My Initial Thoughts on What to Expect in 2012

Hope everyone had a nice holiday season. I'm finally back with my first post of 2012 where I will summarize my thoughts on the current state of the markets and what I expect looking forward.

Buy and hold is dead, but expecting a double dip decline is also foolish. There should be plenty of opportunity this year as both a bull and as a bear. Expect continued volatility as the year unfolds.

RIGHT NOW:
There is major resistance overhead and I am bearish. The Dow and the S&P 500 have not yet signaled a return to bullish sentiment (technically) since the sell-off began last August. The fact is that the first week of August 2011 signaled a break of two major bullish support trend-lines. That introduced the beginning of a bearish cycle. Yes, the immediate trend is up when you look at the higher lows dating back to the early October pivot low, but the markets are hitting a wall overhead right now.

Action in the US dollar supports this view. The dollar is showing strength and is poised to move higher. A lot of this strength is in relation to a weak Euro, but regardless, a rising dollar is not good for US equity markets.

The UUP has already broken out above prior resistance. I expect it is on its way to 23.25-23.50.

The EURUSD has now broken down below prior support. I expect EURUSD is now on its way to 1.25. Resistance above needs to hold at 1.283-1.287 for this to confirm.

The dollar index ($DXY) has not yet confirmed a breakout. It is currently sitting just below resistance at 81.30-81.45. When the $DXY closes above 81.45, that should be confirmation that the dollar is indeed headed higher and that US equities will head lower.

Although there is significant resistance overhead in US equities, that doesn't mean the market is going to bounce off and go straight down. Any good short opportunity will typically prove difficult to take advantage of. It is only normal to see fake-out moves to the downside followed by reversals to the upside. This is when the weaker hands get shaken out. You can already see this happening as the markets have chopped up and down over the first week to begin the year. I wouldn't be surprised to see more consolidation before the market declines. Regardless I prefer selling the rallies right now.

LEVELS TO WATCH:

Key Resistance on the ES:
We have the double-top from 10/27/11 at 1283.50. ES came close to that on Friday trading up to 1282.25 following a positive unemployment number.

Bearish outlook still in play even if this double-top is broken.

Next line of resistance is 1291-1295. This price range could easily be tested. I especially like shorts in this range. 1290-1300 ES is very significant and will act as a formidable wall against higher highs. Any price action above this range will need to be immediately rejected for bearish confidence to remain in play. If ES trades up into that price range, I will be looking to enter a swing-short position with confidence.

In terms of support on the ES, once the ES turns down, expect a first target to the downside at 1249-1252. I'll wait to see the timing of this move and the subsequent price action before I give further levels to the downside.

There are fundamental economic concerns across the globe that support the technical bearishness I have outlined above.

First of all, the Eurozone debt crisis has not gone away. Greece is likely to leave the Euro without less stringent austerity measures. A solution to pay off Italian, Spanish and other PIG countries debts are nowhere near being reached. Pyramid debt instruments like SPVs, EFSF bonds and other newly created schemes have failed to lure in more money. High yields remain a problem in the Eurozone. Central banks continue to resist the temptation to print more money (at least that is the attitude they express publicly). If they don't print and European leaders do not find buyers for their bonds and other debt instruments, deflation will prevail and equity markets will decline.

Debt Ceiling will be an issue again here in the US as the government is now less than $25 million away from hitting the revised number from August of last year.

Tensions mounting with Iran. If the US, Israel or NATO invades Iran, oil prices will go up. If oil tankers were prevented from passing through the straight of Hormuz, oil prices would sky-rocket and equity markets would sell in the same wave of panic.

Interest rates are as low as they can go in the US, even lower than they were following the 2008 crash. There is no more room to lower interest rates further if/when times get tougher.

With all the bad news in 2011, the S&P 500 is only 75 points off its post 2008 highs. I would lean towards the attitude that positive US economic news like declining unemployment numbers and increased manufacturing numbers are already priced into the markets. Without more QE, further upside is limited while the downside potential is ripe for the picking.

We are currently experiencing the greatest debt bubble in history. I can't say exactly when this bubble will officially burst, but you can't grow an economy on credit forever and you can't continue to increase debt without suffering consequences at some point. Will the debt bubble burst within the next year or in the next 10 years? I don't know. Predicting economic events is not the hard part, it is getting the timing right that is difficult. All we can do is trade the "now" and hope to be in good position to take advantage of future market moves and not get caught on the wrong side of disaster.

To close, I want to touch on how bad things could get this year. Assuming the bearish action does play out in the first half of 2012, I don't expect significant escalation to the downside. The worst case scenario would be around 950 on the S&P 500 (don't get me wrong, that would be significant, but it would be unlikely for things to get worse than that). If price was to fall that low, it would provide a tremendous buying opportunity. When things get bad enough, central banks will resume some form of QE or money printing that will put a floor underneath the markets. Lets not forget this is an election year in the United States. The Obama administration knows that a healthy stock market will increase the likelihood of a second term in office. They will do everything in their power to ensure that is the case.

I will conclude this post now before it gets too long... more to come... best of luck to all as we enter what will most definitely be an interesting year.