Friday, January 21, 2011

Was That It?

We’ve been anticipating a correction in the stock market for a couple of weeks, mostly due to signs that the market is overbought and investors have become too bullish in the short-term. Over the past two days, it seemed like maybe a correction was materializing, as the S&P 500 dropped by -1.1%, and the Russell 2000 Index fell by -3.5%. However, today the market is a little higher, so that leaves us wondering, was that it?

We don’t think so. Although the last market selloff was very shallow (the -4% S&P decline in November), we felt coming into this year that the market was probably overdue for a bit of a steeper decline that could carry the S&P down to around its 200-day moving average (blue line in chart below), which would be about -10%. Again, this was largely due to the fact that some signs of optimism are higher than they were last April, just before the market plunged by -17%. We don’t expect that there’s going to be a replay of last spring, but we don’t think a minimal, 2-day pullback is enough to clear the current overbought, over-bullish conditions.