2012: What You Need to Look For Before Your Next Buy…

This year should offer plenty of opportunities for traders and investors alike. We’ll take a look at this year’s potential in just a few seconds. After all, the new year is a time to better ourselves — usually resulting in ridiculously long waits for treadmills at your local gym. But as any fitness buff will tell you, the new faces become fewer and fewer as winter progresses. By March, many of the newcomers have already given up, returning once again to their normal routines, pledging to try again the next year.

The world of finance isn’t much different. Late December and early January is the only time of year when the financial media makes a serious attempt to look beyond the daily ups and downs of the market, instead offering serious-sounding predictions related to the fate of stocks, bonds and commodities. The predictions will be short lived. Rarely will we see a follow-up — and the regular programming of relentless play-by-plays and reports of daily market action will continue.

But right now, we can learn a lot by dissecting the 2012 forecasts. Of course, by this I do not mean following the consensus recommendations. Instead, we can use the analysis to give us a better feel of how sentiment might shape the market this year.

Bloomberg keeps track of forecasts from 12 top strategists, and notes that on average, these analysts are expecting the S&P 500 to rise to 1,348 by the end of this year. According to Bloomberg’s records, it’s the smallest predicted return in 7 years. A Morgan Stanley analyst with the most accurate 2011 prediction sees the market losing more than 7% in 2012, thanks to the continuing European debt crisis and high volatility.

Even professionals who possess a more bullish outlook — citing strong profits and positive economic data — say they are not encouraging clients to buy just yet. In fact, according to an Investment News survey, only a little more than 43% of financial advisers plan on increasing their clients’ exposure to U.S. stocks this year, compared to more than 63% who were looking to U.S. stocks for gains at the beginning of 2011.

By now, you should see how it’s all shaping up. The bears are obviously out of equities or short, while those making any sort of bullish argument are on the sidelines. Despite their bullishness, the optimists still feel that lower prices — and consequently, better entry points — are on the horizon. These attitudes certainly make sense right now. The market has battered bulls and bears alike since the August meltdown. At some level, everyone has been burned by this market, and no one is anxious to jump back in for fear of getting burned for a fourth or fifth time.

So what does it all mean? For now, we might see more of the same, choppy action we’ve come to expect. In fact, Tuesday’s action in the S&P looks a lot like other recent rallies: a strong push at the open, followed by a slow fade. Selling on strength could continue to dominate in the near future. But down the line, I see the possibility for a monster fear rally. What I mean by this is the possibility of one small spark igniting a buying frenzy…

The ingredients are already in place: Big money is underexposed to the long side and corporate profits have been strong. If the S&P can manage a convincing move higher, we could see panic buying form those worried that they could be missing out on a big move. That’s the kind of action that can jump start a significant push higher.

Of course, this scenario is not set in stone. Furthermore, it is not wise to take a contrarian position just because it exists (in our example, the potential for going long in anticipation of a panic-buying rally). There has to be a tipping point of sorts — when the consensus opinion becomes so overwhelmingly bearish that there is no one left to extend the downward trend. A small rally creates short covering, then short-squeezes, which lead to bigger rallies, snowballing into a significant upside move. Look back no further than the early October 2011 bottom for a perfect example:

Discovering this inflection point is a nuanced game at best. And for the record, I don’t think we’re near this point just yet. Look at the recent upside breakout in the S&P. While stocks aren’t totally in the clear just yet, we are seeing a few moves in the right direction. Yes, deficit politics and the eurozone will still play a large role in the market’s direction and volatility for the time being.

But I will be looking for signs of a potential rally in the near future.

In these market conditions, we cannot risk anticipating big moves like the scenario I’ve explained above. We simply have to be ready to react once the market gives us the signal — and the S&P breaking above its October highs would be a satisfactory start.