SMALL-CAPS LEAD THE WAY -- STOCKS AND OIL REMAIN JOINED AT THE HIP -- SWISS FRANC DIVORCES THE EURO -- RISING COMMODITIES COULD BE INFLATIONARY IN 2011 -- DIAMOND BREAKOUT FORECAST $100 OIL -- LONG-TERM RATES CHALLENGE 20-YEAR DOWNTREND

SMALL AND MID-CAPS LEAD THE WAY IN 2010... Link for todays video. The last four months of 2010 witnessed some serious relative strength in small and mid-caps stocks. Chart 1 shows five key stock indices: the Russell 2000, S&P MidCap 400, Nasdaq, S&P 500 and S&P 100. With 2010 drawing to a close, there is little doubt that the Russell 2000 and S&P MidCap 400 will end up on top. Both are up over 25% year-to-date. The Nasdaq is the next closest competitor, but this key tech index is up less than 18% year-to-date. The S&P 500 and S&P 100, representing large-caps, are clearly the laggards here. In fact, gains in the Russell 2000 are twice those seen in the S&P 500 and S&P 100. Relative strength in small-caps and mid-caps is a good sign for the stock market. First, it shows a healthy appetite for risk. Small-caps represent the high-beta end of the stock market: more risk and more reward. Second, relative strength in small-caps bodes well for the domestic economy. Small-caps are less diversified internationally and more dependent on homegrown growth. Relative strength suggests strength in the economy as we head into 2011. Chartists should watch small-cap performance for future clues as well. Small-caps are like the canaries in the coal mine. They are the first to suffer should the economy or market start to sour. A broad market top would likely be preceded by relative weakness in small-caps.

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Chart 1

STOCKS AND OIL REMAIN JOINED AT THE HIP... Gold appears to be in its own bull market, but stocks and oil have moved together for much of 2010. Chart 2 shows year-to-date performance for five inter-market assets: stocks, oil, gold, the Dollar and bonds. Gold is by far the top performer of the five. Gold performance turned positive in March and remained positive the rest of the year (green line). Oil (red) and stocks (black) moved together throughout the year. Both declined in January, advanced in February-April, declined into May and rose from late August until December. Oil appears to be more concerned with stock market performance than the Dollar. Notice that Dollar performance (blue) bottomed in early November and turned positive in by mid November. With a bounce the last two months, the Dollar is back into positive performance territory for the year. Even though the Dollar rebounded, oil continued moving higher from early November until December. Oil seems to be taking its cue from stocks. Both stocks and oil moved from negative performance in late August to positive performance in late September. Both are up double digits year-to-date and showing leadership. Keep this relation in mind when watching oil in 2011.

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Chart 2

SWISS FRANC DIVORCES THE EURO... 2010 was not a good year for the Euro as the currency declined over 8%. However, 2010 did not mark the start of Euro weakness. Moreover, this weakness looks set to continue into 2011. Chart 3 shows the Euro Currency Trust (FXE) peaking in 2008 and zigzagging lower the last three years. The ETF started 2010 with a sharp decline that ended below 120 in June. Even though the summer-fall bounce was quite strong, it retraced 62% with an ABC corrective pattern. The retracement and the pattern are typical for bear market rallies. Further weakness in November pushed the ETF below trendline support and it looks like the downtrend is back in force. Watch resistance at 134 for a bullish breakout.

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Chart 3

Even though Switzerland is not part of the EU, the Swiss Franc tracked the Euro quite well the last few years. The indicator window on the chart above shows the Euro ETF (red) and the Swiss Franc (blue dotted). The Swissy moved in tandem with the Euro until the second half of 2010. Early in the year, the Swissy was plagued by problems with its banking system and proximity to the Euro. This changed mid year as the Swiss Franc started to seriously outperform the Euro. Chart 4 shows Swiss Franc Trust (FXF) forging a low in June and surging above its 2008-2009 highs. Most recently, the ETF formed a falling flag and broke flag resistance this month. Relative strength in the Swissy indicates that this currency has returned to its safe haven status, especially relative to the Euro. PerfChart 5 shows the year-to-date performance for 10 currency ETFs.

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Chart 4

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Chart 5

RISING COMMODITIES COULD BE INFLATIONARY IN 2011 ... Commodities were strong overall in 2010 with silver stealing the show as the top performer in 2010. PerfChart 6 shows year-to-date performance for eight commodities. The Gold SPDR (GLD) is up around 28% year-to-date and the Silver ETF (SLV) is up a whopping 78%. Clearly, silver outperformed gold in 2010. Copper, Lumber and Agriculture were also strong with all three gaining over 20% this year. Strength in copper and lumber points to increased demand from a strengthening economy. Strength in Agriculture could make its way down the food chain and lead to price increases at the grocery store.

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Chart 6

The long-term charts for gold and silver show nothing but uptrends. Chart 7 shows the Gold SPDR trading within a rising channel. Gold continues to benefit as a currency alternative and a possible hedge against future inflation. Commodity prices cannot rise forever without some inflationary pressures. In addition, the Fed and European Central Bank (ECB) are printing lots of money. Chart 8 shows the Silver Trust hitting the upper trendline of the rising channel. The ETF is overbought after a big run this year, but shows no signs of weakness. Note the inverse head-and-shoulders breakout in early September. This is a continuation head-and-shoulders pattern because it formed as a consolidation after an advance. The breakout signaled a continuation of the prior advance.

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Chart 7

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Chart 8

DIAMOND BREAKOUT FORECAST $100 OIL ... Even though oil did not perform as well as some of the other commodities, West Texas Intermediate ($WTIC) did break above its spring high and forged a 52-week high near yearend. Chart 9 shows $WTIC with a diamond consolidation and a breakout around 80. The height of the pattern is around 20 and this can be added to the breakout for a target around 100 (80 + 20). Also notice that the 62% retracement resides around 105. Given the uptrend in stocks and bullish pattern in oil, it looks like oil will hit triple digits in 2011. Broken resistance at 80 turns into support. A break below 80 would call for a reassessment.

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Chart 9

LONG-TERM RATES CHALLENGE 20-YEAR DOWNTREND... 2010 witnessed an important low in long-term interest rates, which corresponds to a top in bonds. Reasons very for the sudden bottom in rates vary and peak in bonds. First, strength in commodities could mean inflationary pressures in 2011. Second, the major equity indices are at multi-year highs and this points to robust economy. Third, the US deficit remains exceptionally large and this means more bond supply hitting the market. Speaking of bond supply, there are estimates that over $6.5 trillion in corporate debt will be maturing in 2011 and 2012. This debt will need to be rolled over, which means even more supply coming to market.

Chart 10 shows the 10-year Treasury Yield ($TNX) forging a higher low in October and surging above resistance in November. The 2009-2010 highs mark the next resistance zone around 40 (4%). Chart 11 shows the 30-year Treasury Yield ($TYX) forming a higher low around 3.5% and surging above 4% this year. A higher low and breakout signal the start of a long-term uptrend in rates. The next resistance zone is around 48 (4.8%). As chart 12 shows, a break above the 2008-2010 highs would reverse a 20+ year downtrend in long-term rates.

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Chart 10

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Chart 11

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Chart 12

HAPPY NEW YEAR... Wishing all of you a happy and prosperous 2011!

Chart 13