Market Correction Won't Be as Harsh as Expected

While stocks have rallied as much as 60% from the lows, where has all the money flowed to? Based on data from the Investment Company Institute, not to the stock market. While funds have been flowing out of money market mutual funds since March, they haven't been going to equity (domestic) or hybrid mutual funds. They have been going to bonds, which indicates how skeptical people have been of the stock market rally, in a world where people have suddenly favored low but stable returns and shunned risk.



But with the global governments pumping lots of money into the system in undprecedented fashion, could the investors' love for bonds implode on them as inflation eventually creeps up from behind? Dan Dorfman writes about a potential "$250 Billion Blunder" in bonds.

Meanwhile, with all the bearish pundits (who obviously also parked their funds in bonds or stayed in money market) calling for a 20% to 30% crash in the stock markets, one can wonder how equities can drop in that fashion when there aren't enough long positions to liquidate in the first place. For example, the bearish Mr. David Rosenberg presents his case about the overvaluation of equities. Of course, he's using trailing earnings.

While the market is short-term overbought, and I do believe a correction is coming, I would place more emphasis on the fact that most people still missed this rally. Thus the correction won't be as harsh as expected since there is nothing to sell. Check out my analysis of where the market is headed short-term.

Comments

[logicalthought:]

>>...one can wonder how equities can drop in that fashion when there aren't enough long positions to liquidate in the first place.<<

LOL... You're kidding, right? This statement makes absolutely no sense whatsoever, assuming that there are approximately the same number of shares in existence now as there were during the March lows (thereby making for the same number of "long positions"). In fact, I suspect that there may actually be MORE shares out there (and thus more "long positions"), as there have been few if any buy-backs while there has been lots of equity issuance. Meanwhile, what HAVE declined greatly are the short positions, so you can kiss that cushion goodbye.

Sep 24 07:20 AM

[Eco-RE-Market:]

(I do believe a correction is coming), of course, it is, most stocks are overvalued and skyrocked since the low March this year, for instances: BAC went up 8 times from its low, and LVS up 20 times. The question is, if the economy is actually getting better, why job lost still piled up and foreclosure (residential) still keep going, and (commercial) has just started. I strongly believe residential foreclosure won't stop until the end of 2012, base on 3 & 5 years ARM-LOAN when the market still HOT in 2007, and if the economy is actually getting better, why, the GOV has to extend another 13 weeks for those are out of un-employment benefit.

Sep 24 07:32 AM

[Roger Knights:]

"the bearish Mr. David Rosenberg presents his case about the overvaluation of equities. Of course, he's using trailing earnings."

Here's Rosenberg's analysis using forward earnings, from the recent SA article, "Double helping of the astute David Rosenberg," at seekingalpha.com/artic...

"Bullish analysts like to dismiss the actual earnings because they are “depressed” and include too many writeoffs, which of course will never occur again. Fine, on one-year forward (operating) earning estimates, the P/E ratio is now 15.7x, the highest it has been in nearly five years. At the peak of the S&P 500 in the last cycle — October 2007 — the forward P/E was 14.3x, and the highest it ever got in the last cycle was 15.4x. So hello? In just six short months, we have managed to take the multiple above the peak of the last cycle when the economic expansion was five years old, not five weeks old (and we may be a tad charitable on that assessment). As an aside, the forward multiple on the eve of the 1987 stock market collapse was 14x and one of the explanations for the steep correction was that equities were so overvalued and overbought that it was vulnerable to any shock (in that case, it came out of the U.S. dollar market). It certainly was not the economy because that sharp 30% slide took place even with an economy that was humming along at a 4.5% clip.

"In other words, valuation may not be the best timing device, but it still matters. If the S&P 500 was in a 700-750 range, de facto pricing in zero to 1% real GDP growth, we would certainly be interested in boosting our allocations towards equities. But at 1,060 and over 4.0% GDP growth effectively being discounted, we will be spectators as opposed to participants, understanding that the key to success is to NOT buy at the peaks."

