The S&P had the lowest YTD change in 61 years with a close only -0.04 points below where it started 2011. That is the smallest change since 1950 when the S&P closed exactly even.

Market Statistics

The S&P closed at 1,257.60 for 2011. That was only -0.04 points below the close for 2010 at 1,257.64. Considering 2011 was a year of record volatility we should probably be grateful for the rebound rather than frustrated about the lack of gains. If you take the longer term view the S&P closed 1999 at 1,272. That means there has been zero market appreciation over the last 11 years. That is not very encouraging. However, Friday's close is still almost 89% above the 666 low in March 2009. An 89% market rally in less than three years is still a decent rally when the average S&P gain is only 8% per year.

S&P Chart Quarterly

Over that same period Abbey Joseph Cohen has been consistently wrong in her predictions for S&P growth. Her prediction for 2011 was 1,500 and she only missed it by a mile in technical terms. The lowest analyst prediction at the start of 2011 was 1,333 and the average was between 1400 and 1500.

Since this is the New Year newsletter I will cover more on predictions and history later.

There were only a couple economic reports on Friday and neither were market moving. The ISM-NY rose ever so slightly to 534.0 from 533.5. After setting a high of 538.8 back in July the business conditions in New York have cooled. The internal components were not exciting. The six month outlook declined to 63.7 from 71.0, while the current conditions component rose slightly to 51.1 from 47.2. Normally the six month outlook is the bullish of the two and that suggests respondents are starting to factor in things like a recession in Europe and the next installment in the U.S. debt limit saga.

The quantity of purchase component declined to 48.3 from 54.3. People were buying less. The employment component declined sharply to 46.6 from 52.1. The urge to hire is fading and the decline into contraction territory suggests the service sector is actually laying off workers.

Moody's ISM-NY Chart

The ECRI weekly leading index declined slightly to 120.9 from 121.3. Not a big move but the index has been weak since the middle of November. The 120.9 is only 0.1 point away from a two month low. The index, which is powered by accumulated results of other reports, is suggesting there are some clouds forming on the horizon for 2012.

Moody's ECRI Chart

The calendar for next week has some serious economic land mines. The first is the estimates of China's GDP on Monday. The consensus is for 8.5% growth but conditions in China are starting to attract attention because of the negative news. I would not expect China to shock the world by guiding lower but analysts will be reading between the lines of the release. This could be the start of a shift of attention from Europe to China as the next big problem.

The national ISM on Tuesday is officially expected to rise slightly but several recent regional reports have shown some weakness. If the national ISM were to decline the bears would come out to celebrate.

The FOMC minutes will give us a clue on what to expect at the FOMC meeting in late January. Some expected a QE3 announcement but recent commentary suggests a "wait and see" approach by the Fed. They want to keep their remaining bullets intact in case there is a new event in Europe. The market may not be excited about language in the minutes that suggest no QE3.

This is the payroll week and that starts on Thursday with the ADP, Challenger and Monster Employment reports. The estimates for the ADP report are showing a decline in the number of new jobs for December but they are still expecting decent growth at +180,000. There is no estimate for the Challenger report or the Monster report. However, the Monster Employment Index declined in November from 151 to 147. Another decline would not be greeted warmly even though we should expect a decline in employment advertising in December. Seasonal workers have already been hired and nobody runs any serious ads ahead of the holidays. That process will begin again in January. This means the Monster index "should" decline for December.

Lastly the Nonfarm Payrolls on Friday are expected to show a gain of +150,000 jobs compared to +120,000 in November. Personally I think this is overly optimistic. However, since the survey was conducted between Dec 11th - 17th it is probably too soon to capture the terminations of the seasonal workers. That means the real change in the recent trend may not be reported until the end of January and all the seasonal workers will have been terminated. Several of the regional reports have shown weakness in the employment components so it will be interesting to see how that translates to the nonfarm payroll survey. A number under 100,000 would not be well received and it might take a number over 165,000 to get traders excited. It seems to me that traders seem to get overly optimistic about the payroll numbers so they always have bigger expectations than the official consensus. The majority of the time those expectations are dashed by the real numbers.

Economic Chart

There was very little stock news on Friday because there was nobody around to report it. Volume was only 3.9 billion shares. The high volume day for the last five trading days was Wednesday at 4.2 billion and that was only about 60% of normal and 45% below the three month average. The lights were on and the tickers moving but nobody was participating.

