The year 2011 has come and gone. Many of the major stories of 2011 will continue to impact the world and the markets for years to come. Lack of leadership and bitter bipartisan rivalry in the U.S. over raising the country's debt ceiling prompted Standard & Poor's to downgrade the U.S. credit rating for the first time in history with a drop from AAA to AA+. Across the Middle East it was a year for an "Arab Spring" that is still reshaping the region with major changes in Egypt, Libya, and ongoing conflict in Yemen and Syria. It was also a year marred by a massive earthquake and tsunami in Japan, where nearly 20,000 people lost their lives. This Japanese disaster was exacerbated by a dangerous meltdown at the Fukushima nuclear plant, which called into question the safety of nuclear energy around the world. Yet the major story for 2011 is the still unsolved toxic sovereign debt issues in Europe. After numerous summits and negotiations it seems that the EU's leaders are still unwilling or unable to make the hard decisions for what is essentially two different Europes, the relatively strong core versus the struggling periphery.

Here at home in the U.S. the holiday shortened week was quiet. Stocks traded with extremely light volume since so many market participants had already closed their books for the year and gone home. Worries over Europe remained front and center. Italy was successful in completing a couple of significant bond auctions last week but yields are uncomfortably high. The yield on the 10-year Italian note is hovering at 7%, which is unsustainable for any significant period of time. Italy needs to raise 113 billion euros worth of debt in the first quarter of 2012. They will be unable to do so if yields on their long-term bonds remain near 7%.

You can see the fear of Europe in the action in the euro. The currency is hitting new relative lows while the U.S. dollar is in rally mode. A rising dollar is traditionally bearish for commodities and silver and gold both sank to new relative lows last week. Gold made headlines when the precious metal fell to approximately -20% from its highs ($1,923 an ounce), which technically puts gold near new bear-market territory. I wouldn't start buying puts yet. Plenty of pundits are calling the drop in gold a new buying opportunity.

Weekly chart of the Euro currency ETF (FXE):

Weekly chart of the Gold ETF (GLD):

The was a lot of economic data last week but it didn't have much impact on the stock market. The Case-Shiller 20-city home price index fell -3.5% in October. The weekly initial jobless claims data surged from 366,000 to 381,000, which was worse than expected. The ECRI weekly leading index inched down from 121.3 to 120.9. The Chicago PMI for December slipped to 62.6 from 62.5 but that was better than expected. The New York ISM rose from 533.5 to 534.0. Consumer confidence for December rallied from 56.0 to 64.5. Economists were only expecting a rise to 58.0. The biggest surprise for the week was the pending home sales data, which surged +7.3% versus expectations of +0.6%. Housing analysts warned not to take that number at face value.

Major Indices:

December 31st, 2010 the S&P 500 closed at 1,257.64.

December 30th, 2011 the S&P 500 closed at 1,257.60. That's the smallest year-to-date change in 61 years.

Investors have been told for years that on average the market rises +10% a year. This is the basis for the buy-and-hold strategy. Bad years will be offset by good years and long-term you'll average a +10% annual return. That wasn't the case for the S&P 500 in 2011, which closed flat for the year (-0.0%). As a matter of fact that hasn't been the case for the last 11 years. The S&P 500 closed the year 1999 at 1,272. It just closed 2011 at 1,257. That's drop of -1%. For the record, if you were able to buy the bottom in 2009, and I'm not saying anyone did, the S&P 500 is up almost +90% from those lows. Of course everything is relative. The S&P 500's -0.0% for the year looks bad until you look at how the rest of the world performed in 2011. Britain's major index fell -6%. Germany dropped -15%. France and Japan fell -17%. The Chinese Shanghai index plunged -22%. Two countries that have constantly been in the headlines are Italy and Greece, which are down -25% and -52%, respectively. Suddenly flat for the year doesn't seem so bad.

Technically the S&P 500 index is hovering near its simple 200-dma and it remains under resistance in the 1265-1270 zone. A breakout higher should send us to the next level of resistance near 1285 and then the 1300 level. Further declines would push us to short-term support near 1250 and then round-number support near 1200. If you're optimistic then the inverse head-and-shoulders pattern on the S&P 500 is forecasting a rally toward 1,362 but the index has to breakout higher first. Last week I told you that the Point & Figure chart on the S&P 500 is still bearish but a move past 1270 would produce a new triple-top breakout buy signal.

Daily chart of the S&P 500 index:

Looking at the NASDAQ composite index you can see that over the last few months it has been consolidating sideways in a big triangle pattern of lower highs and higher lows. These are normally neutral patterns. Given the narrowing consolidation it should see a breakout in the next couple of weeks (if not sooner). The simple 200-dma is overhead resistance as is the multiple trendlines of lower highs. Meanwhile a breakdown under 2500 would probably signal a new drop toward the 2011 lows.

Daily chart of the NASDAQ Composite index:

The small cap Russell 2000 index ($RUT) is also building what appears to be a potential inverse H&S pattern. A breakout past resistance (the neckline) would suggest a rally toward the 840 area. Of course the $RUT needs to push through resistance near 750 and its 200-dma near 760 first. If stocks turn lower then we can look for potential support near 710 and then 670.

Daily chart of the Russell 2000 index

The first week of January is going to be a busy one for economic data. One of the biggest events of the week will be on Monday while the U.S. market is closed. Economists are expecting China to announce their latest GDP estimate on Monday and analysts are expecting +8.5% growth. If this number is two low it's going to really fan the flames of fear that China is seeing a hard landing, which would boost worries over a global slow down.

On Tuesday in the U.S. the national ISM is expected to rise. Meanwhile the latest FOMC minutes will be released. On Friday the jobs report could be a major market mover. Economists are expecting +150,000 jobs versus +120,000 in November. We need to keep in mind that the December report could be artificially inflated with temporary seasonal workers that will get laid off in January and depress the January numbers.

- Monday, January 2 -
U.S. markets closed for New Year's holiday
China's GDP estimate

- Tuesday, January 3 -
ISM Index for December
FOMC minutes

- Wednesday, January 4 -
Factory Orders for November
Auto and Truck sales

- Thursday, January 5 -
Weekly Initial Jobless Claims
Challenger, Christmas & Gray mass layoff report
ADP Employment report
ISM Services for December

- Friday, January 6 -
Non-farm payrolls (jobs) report for December

The Week Ahead:

The U.S. markets did not see much of a Santa Claus rally (the last few days after Christmas). Traditionally that doesn't bode well for stocks come January. I suspect that the first few days of January could see a pop as fund managers put new money to work. However, odds are any rally stalls as investors wait for the Q4 earnings season to begin. Corporate guidance looking forward into 2012 will play a huge role in determining market direction for the rest of the first quarter.

I suspect the trend of very slow but improving economic data in the U.S. will continue. However, we will remain very susceptible to negative headlines out of Europe. There are significant chunks of Europe that are facing severe recessions as governments follow through on their austerity measures. The EU leaders still don't have a concrete plan to solve their toxic debt problem. Italy is in hot water with its long-term bond yields hovering near 7%. The EU has huge amounts of debt it needs to roll over in the first quarter of 2012 and that's not going to be an easy task if they can't bring bond yields down. Meanwhile there seems to be growing concern over China's economy.

One of the biggest landmines for the first quarter of 2012 will be credit downgrades. The major ratings agencies have already warned us by putting several countries on creditwatch negative. Here in the U.S. the 2012 Presidential race is heating up. All the attack ads on TV could be a bearish factor on investor and consumer sentiment.

One thing we can be sure of and that's 2012 will be an interesting year!

- James