Friday, February 25, 2011

Are We Finally Getting a Meaningful Correction?

For the past several weeks, we’ve been intending to boost risk exposures in our portfolios. In our view, the cyclical backdrop has been steadily improving (notwithstanding current geopolitical concerns), which should continue to be supportive of equities for the next few months, at least. However, given the market’s surge since late November, we’ve been patiently (some might say “wrongly”) waiting for a correction that would alleviate some of the growing bullishness in the market. As is often the case, the market has refused to cooperate for the most part as it keeps grinding higher, up until this week. The spreading turmoil in the Middle East has been driving commodity markets higher, which finally captured the stock market’s attention as oil prices breached the $100/barrel threshold.

Now, we find ourselves in a similar place as late January, when I last wrote an entry about a possible correction forming. Before today, the S&P 500 was down almost 3% from its recent closing high. Since the market has been routinely shaking off brief setbacks lately, we’ve been wondering, once again, if that was it.

According to data from Ned Davis Research, a 5% correction in the S&P 500 Index has historically occurred every 50 days, on average. In secular bear markets (which we believe we’re still in), they occur every 32 days on average. Through yesterday, it’s now been 126 days since the last 5% correction, which occurred last August when the S&P fell by 7%. In short, we’re “overdue.” But, back to that whole market not cooperating thing, there have been periods much longer than this between 5% corrections in the past, too. So while we have reason to believe the market is due for a deeper decline (despite today’s rebound), we need to be prepared for the fact that this market may continue its impressive (or, frustrating for waiting dip buyers like us) resilience.