Leap Wireless and MetroPCS both rallied on comments from JP Morgan that either one could become an acquisition target of AT&T now that the T-Mobile acquisition is dead. AT&T needs additional wireless spectrum in order to compete with Verizon and Sprint and to build out its 4G LTE network. There are 327.6 million wireless subscriber connections in the U.S. compared to a population of only 315.5 million. Cellphones and tablets are sucking up bandwidth and companies like Verizon and AT&T are scrambling to find more. Verizon has been buying unused spectrum from the cable companies while AT&T had hoped to get it from T-Mobile. JP Morgan believes LEAP and/or PCS would not have the same regulatory hurdles for AT&T and they could complete an acquisition. JPM felt that LEAP could be worth $13 and PCS spectrum alone could be worth $6 a share. Shares of LEAP reacted the most with a +1.50 spike intraday that sold off for only an 80-cent gain by the close at $9.29.

LEAP Chart

American Airlines parent AMR is going to be delisted from the NYSE before the start of trading on Jan 5th. The stock is down -93% for the year and has been trading under $1 since Dec 8th. Any company with an average closing price under $1 over a 30 day period is subject to delisting. The notice gives any shorts the opportunity to cover their positions before the stock disappears to the pink sheets.

AMR Chart

Walgreens (WAG) is facing a major deadline on Sunday when it can no longer process prescriptions for Express Scripts. They have been unable to agree on a new contract and the current contract expires on Saturday. Last year Walgreens filled 88 million prescriptions for Express Scripts worth more than $5.3 billion. Walgreens has 7,810 stores. The contract battle has been going on for many months. Express Scripts said Walgreens made a serious effort in mid December to patch up their differences but could not come to an agreement. Walgreens has been offering customers discount prescription cards to try and get them to stay with Walgreens but according to Express Scripts very few have made the commitment.

I have an Anthem health plan and they sent me a list of pharmacies since the Walgreens contract was cancelling. Millions of consumers will be forced to change pharmacies. When I drove by Wal-Mart on Friday they had signs on the street saying "Are you being forced to change pharmacies? We are authorized to process.." and a list of the companies being forced to leave Walgreens. I don't know what the deal killer was with Walgreens and Express Scripts but apparently Walgreens thought they could use their weight to force a deal. It appears they were wrong and it could be a costly decision. Walgreen's shares have been relatively flat since the initial conflict was announced several months ago but if they can't reach an agreement quickly I would expect shares of WAG to head lower soon.

Walgreens Chart

The decline in gold has really generated a lot of market opinion. If you look hard enough you can find 2012 estimates from $800 to $2500. Some people are calling it the ultimate bubble and others are calling it a buying opportunity. Gold has fallen about $400 off its $1,923 high and has reached bear market territory. It closed on Friday at $1567.

Numerous analysts have suggested the $1,485-$1,530 level was the key support level where they expected a bounce. Others are a little more bearish at $1,250-$1,300. Almost all believe gold will rise again and quite a few expect a new high over the next 18 months. Only a couple are expecting a real implosion.

Dennis Gartman said he would begin adding to positions at $1,525 and above. Personally I would feel more comfortable with a touch and rebound from $1,485 but the difference between those numbers is insignificant.

Charles Biderman from was out on Friday saying gold has no choice but to go higher long term because of the trillions in QE still ahead of us in Europe and the USA. He said it could go lower in the short term so he advised average costing into positions on a weekly or monthly basis.

I have no doubt about the future for gold and silver but I think the biggest headwind is the rising dollar. As long as Europe continues to circle the drain the euro will decline and the dollar will rise. That is negative for gold and other commodities. I think the long term outlook for the dollar is very weak once Europe starts to heal. For that reason I will continue to buy silver on the dips and leave gold for those with deeper pockets.

Gold Chart

Silver Chart

The market in 2011 was like a roller coaster ride. We started and stopped at the same place but the ride in between was extremely frightful. 2011 broke several records and the one most disconcerting was the four consecutive days in August with 4% Dow moves. That was the first time that has happened. Hopefully we won't see it again in 2012.

August Volatility

More than $6.3 trillion was wiped off the global markets in 2011. Global capitalization declined -12.1% to $45.7 trillion. Relatively speaking the U.S. markets performed rather well. Of the major markets only Ireland did better.

Global Markets

The reason for the declines was of course Europe and the sovereign debt crisis. Unfortunately it is not over. The forced austerity on top of an already weak global economy is going to weigh heavily on Europe in 2012. As many as 10 of the 17 countries in the euro zone are falling into a recession that will be extremely deep and painful for several of them.

The debt problems could get worse before they get better. According to Citigroup there are 457 billion euros of euro zone sovereign debt due to be repaid in Q1. Italy will account for 113 billion of that total. Italy is facing record high yields with the 10-year bonds sold last week at a yield of 6.98% an indication of more trouble ahead. A yield of 7% is considered unsustainable and that is especially true for refinancing 113 billion euros of debt in the first quarter alone. That means they will have to sell short term debt of 6-mo to 2-years and keep rolling it over in order to keep the rates lower. That puts Italy at even greater risk because any change in outlook and they would not be able to constantly roll over the debt. Relying on short term funding is very dangerous and puts you at the mercy of the bond vigilantes.

