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The S&P 500 hit an intraday all-time high of 1687 early on Wednesday and then dropped 2%, closing down 0.83% for the day. This is what technicians call an "outside day down" or "bearish engulfing" and looks to be the start of a long-awaited correction. This may sound like technical mumbo-jumbo for long-term fundamental investors, but it was enough to move me to lower equity exposure, as I describe below. For those who want a visual depiction of this wake-up call, here it is for the S&P 500 SPDR (NYSEARCA:SPY):

(click to enlarge)

The market opened a bit higher, ran up and reversed, culminating a one-month move up with hardly a down day and continual closes above the 10-day moving average (the blue line above). Thursday and Friday both opened lower and traded up during the day but were unable to close positively. We also saw the 10-year Treasury move above 2% for the first time in two months and a sharp move down in the previously soaring Japanese stock market on Thursday.

I have been bullish since late 2009. I shared my positive outlook for 2013 in early January when I suggested that the jump to start the year was real:

Some of you may be wondering why I haven't yet shared my official full-year forecast for the S&P 500. I decided after missing it the last two years (1500 for 2011 and 1600 for 2012) to put away the crystal ball. I do have a forecast that I shared on my Invest By Model blog in December: 1664. I base this on ending the year at 14.5 PE on a forward basis (this implies a 2014 EPS estimate of almost $115). It's not worth an article, but I wanted to share this in case anyone actually cares. If I had to guess, my forecast this year will be wrong again, except too conservative rather than too aggressive. In any event, I wish everyone good luck this year.

The market cleared my year-end target level this week. While I expect that we could move higher later this year, I want to see signs of the fundamentals improving. The rally of 16% or so this year has been primarily PE expansion. It would be easier to embrace this market if earnings estimates were rising, but they aren't. At the beginning of the year, I viewed technicals positively, fundamentals neutral and valuation positively. At this point, I view technicals negatively, fundamentals still neutral, but valuation neutral too. Adding this up, I am somewhat negative.

Before I share my expectations, I want to present an update to a chart that many readers appreciated when I was discussing what I described as "new seasonals" earlier this year. The chart is a running return by week over the past four years:

(click to enlarge)

All four years have started positively. 2010 dipped after starting in the green, but this was following a huge rally in 2009. The other three years stayed positive through the first quarter, while 2012 never went negative during the year. It's unusual that the market doesn't trade in the red at some point during the year. Will this happen twice in a row?

The rally this year has lasted the longest. With one week to go, May is still positive and will mark the sixth consecutive monthly increase (including dividends) as long as we close above 1595. Runs like this are rare! Even with the slight retrenchment last week, SPY is still 11.3% above the 200-day moving average.

It's always difficult to tell what lies ahead. I surely have no crystal ball. The market corrected in 2010 with a flash crash that no one anticipated. The rout in 2011 followed trouble in Europe and then our own failure to increase the debt limit. If I had to guess what may trouble the market this year, it's interest rates. As I explained a couple of weeks ago when I suggested that the end of QE isn't the end of the bull market, I don't think that this is a long-term issue - the market is not pricing in rates this low indefinitely. Still, the knee-jerk reaction to rising rates will be to sell stocks. Keep an eye on the 10-year Treasury, as it is moving higher. It probably doesn't help that Bernanke's likely retirement in early 2014 could add some uncertainty about monetary policy.

When the market took off following the April employment report (May 3rd), it blasted through 1600 and never looked back. I expect at a minimum that we will retrace to fill that gap, but I am targeting the 1530-1570 area. At the low-end this would be a 9.3% move lower from the all-time high. We started the year at 1426, so 1550, the mid-point of my range, would be about a 50% retracement. Perhaps a better way to look at is to consider the move from the lows of November last year (1343). This marked the bottom of a correction from September 14th's peak of 1474.51 (9%). We rallied almost 26% since then. My range covers a retracement of 34-45% of this rally and suggests giving up about 1/2 the 2013 gains thus far, but it could certainly be worse. A 50% retracement of the move from November would leave us at 1515. A 2011-style move of 20% would put us below the year-end close of 1426 at 1350, just above the November lows.

My negative near-term view on the market has led me to reduce equity exposure in my model portfolios at Invest By Model where I am able. My Top 20 model portfolio doesn't have a market-timing component, but my Conservative Growth/Balanced and Sector Selector ETF models do. The former has a benchmark of 60% stocks and 40% bonds and requires a minimum of 45% stocks and 10% bonds. We have been sitting at the minimum on bonds for some time now and have been reducing the stocks over the past few months, and, after Thursday, are now 45% cash (the max). The ETF model went from 2% cash to 22% cash on Thursday as well (it has a 25% cash maximum). I don't use options strategies, but implied-volatility is low, which means buying puts may be prudent.

Market-timing is quite tough. Being successful requires not one but two correct calls (out and then back in). I am actually more a "trees" than "forest" type of investor and don't typically make these types of deviations, but I am expecting some turbulence ahead. Truth be told, the pullbacks in 2010 and 2011 far exceeded my projections, so my call for a 9% or so pullback here could also miss the mark. What do you think: Is this the long-awaited correction?

Source: Why This Long-Time Bull Is Moving To The Sidelines