A Technical Look at What 2006 Holds

The New Year is just around the corner, and here’s what I’m predicting for 2006.

 The final days of 2005 have been better than many had expected, especially after a largely up-and-down year for stocks. From January to November, stocks trended higher on five occasions, but failed to hold on four rallies. But, over the next couple of weeks, I believe stocks will manage to squeeze out a gain for the third straight year, albeit the smallest gain during the three-year bull market. Given this, you have to wonder if the market is signaling the end of the current bull cycle.

 Now, as we get ready to welcome 2006, stocks appear to be facing some upper resistance. For the DOW, the 11,000-point resistance level is a hurdle. Since coming within 2.50 points of 11,000 on November 25, the index has faced selling pressure, probably due to year-end portfolio adjustments. The NASDAQ continues to eye 2,300, which may be tested early in the year. The NASDAQ needs to see a strong breakout at 2,300 with high volume to be sustainable. Watch to see if volume picks up in January, especially on the days the markets rally.

 So, what should you expect in 2006? In my view, 2006 could be very similar to 2005, given the market uncertainties. For investors, a major determinant will be whether the new Fed chairman Ben Bernanke will put a halt to climbing interest rates. The Fed just raised the Fed Funds rate for the 13th consecutive time to 4.25%. The latest hike was largely expected and ignored by the market, but there were some suggestions from the Fed that the end of rate increases may be near, helping to add some optimism to the market.

 Rising interest rates trickle through the economy and could impact consumer spending, as financing costs rise and disposable income falls. We are already seeing some weak guidance from the real estate market, which could see some selling in 2006. Real estate stocks have been on the decline, and this could extend into 2006.

 The consensus is that the Fed Funds rate could jump to 5% by the end of 2006. The question is, will this have a significant impact on the current economic growth? The Fed will need to balance rate hikes or risk stalling the current economic growth. The last thing the Fed wants to do is to stall the economy. Inflationary data continue to be benign, pointing to economic growth with few pricing pressures.

 Another area to watch in 2006 is oil prices. After declining to the $56 level in late November, the cash crude on the NYMEX rallied back to the $60 level but has failed to hold. The futures market is pointing to $60-plus prices in 2006, which again could pressure stocks, as we saw in 2005. Sixty dollars is a key technical level, where there is selling pressure. But, at what point will stocks begin to sell off?

 Some pundits argue the market can handle $65 a barrel, but I believe this price level will drive selling. The overall consensus is that $70 oil, as we saw in late August, could kill the market. The technical picture looks bearish at this time, as we head into 2006, but it could easily revert back to the bullish side.

 The Relative Strength is weak. On the charts, a breakout at $62 will be required for a move towards $65 and $70. I believe prices could have a tough time rebounding back to $70 in 2006, based on the current climate.

 Other factors that will impact stocks in 2006 are earnings and guidance. The stronger-than-expected Q3 earnings helped to improve market sentiment. All eyes will soon focus on the Q4 and guidance for 2006. If we get a strong Q4, we could see another surge in stocks. The guidance will be critical. I expect earnings to be mixed in 2006, as they were in 2005.

 So, what are the sectors to watch in 2006? With energy stocks fading somewhat on the radar of investors, we could see more activity in the gold sector. Cash gold traded as high as $541 an ounce on December 12, 2005. Gold prices have stalled after the recent strong rally, as gold was technically overbought and due for some profit taking. The cash price of gold on the COMEX made a bearish retreat below its 20-day moving average at $506 on December 14, 2005, followed by a downside breach of the $500 key technical support level to $493.35 on December 16, 2005. Gold prices have since rebounded back above $500, but the near- term technical picture is moderately bearish and the Relative Strength is weak, so gold could see some difficulties holding at above $500. We need to see gold hold at the key $500 support for a potential rally. Another decline below $500 could see a move to the 50-day and 100-day moving averages at $484.19 and $467.25, respectively.

 I like gold in 2006, and I continue to believe there will be good trading opportunities in precious metals. Watch for potential merger activity to increase. Also keep your eye on the smaller gold producers. I expect consolidation in the sector will continue, as producers look to reduce operating costs and increase reserves.

 In the metals arena, we could also see more action in copper, as demand from China continues to grow.

 I expect trading to remain active in technology, although I question some of the valuation assigned to stocks. The retail sector has been showing some weaker-than-expected sales during the holiday shopping season, so watch for some sluggishness among retail stocks in 2006.

 Heading into 2006, my near-term technical outlook is neutral to moderately bullish.