be any I stated above but it will find an excuse. Regardless of the excuse given on CNBC or Bloomberg it will be a simple bout of profit taking hiding behind a news event. Don't be fooled.

2011 should be a banner year for traders and investors. The general consensus is for something over 1400 on the S&P after a dip to 1200-1220 in January. That is a +17% gain from 1200 to 1400 and quite a few estimates are higher.

Last year was a tough year to trade because of the flash crash and the worry over a potential second recessionary dip. Both of those problems are behind us and the worst thing we have to worry about in the U.S. is job growth. That appears to be moving in the right direction although very slowly. European debt will again be in the news with Ireland elections in January, Spain and Portugal refinancing in Feb/Mar. The worst of that story should be behind us as well.

Focus on the positive, don't fight the Fed and buy the dips!


2010 is now over and the End of Year Special is almost over as well. We do leave it open for a few days in the New Year for people who had already exceeded their tax deductions in the prior year. 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. If you want to fully participate in the new bull market you need to take advantage of the special now before it is too late.

I received some emails this week I want to share. Apparently the economic worries did not keep subscribers from profiting from Option Investor.

Jim, I just subscribed again and wanted to let you know that last year was my first time back after a 10-year hiatus. It's been a profitable return to the newsletter and I really appreciate the insight. Thanks, JR.

Jim, you did a great job in 2010 picking winners. My only regret is not taking bigger positions. May your wisdom continue in 2011. PWR

Jim…One thing you have taught me over the many years is to listen to the market and charts --- and not all the gurus out there. Since I have accepted that, life in the market has been great. Wishing the market UP or DOWN is simply a costly adventure. It has been a great ride since the start of your service way back when. TC (Subscriber since 1999)

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