Has Anybody Seen the Correction?

There was a suggestion by one of the Fed district presidents last Tuesday that higher interest rates “might” come sooner than expected, moving the market lower as the traders ran for the exits. That was forgotten on Wednesday when we had the release of the minutes of the most recent Fed Open Market Committee meeting. The notes showed that it was determined that a mix of Fed tools is likely needed to “normalize” rates.

Normalize means the further winding down of the bond buying associate with quantitative easing and the raising of short-term interest rates – with no hint of earlier than expected action. With that news, the market made up all it had lost and more. Matter of fact, Friday saw the S&P500 setting a new all-time closing high.

The correction anticipation crowd

First, for the record, a market correction is defined as a drop of 10 to 20 percent from its recent high. Next, we haven’t had one for quite some time. Therefore, many more are now suggesting that such an event MUST be coming soon. Apparently, simply because we haven’t had one…

This crowd has been calling for / anticipating / needing (?) a correction pretty much since the bull first started running. Members of this crowd currently include such folks as Peter Bookvar, Ralph Acampora, Marc Faber and others. (Dennis Gartman, who has been one of the major voices calling for a correction, now says he’s been “abundantly wrong” in having done so and that he is “probably going to be wrong continuing to expect one.”)

These guys are saying – have said – that the drop could be from 20 to 25 percent. Please note that, while the drops suggested are significant, none of them are saying that this is the beginning of a bear market with its consistently overall downward trend.

Corrections are relatively short-term in how they affect the market so these guys seem to be pumping up something (a correction) that really has little long-term significance.

I think the reality is that no one knows exactly how the markets will react once rates do start moving up. While that’s not imminent, at some point, we’ll have to rely on fundamentals to determine values – as we have always done – and, for now, the fundamentals continue to improve. In the meantime, there’s a lot of backing-and-forthing going on as traders and investors try to position themselves for this evolution.

Stealth correction

Seems to me that we actually may have been correcting over these past few months. The high-growth, momentum and small cap stocks have all been beaten up during this time. In reality, the rest of the market has been mostly sideways. Sure, we’ve established new highs in the Dow and the S&P but not with huge momentum driving them forward as we saw in the late 90s. As Paul Hickey, co-founder of the research firm Bespoke said last week, “…it seems that, instead of having a correction in price, it’s (the market) having a correction in time.” I think Mr. Hickey is on to something here.

Dr. Ed says…

Dr. Ed Yardeni, a long-time, highly regarded independent market strategist, says that, “…lots of stocks are down 10 to 20 percent since March.” His take is that many institutional investors and hedge funds have been rebalancing their portfolios away from high P/E to low P/E stocks, to stocks with predictable earnings and from growth to value. They’re doing this, in his opinion, to avoid having to give back the gains from last year’s rally. This makes a great deal of sense to me.

Regarding the corrections we went through from 2010 to 2012, he said those were caused by big economic events/concerns that each could have led to a recession. Once we got past that concern, the markets followed the corrections with relief rallies.

Right now, I don’t see any such major concerns out there.

The big picture

If/when a correction comes, the human though not necessarily rational response will have many investors wanting to get out. It doesn’t really make sense to do so because you don’t know when, where or why a correction will end. You can know that there will be an end which, in all my experience and study, has led to the markets resuming their upward trend.

If you do get out, just make dang sure you have a plan to get back in – and stick with it. I strongly recommend against because it doesn’t make sense to liquidate a portfolio designed to serve a lifetime just because of some market blip. You think 20 percent isn’t a blip? Try and find one on even a 10 year market trend chart…

Unless you plan on spending the money in the shorter term, I see no reason to vary from a long-term strategy of staying with stocks. Bonds have done very well this year, to be sure. However, along with the small caps and many social media companies, bonds remain expensive. If – and when – rates rise even a little, with interest rates as low as they are now making them even more sensitive, the recent gains in bonds and bond funds will go away pretty fast.

Cheers!

Mike

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