Deep down, every investor is an artist. Your portfolio tools are your paintbrushes and the next trading day or trading year is the blank canvas. Artists will tell you that the first few strokes are the toughest as they set the stage for the entire painting.

The same is true for investors. The New Year is often viewed as a clean slate. If you start the New Year off on the wrong foot, you are under pressure to catch up for the remainder of the year. A good start, however, will give you the freedom to express your investment ideas freely and provide much needed confidence.

Thursday’s (12-31-09) last hour drop prevented the major indexes from closing the year on a high note. Up until then, however, everything has been viewed through the proverbial pink glasses. For those with short-term memory loss, keep in mind, rose-colored vision spells trouble ahead.

Lesson #1: Don’t be gullible – dare to be a contrarian

The forecasts given by Wall Street’s expert, polled by Bloomberg, are exclusively positive. Most will view this as a positive sign. But before you too come to this conclusion, make sure to read on.

Bloomberg reported on December 14th 2009 that Wall Street strategists expect the S&P 500 (SNP: ^GSPC) to rally 11% in 2010 with a year-end 2010 target of S&P 1,223. Earnings for the S&P 500 companies are expected to jump 23% to $73.69 a share. JP Morgan’s analyst recommends buying technology (NYSEArca: XLK) and materials stocks (NYSEArca: XLB) with a year-end S&P target of 1,300.

To draw some much needed perspective, we’ve decided to republish excerpts from a global economic forecast given by one of the most prestigious brokerage houses on Wall Street. Take a guess at when it was given and by whom:

“The global economy will continue to grow with no sign of a significant cyclical slowdown.”

Believe it or not, this forecast was given by Merrill Lynch on June 8th, 2007. At the time, the Dow Jones (DJI: ^DJI) was within 10% of its all-time high. The forecast obviously was too bullish and failed to predict their demise.

Similar to the months leading up to the 2007 all-time highs, the last few months have literally lulled investors to sleep. With no correction deeper than a few percent, bearish investors and advisors have nearly become extinct.

Bearish investment advisors and newsletter writers tracked by Investors Intelligence have reached a 22-year low of 15.6%. Bearish individual investors, tracked by the American Association for Individual Investors, have dropped to 23%, the lowest reading in about four years.

As the chart below shows; the year-end 2009 sentiment somewhat parallels the year-end 2008 sentiment. On December 14th, 2008, the ETF Profit Strategy Newsletter noted the following: “Optimistic sentiment, which should be more visible above Dow 9,000, will give way to further declines. These should draw the indexes close to or below Dow 6,700.”

Investor sentiment, along with the Dow, did spike in late December/early January. After hovering around 9,000 for a few days, the Dow plummeted 30% in 60 days.

If you believe the analysts that are calling for a 10 – 20% rally in 2010, you may want to compare their advice during 2007 before the top, or in March 2009 at the bottom. Odds are they assisted your entry into and out of stocks at the worst of times.

Lesson #2: Trust the hard facts, not your feelings

The Dow Jones, S&P 500 and Nasdaq (Nasdaq: ^IXIC) are the most commonly referred to U.S. stock indexes. To get a true reading of the composite U.S. stock market, however, it helps to sometimes take a look at the DJ US Total Stock Market Index (DJI: ^DWC), formerly known as Wilshire 5000 Index.

ETFs tracking this index include the iShares Dow Jones Total Market Index Fund (NYSEArca: IYY), SPDR Dow Jones Total Market ETF (NYSEArca: TMW), and by extension the Vanguard Total Stock Market ETF (NYSEArca: VTI).

From its March lows to October 15th, 2009, the DJ US Total Stock Market Index gained 4415 points. Since then, it climbed only 183 points. This belabored 183-point move, however, has had a profound effect on investor’s psyche.

Over that period of time, the Volatility Index (Chicago Options: ^VIX) has worked itself down to a 70-week low. The percentage of bullish advisors has reached levels not seen since 2007, while bearish advisors have become more extinct than in any other time over the past 22 years. The chart below shows this confluence of indicators plotted against the Wilshire 5000 Index. The saying, “the calm before the storm” has just received a whole new meaning.

Lesson #3: Bailouts work, or do they?

The government’s bailouts are commonly credited with sparking the rally from the March lows. If that is the case, why did stocks tumble after the initial $700 billion bailout package in October 2008 or the second $787 billion package in February 2009?

The Fed’s announcement to buy up to $1.2 trillion worth of its own bonds did not come until March 18th, 2009. Treasury Secretary Geithner’s Public Private Investment Program (PPIP) was not announced before March 23rd and the bank stress test results didn’t become public until May.

On March 23rd, the Dow soared 496 points, allegedly because of the PPIP. Sure, the government stimulus plans infused some much needed confidence into the market, but they certainly were not the only catalyst to send stocks soaring.

In the midst of the doomsday atmosphere, the ETF Profit Strategy Newsletter sent out a Trend Change Alert on March 2nd, recommending to load up on short and leveraged ETFs – in particular financial ETFs such as the Financial Select Sector SPDRs (NYSEArca: XLF), Ultra Financial ProShares (NYSEArca: UYG), and dividend rich ETFs with exposure to the financial sector such as the iShares Dow Jones Select Dividend ETF (NYSEArca: DVY) or SPDR Dividend ETF (NYSEArca: SDY).

The market did not bottom because of the government-induced money injection; it bottomed simply because it had fallen too far too fast. After an 18-month meltdown, stocks were oversold and investors were overly pessimistic. This is the kind of stuff bottoms are made of.

The opposite is the case today. Just as extreme investor pessimism offered an incredible buying opportunity in March 2009, extreme optimism is likely to enter the books as a selling opportunity of historic proportions.

Stuck in a rut, why?

As mentioned above, the Dow Jones, S&P 500, the Dow Jones Total Market Index, and by extension the Nasdaq have been stuck in a tight trading range for almost two months. Such range-bound trading is unique and to some degree even obscure. The January issue of the ETF Profit Strategy Newsletter explains why it would make sense for the indexes to be stuck right there.

Since September, the newsletter has highlighted S&P 1,120 - 1,125 as the potential stopping point for this rally. S&P 1,120 equals the 50% Fibonacci retracement. This means, at 1,120, the S&P 500 retraced 50% of the points lost in the 2007 – 2009 declines. The Dow Jones also has been stuck at the 52% Fibonacci retracement level.

During the 1929 – 1930 bear market rally, the Dow Jones retraced exactly 52% of the previously lost points before continuing its relentless decline.

Additionally, the Dow Jones and S&P 500 have been confined to a narrow trading range outlined by the 500-day and 2000-day moving averages. In fact, the 500-day MA has crossed below the 2000-day MA for the first time since 1982 and continues to slide lower (detailed chart analysis is available in the January issue of the ETF Profit Strategy Newsletter).

Conclusion

There is a misconception that the lack of volume which has accompanied December’s trading is seasonal and normal. A comparison with December 2008, however, shows that the average daily volume for 2009 was 22% lower than the average daily trading volume for December 2008.

Chances are that higher January volume will lead to higher volatility (perhaps even another short spike up) and ultimately lower prices. This at least is the message conveyed by investor sentiment and long-term valuation metrics, which are in deeply overvalued territory.

How low can the market go? The ETF Profit Strategy Newsletter provides a target range for the ultimate market bottom along with precise short, mid, and long-term forecasts for the major asset classes.

Thus far, the 2010 canvas is still clean and unblemished. Will your first strokes be that of genius or strokes you wish you could erase? More importantly, how will your portfolio look at the end of the year and at the beginning of your retirement?