What will the market do in 2012? The first five trading days of January can tell us a lot about the year ahead. This year, I think the opening trading days are extremely important to watch as the market is on the verge of an important technical event.

Stocks have been locked in a downward trend since the beginning of May leaving most investors frustrated and battle worn. Not only has the trend been down but the volatility has also been extreme, shaking any responsible risk taker out of positions with fast price whip saws.

The great thing about tough markets is that it is always easier to get better than it is to get worse. As 2011 came to a close, there began signs that the market is turning around. Economic conditions are slowly improving, the 2012 US Presidential election may bring an end to US government gridlock, Europe has started to stabilize, China is showing a willingness to stimulate their economy, the housing market has stabilized and the financial stocks have started to find some buyers.

While these are good talking points for the Bulls, you must know that I ultimately look to the charts to tell me what people are actually doing with their money. Talk is cheap; I want to know if people are putting their money where their mouth is.

A look at the charts shows that we are at a critical point. Below is the chart of the SPY, an exchange traded fund based on the S&P 500 index. There are two important things to take away from this chart. First, the bottoms have been rising for the past three months. That is a sign that optimism is improving.

Second, the market is now testing the downward trend line that has held up since the start of May. A break of that trend line would signify a change of control, putting the buyers in a stronger position than the sellers:

If the markets start 2012 strong, the important downward trend line shown in red will be broken.

The Financial sector has been a big drag on the stock market. These stocks have suffered through the global debt crisis and need to turn around if the overall market is going to reverse the pessimism. Financials are also testing their downward trend line and have been forming rising bottoms recently:

The other big drag on the US economy has been the housing sector. It is somewhat surprising to see how well these stocks have done over the past two months. They are now at some resistance inside the trading range they have been in for the past couple of years:

The situation is similar in Canada with the TSX below but approaching its long term downward trend line:

However, the Canadian Financial stocks are leading their US counterparts, having made a move through the downward trend line this past week:

Outlook
If the charts are able to break these downward trend lines in January, I expect at least a few months of strength that will take prices up toward resistance at the April 2011 highs. Expect prices to then get stuck there through the traditionally slow summer period before a possible break to new highs to end 2012.

It is critical that investors wait for the break of the downward trend line before moving in to stocks. This downward trend line is resistance and, until broken, puts the control of the market in the hands (paws?) of the Bears. If the Bulls fail to take control, investors should remain defensive with holdings in dividend paying stocks with Sentiment Stockscores > 60 as I discussed in last week’s newsletter.

Watch the market closely for the first two weeks of 2012. Stocks are at a potential turning point but be sure to wait for the market to give you the message that it is time to start buying again.

Best wishes to everyone for a Happy, Healthy and Prosperous 2012.

References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
Get the Stockscore on any of over 20,000 North American stocks.Background on the theories used by Stockscores.Strategies that can help you find new opportunities.Scan the market using extensive filter criteria.Build a portfolio of stocks and view a slide show of their charts.See which sectors are leading the market, and their components.