Italy is only one problem. Greece is not done and Spain is rapidly approaching critical mass as well. Greece has not finalized the 50% haircut for its debt. Bond holders continue to walk out of meetings over changes in the terms. It is far from a done deal and that would only bring their debt down from 160% of GDP to 120% by 2020. That is not a sustainable level.

Europe will continue to be a problem in 2012 but at least there is progress with the central banks swap lines announced last month and the ECB low interest loans. Those measures improved liquidity but did not solve the problem. Europe is like a boat with dozens of leaks. Each measure plugs a couple of leaks but the boat is still sinking but only at a slower rate. Until the ECB commits to buy enough sovereign debt on the open market to solve the problem permanently we will continue to have these routine flare ups.

The banking sector in Europe is the next problem for our markets. The nearly 500 billion euros borrowed from the ECB the prior week was just a down payment. Some believe it could take two trillion in these three year loans to keep the banks afloat. Spain's Banco Santander (STD) and Italy's Unicredit (UNCFF) are constantly mentioned as the next banks likely to fail. Fortunately the U.S. economy has started to improve and continued improvement in 2012 could focus attention on the U.S. and away from Europe. The earnings cycle begins in one week with Alcoa earnings on Jan-9th. If Q4 earnings continue to show improvement and the employment numbers next week don't disappoint the market could breathe a sigh of relief and move higher.

The economic picture from China could be the fly in our soup. I have been reporting for the last couple months about the deteriorating conditions in China. So far the government has not taken any drastic actions to halt the economic decline. Early last year they tightened economic policy several times in an attempt to slow inflation. They have yet to remove much of that tight money policy so they have a full arsenal of weapons they can use to stimulate the economy and avoid a hard landing. In the U.S. we know from experience the central bank and the government have a very bad track record for managing economic cycles. They always seem to be late to the party. Let's hope China is not late to their party and they are able to avoid a crash landing. Bad news from China could easily cause serious trouble in our markets.

One thing we know for sure is that something is going to change in 2012. The chances are slim the USA will have a boring old 8% gain for the year on low volatility. There are far too many factors at play. By the time you factor in some new sovereign debt issues, European bank failures, oil embargo on Iran, a resurgence of the Arab spring, a hard landing in China, the 2012 election cycle and sluggish economic growth the outlook is anything but boring.

The U.S. markets definitely favored conservative stocks over the last year. Dividends were the new buzzword and those stocks with decent growth and a big dividend were buyer favorites. Utilities are the most conservative stocks you can buy and it was the hot sector for 2011. That should tell you a lot about the investor mindset.

Airlines were the worst performers as higher fuel prices and intense competition kept profits low despite high load factors. This sector will continue to decline as the decade progresses thanks to higher oil prices. The technology sector was flat at +1% gain despite the tens of millions of iPhones, iPads and Androids being sold. Tablets cut into PC sales and warnings from chip companies depressed the outlook. The Thailand floods just increased the depression due to shortages of parts and hard drives.

Energy started off the year strong but the crash of oil prices in April and the stock market decline in August knocked even the strongest energy stocks back to 2010 price levels. Were it not for the Oct/Nov rebound in crude the sector would have been down for the year instead of the mediocre +3% gain.

Financials were knocked for a -18% loss on worries over contagion from Europe, the new Dodd Frank legislation, the Basel accounting rules and the impact of too big too fail restrictions. Suits over subprime mortgages and their packaging into mortgage backed securities resulted in multiple settlements in the hundreds of millions of dollars each. Lastly the short sale ban on financials in Europe meant that global investors were shorting U.S. banks to hedge against European risk. Banks forced to raise additional capital were issuing new stock and selling profitable assets. It was not a good year to be a bank investor.

Sector Performance

Bank Analyst Dick Bove said last week the banking sector is selling at bargain basement prices. There is $1.5 trillion in excess liquidity in the U.S. banks. Earnings are growing and business loans are rising at better than a 10% growth rate. Banks are starting to lend and businesses are starting to borrow. He said the current prices of bank stocks had no relation to the fundamental valuation of their businesses. He strongly recommended bank stocks across the board for 2012.

The S&P has closed positive on the last trading day of the year only one time in the last eight years. Fund managers tried very hard to keep the S&P in positive territory but a flurry of selling at the close and they just couldn't keep it in the green for the year. It was a valiant effort. The final decline to 1257.60 was minimal at -5 points but it was just enough to close under the 200-day average at 1259. Obviously the $64 question today is what will happen next week.

