What goes into formulating a stock market outlook for the year ahead? I think the biggest element is defining the expectations as set by the mass media, which in turn influence the buy and sell decisions that investors have already made. This in turn tends to swing the crowd to an extreme of either too much fear or an overriding complacency. So where are we now?

Here's my take on several key factors that will affect stocks in 2006:

1. Energy Prices - Certainly the rise in energy prices in 2004 and 2005 put a drain on the economy, as discretionary dollars from consumers were eaten up at the gasoline pump. The driving factors sparking higher fuel costs include the massive 9% annual growth rate in China, which appears to us to show no signs of slowing down. Supply concerns peaked in the fall of 2005 with the two hurricanes, though refining capacity remains maxed out with no new refineries coming online in the last three decades. We expect energy prices will rise again in 2006, but at a slower rate. We're expecting a slow rise back up to the $65 per barrel area by year end 2006. This should lead to solid if not spectacular gains in oil and oil service stocks. At the same time, the rest of the stock market should again be constrained by relatively high fuel costs.

2. Interest Rates - For the longest time, pundits have been predicting higher interest rates. While the Fed did raise short-term interest rates persistently in the past 18 months, the long-term interest rate on 30 year bonds actually dipped slightly in 2005. However, as the yield curve is now showing signs of inversion, with yields on the 2-year note slightly greater than yields on the 10-year note, this is historically a precursor to a slowing economy with a 50-50 shot at a recession. When combined with the increasing inflationary factors of high energy prices and multi-year highs in gold prices, this paints a less-than-rosy outlook for the economy. The prospects for "stagflation" with slowing growth amid increasing inflation take us back to the early 1970's, in which another fuel crisis sparked a nasty bear market for stocks in 1973-74.  We rate the odds of such a severe bear market as relatively low this time, but the key to watch is how high interest rates can go. A move over 5.0% on the 30 year bond would be very bearish but we can't see inflation getting too far out of control amid an economic slowdown. So we expect a slow rise in rates that the stock market can adjust to and not cause any major dislocation.

3. Leadership - The two stocks that have been impervious to a choppy market in the last couple of years, Apple Computer (AAPL) and Google (GOOG), are now both risky in our view. Both stock have been subject to national magazine cover stories in the past 4-8 weeks, which often means that expectations have now been dramatically raised for these two market leaders. Watch how these stocks react in early 2006, as early selling pressure would suggest that investors are starting to lock in their gains as the new tax year hits. There will be new leadership to emerge in 2006, with the energy sector still holding the most stable ground for steady earnings gains. In particular, the natural gas sector looks most promising to us. In addition, we like high dividend paying stocks in general, like Canadian energy trusts and tobacco stocks, where total return should continue to produce double digit returns in a single digit year.

Price Headley is the founder and chief analyst of BigTrends.com.