That we are having a correction is not very surprising. The current bull market rally started in March, and is up by a whopping 73% since then (using the S&P 500 Index). Meanwhile, the worst correction we’ve had so far was about -6.5% over several weeks last June. Throughout the rally we’ve watched credit markets stabilize, many measures of domestic and global growth have rebounded, and earnings have surpassed overly pessimistic forecasts of Wall Street analysts. In addition, valuation has gone from cheap to slightly expensive, many shorter-term technical measures have gotten extended, and sentiment has shifted from too gloomy to quite complacent.
Investors are logically wondering if the market rally is over, or if it’s just a long overdue correction that will eventually be resolved by another leg higher. We’re currently siding with the latter. But we can’t allow ourselves to grow complacent, and as this correction unfolds we’ll be monitoring certain things. Specifically, we’ll be looking for credit spreads to stay contained, we’ll be watching the number of new 52-week lows in stocks, and we’ll be scrutinizing the economic data and fourth quarter earnings reports. We'll also be watching intently to see if technical damage from the decline begins to damage the positive longer-term trend that's currently in place. Should the weight of the evidence take a turn for the worse, then we’re prepared to change our view and alter portfolio allocations materially.
No one can ever know precisely whether a sudden decline is merely a short-term pullback, or something worse. But right now the weight of the evidence indicates that this is probably just an overdue correction within the current bull market. Stay tuned…