Of the last 15 years there have been an almost even number of up days and down days (8-7) on the first trading day of the year. It is hard to see a trend there. If we extend it to cover the first week it remains a dead heat. However, if we look at the end of January compared to the first day of the year the Dow is down 10 times and up only 5. Looking even closer there was a significant sell off in January 12 out of 15 years. In some cases they lasted only a week or so but they were normally significant program driven declines. Once the year end money was invested a sharp selloff appeared to capture profits. I speculate the hedge funds were invested ahead of the retirement fund pop for mutual funds and the hedge funds took profits when it was over. The pattern is very well defined.

Even though we have had some serious bouts of volatility over the last several months the Dow did finish near five month highs. That suggests a lot of funds were long into year end and with the European crisis alive and well they may not want to stay long next week. The payroll reports on Thr/Fri could be a pothole they would like to miss.

The S&P continues to struggle with resistance at 1265. There is a pattern of higher lows and we could be coiling for a breakout. A move over that level would be a buy signal if it came on higher volume. I doubt that higher volume will appear on Tuesday. Everyone will still be recuperating from the long weekend. We saw an opening spike to 1269 last Tuesday but it did not stick. For that reason I would like to see a move over 1270 for real confirmation of a breakout.

Initial support is now 1250 and then a long drop to 1210. We can do that without breaking the uptrend from the October lows. It will all depend on the headlines and the fund flows.

S&P Chart

IBM (+25%) and MCD (+31%) represented 50% of the Dow's gains for the year. Bank of America (BAC) was the biggest Dow loser for the year at -60%.

The Dow has a VERY clearly defined resistance level at 12,285. We have seen a dead stop on every attempt on each of the last five trading days. However, every attempt at resistance weakens that resistance. The minor 69 point decline on Friday was a setup for a running start on Tuesday if the bulls so desire. Remember, this is a three day weekend and there was severe event risk from Europe and China plus the FOMC minutes on Tuesday. There were good reasons to be cautious into the close and a -69 point pullback is just noise.

The Dow appears to be poised for a breakout. It has the highest penetration from the Nov/Dec consolidation phase. I believe this was due to fund managers buying large caps for safety rather than by choice. Next week should be interesting. Initial support is 12,150 then 12,000.

Dow Chart

The Nasdaq has closed higher on the last trading day of the year only once in the last 12 years.

The Nasdaq declined -8 points to come to rest just over critical support at 2600. The downtrend resistance is still intact. There is a series of higher lows and lower highs in what appears to be a consolidation pattern but the uptrend is weak. Resistance at 2625 held earlier in the week and a break back below 2600 would be negative.

The Nasdaq was handicapped over the last several months by several major decliners. The highest profile Nasdaq decliners for the year were RIMM -75%, FSLR -74% and NFLX -61%. At this point they are cheap enough they can't really impact the index going forward.

Helping the Nasdaq is the new buzz about the Apple products to be announced in the next couple of months and the breakout over $400 in AAPL shares. Google also closed at a new four year high on Friday at $645. Gains in those stocks are helping to overcome the declines in other sectors.

Since both GOOG and AAPL are highly liquid large caps the gains could have been fund managers hiding money over year end. We will know for sure by next weekend if those gains were temporary.

Nasdaq Chart

The Russell 2000 is facing strong resistance at 750 that appears rock solid. However, initial support is not far below at 735 so we have a tight range to give us a clear trading signal. Since the Russell is the real sentiment indicator for the market a break over 750 would be a strong buy and a decline below 735 a soft sell. A continued decline below 710 would be a strong sell.

Russell Chart

Tuesday could be frantic and move in either direction. There is no clear signal and like most of 2011 the market will be headline driven. China's GDP estimate for 2012 on Monday will be critical for the market open. In the afternoon the FOMC minutes will be the key point. There will probably be other European headlines as leaders position themselves for the January meeting to go over the new plan.

I do expect a significant dip in January. It could be sooner rather than later but I do expect it. I would also be a buyer of that dip assuming the nonfarm payrolls and ISM reports are not disasters. The USA is the strongest economy in the OECD even at our current 3.0% GDP estimate for Q4. The U.S. is attracting foreign capital because there is nowhere else that has the same relative safety. Europe is sliding into what could be a deep recession for as many as 10 countries and possibly more. Investors are fleeing Europe. China is a question mark until the next set of data is released. Emerging markets have been weak as are Latin American markets. The U.S. is the safe harbor and that will continue to help our markets and debt sales.

If you have not taken advantage of the Year End Subscription Special your time is running out. We normally extend it into the first week of the New Year for people who have already maxed out their deductions for 2011. If you want to take advantage of the steep discount and get the full package of newsletters plus the bonuses you need to act quickly. Don't be a terminal procrastinator like me. We only have a few silver dollars left. Don't be left out.

Jim Brown

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