10 Things to Watch for in 2011: (SPY, DIA)

As we stand at the dawn of a New Year, everybody would like to have a crystal ball so we can know what's coming next. 

Of course, sadly, no one has such a crystal ball, and so any predictions or prognostications you read at this time of year are nothing more than educated guesses or hopeful stabs in the dark. 

However, looking into the fog shrouded months lying just ahead, we can see some clear themes already emerging.  Here are ten things to watch for in 2011: 

1. Analysts almost uniformly expect 2011 to be a bullish year for U.S. equities due to the Fed's continuing program of quantitative easing and improving economic conditions at home. Watch for continued bullish sentiment which alone should be a wildly bearish indicator as the herd is almost always wrong. 

2. The situation in Europe could very likely affect global equity markets in 2011 as the Eurozone continues to struggle with its debt problems.  Watch out for problems in Spain because Spain is too big to fail and too big to save. 

3. Rising interest rates in the U.S. could put a huge damper on U.S. corporate profits, the housing market and the ability of the country to finance its growing debt. Watch for the direction of U.S. interest rates. If the bond vigilantes come after the United States, it's game over for this recovery. 

4. The rising price of oil could become a major drag on the economy.  Watch for oil to cross $100/bbl. on a sustained basis. 

5. New moves to install “austerity” programs by the new Congress could choke off the recovery.  Watch for moves to limit the powers of the Federal Reserve and moves to cut spending that could easily create a double dip recession. 

6.  The housing market continues to languish.  Watch for a “double dip” in housing. 

7. Unemployment remains stubbornly high.  Watch for a retreat in recent employment gains. 

8. The coming default crises for states and municipalities.  Watch for cities and states to lay off workers and default on their bonds. 

9. The slowing Chinese economy.  Watch for the Chinese economy to continue to slow and the Shanghai Composite to enter bear market territory.  

10. The announcement of QE3, QE4, QE5…..Watch for the Federal Reserve to announce the continuation of QE2 past the June expiration of QE2.     

Overall, I believe that 2011 will be a choppy ride as global economies continue to struggle with too much debt and the fallout of the financial crisis that started more than three long years ago.  The most likely scenario for 2011 is that it will be another year when “traders” will fare better than “investors” and that we'll most likely continue to experience volatility as the financial crisis continues.  

 Looking at My Screens 

On a short term basis, markets remain overbought and due for a correction.  On a macro basis, we see massive divergences in the chart below: 

chart courtesy of http://www.stockcharts.com 

In the chart above, the Shanghai Composite is the red/black bar chart and the S&P 500 is the smooth, grey line overlay.  You can see here how the Shanghai tends to lead the S&P and how closely correlated they have been until early November at which time the S&P went north while the Shanghai went south. 

One way or the other, it's highly probable that this divergence will resolved.  The Shanghai could make a miraculous recovery in the face of government tightening or the S&P 500 could correct downwards. 

The View from 35,000 Feet 

The prevailing view is unbridled optimism and for more growth ahead, however with $88 Billion leaving equity funds in 2010 and insider selling at high levels, there are clearly some clouds hovering this bright outlook. 

What It All Means 

I would not describe myself as a contrarian, however, contrary to most mainstream analysts and pundits, I would suggest that we approach 2011 with a good deal of caution and be ready to seek profits no matter in which direction the markets may take us.    

The Week Ahead 

2011 will get off to a fast start with a slew of important economic reports due out this week. 

Monday: November Construction Spending, December ISM 

Tuesday: November Factory Orders, FOMC Minutes 

Wednesday: December ADP Employment Change, December ISM Services Sector 

Thursday: Initial and continuing unemployment claims 

Friday: December Non Farm Payrolls, December Unemployment Rate 

Sector Spotlight: 

Winners: Singapore (EWS) South Korea (EWY) 

Losers: Biotech (IBB) Small Cap (IJR) 

Wishing you a wonderful New Year!

Disclosure: Wall Street Sector Selector invests in a wide variety of exchange traded funds and positions can change at any time.