Editor’s note:

• This is the third yearly outlook report by Doctor Duarte.  For his previous reports visit http://www.financialsense.com/editorials/duarte/2004/1231.html.

• For all of Dr. Duarte’s Financial Sense.com editorials visit: http://www.financialsense.com/editorials/duarte/main.htm.

This report originally appeared on Joe-Duarte.com on 1/-3/06. It was posted at 6:15 Central Time.

2006 will be a year of further fragmentation, as established powers, such as the United States will have to fight rising regional powers who are trying to reassert their influence over their former strongholds.

It could also be a year where expecting the unexpected is likely to be the rule, not the exception, as politicians and corporate leaders all over the world will be setting out to get things done, always a reason to be extra alert as a trader.

Areas of major interest are likely to be Eastern Europe and its relationship with Russia, Iraq, Iran, Syria, and Latin America.

Southeast Asia will continue to be an area where Japan and China continue to vie for increasing influence, with Taiwan still a key cog in the political machinations of the region.

Last year, in our Predictions For 2005 column we called 2005 a year of reckoning, noting that 2005 would be a year “in which 2004’s scores are settled, and loose ends are tied,” adding that “score settling and loose end tying usually foster retribution,” and that any gains were likely to be temporary.

And that’s just about what we got, as the Post 9/11 era continued to evolve into increased regionalism, and the contraction of globalization.

The biggest surprise? How about President Bush ending the year in fairly good shape, and Iraq showing significant improvement. The odds on both are now 50/50, which is more than anyone had thought possible. Would we take this bet? No, but, it’s so much out of the mainstream that we couldn’t resist.

Stocks And Other Markets

Expect the unexpected. The second year of the Presidential Cycle is usually just as rough -and- tumble as the first. But, with a new Fed Chief coming in, and a mid-term election looming, anything is possible. By March, we should have a good idea as to what the first half of the year will be like. If things follow the norm, by December we could be in rally mode.

Last year, for stocks, we suggested that “expectations should be tempered,” and we predicted “mostly sideways action throughout the year,” while noting that “timing strategies, sector, and individual stock selection, “were “likely to be the only real way to make money in this market.”

We liked drug, biotech, oil, and oil service stocks, and we predicted a fall in international markets, if the dollar strengthened.

This year we still like drugs and biotech. Gold and oil will also likely provide excellent trading opportunities, especially for traders who are comfortable with going both long and short.

Look for ample trading opportunities in the currency and commodity markets once again. This could be a significant year for gold and oil. If the commodities reverse 2005’s gains, short selling profits could be the big surprise of the year in these markets.

In the currency markets, watch for developments on the Yuan from China, as a faster than expected move toward convertibility and market pricing of the Chinese currency would be a major surprise.

Drug and biotech should have decent years. Gold and energy stocks will also figure heavily.

Also look for interesting developments in Fallen Angel stocks.

International stock market will be going for two bullish years in a row.

U.S. Traders will likely make major decisions in the period near the mid-term elections in the U.S.

Interest Rates

Last year, we predicted that the Fed would pause in its rate increase cycle.

We sure got this one wrong. And this year, we’re not sure as to what’s possible, given the change of helm at the Fed, with Greenspan bowing out and Bernanke taking over.

Oil And Natural Gas

Last year, we noted three things with regards to this sector:

1) Much depends what happens to crude oil at the $40 area, and whether Al-Qaeda can actually do major damage to a significant oil installation.
2) What Russia does after its de facto nationalization of Yugansk, and Putin’s maneuvering to keep the U.S. at bay.
3) Weather, especially hurricane season damage, and the extent to which winter is actually cold or not so cold will also be an important factor.

This year, we would expect much the same thing. Russia started off 2006 with a bang, as it shut off natural gas deliveries to Ukraine, and by default reduced the flow to much of Eastern Europe, setting a nasty precedent, just as a major winter storm was making itself felt in Europe.

Most important will be the world’s reaction to OPEC, Russia, and any energy producer who tries to politicize supplies.

Geopolitics

Iraq And Iran Are Central

Last year we wrote: “Iraq will be the axis again. Successful elections, a significant decrease of insurgent activity, and a push in the actual rebuilding of the country are the goals of the U.S. and the interim Iraqi government. What they might get is a Shiite dominated government, followed by a savage crackdown on the insurgents by the Shiites, and the potential for some international conflict between Iraq, Iran, and Syria.”

This year, it’s more of the same. The U.S. is trying to slowly withdraw troops, and financial support, as rebuilding funds have been withdrawn from the budget to be submitted by the White House to Congress.

The key to Iraq is whether the new Iraqi government can decrease the influence of the Sunni insurgence, which is increasingly more important in its ability to cause trouble than the more publicized Al-Qaeda cells. There is a steady flow of information that suggests that Al-Qaeda is not as important a factor in the insurgency in Iraq, as it was earlier in the conflict.

Last year, we said: “The nasty surprises of the year could come from China, Africa, and Iran.“

Make it Iran, Iran, and Iran for 2006, as Iran’s president, Mahmoud Ahmadinejad continues to make anti-Israel statements, and Iran continues to work on what many in the international community are taking for a nuclear weapons program.

China will likely have a make or break year, as their banking sector will have to conform to the terms of the World Trade Organization agreement. The key is whether domestic savings move to foreign banks in large enough amounts to cause Chinese banks with no foreign partners to fold. If this happens, and enough money disappears, social unrest is possible.

Last year we wrote: “The Democrats will try to find something on Bush and the Republicans that could turn into a scandal. Watch for Rep. Henry Waxman to dig up the mud.”

We could have substituted Senator Charles Schumer for Waxman, but the story was the same, although the White House got caught by lots of leaks in 2005. Look for the wiretap story to work its way through the circuit. If there are any connections to the election made, we could see things escalate into a Watergate type scenario.

Last year we wrote: “Hugo Chavez and Fidel Castro are up to something. And it can’t be any good for the U.S.”

And yes, we got this right. Chavez continued to expand his influence in Latin America. The strategy as the year ended was to use petrodollars to buy Latin American government debt, especially Argentina’s debt. Chavez is also paying off Venezuela’s loans to the IMF early.

Look for allegations of Chavez and Castro trying to influence the Mexican election in the summer.

Conclusion

2006 will be a very high stakes year for world leaders, so we can expect them all to pull out all the stops, leading to a very intense year of political developments, which means that the markets are likely to very lively.