Sep 24 07:42 AM

[bartpr:]

no one can analyze something that has not the ingredience presented yet of what the driving force of a correctin will be. looking back at the 2002 bottom, after a long move up of some 70%. the market made a 17% correction before moving higher. i am not saying this will repeat, but the conditions now are a lot worst than 2004.

fact. the long term bear market is known to be alive. stocks topped out in 2000. secular bear market can last more than 15 years. i believe the best that can be expected is a trading range until the mortgage defaults complete the worst of the downside. the economy and consumers will not be in any good codition until this occurs. 2010 and 11 are expected to bring more defaults to the table.

Sep 24 08:36 AM

[Terence Chan:]

I think we're looking at it from a different perspective. I'm not talking about the number of shares out there. You probably took it too literally. I'm talking about demand and supply of stocks. Few institutions were able to go long AFTER we bottomed in March, thus there was no NEW supply added to the system. New demand turns into new supply eventually, and demand wasn't there at the bottom. It's always like this at troughs. The demand will come in when it's too late and the market has rallied so much from the bottom. The OLD supply (the smart people who held their shares and didn't dump it in panic with the capitulation) distributed it on the way up in this rally. They won't wait and dump it at the peak because they know that the bid volume won't be there. The few who absorbed this old supply are stronger hands since they are probably ahead in their positions. They will buy more on the dips.


On Sep 24 07:20 AM logicalthought wrote:

> >>...one can wonder how equities can drop in that fashion when there
> aren't enough long positions to liquidate in the first place.<<<br/>
>
> LOL... You're kidding, right? This statement makes absolutely no
> sense whatsoever, assuming that there are approximately the same
> number of shares in existence now as there were during the March
> lows (thereby making for the same number of "long positions"). In
> fact, I suspect that there may actually be MORE shares out there
> (and thus more "long positions"), as there have been few if any buy-backs
> while there has been lots of equity issuance. Meanwhile, what HAVE
> declined greatly are the short positions, so you can kiss that cushion
> goodbye.

Sep 24 09:45 AM

[Terence Chan:]

When I say demand and supply, don't misunderstand me. It's not the actual amount of shares out there. It's the desire to buy (demand) or sell (supply) stocks. The mutual funds ($11 Tril in assets) flows shows not a lot of people didn't buy this rally then (put it in money market) and even now (put it in bonds). So where do you get new people with intentions to sell now? Institutions smart enough to buy the last few months won't flip it since they are still underweight equities and need to add their weightings. They will buy more.


On Sep 24 09:45 AM Terence Chan wrote:

> I think we're looking at it from a different perspective. I'm not
> talking about the number of shares out there. You probably took
> it too literally. I'm talking about demand and supply of stocks.
> Few institutions were able to go long AFTER we bottomed in March,
> thus there was no NEW supply added to the system. New demand turns
> into new supply eventually, and demand wasn't there at the bottom.
> It's always like this at troughs. The demand will come in when it's
> too late and the market has rallied so much from the bottom. The
> OLD supply (the smart people who held their shares and didn't dump
> it in panic with the capitulation) distributed it on the way up in
> this rally. They won't wait and dump it at the peak because they
> know that the bid volume won't be there. The few who absorbed this
> old supply are stronger hands since they are probably ahead in their
> positions. They will buy more on the dips.

Sep 24 10:02 AM

[Terence Chan:]

Sorry, "not a lot of people didn't buy this rally then" should be a lot of people didn't buy this rally then


On Sep 24 10:02 AM Terence Chan wrote:

> When I say demand and supply, don't misunderstand me. It's not the
> actual amount of shares out there. It's the desire to buy (demand)
> or sell (supply) stocks. The mutual funds ($11 Tril in assets) flows
> shows not a lot of people didn't buy this rally then (put it in money
> market) and even now (put it in bonds). So where do you get new
> people with intentions to sell now? Institutions smart enough to
> buy the last few months won't flip it since they are still underweight
> equities and need to add their weightings. They will buy more.<br/>

Sep 24 10:04 AM

[logicalthought:]

>>So where do you get new people with intentions to sell now?<<

What you get is a lot of people "back to even" (or almost back), who swore they'd sell there. However, I do understand that the "greed factor" can take over at that point, and some of those who swore they'd sell if stocks came back may, at that point, try to hold on. That's why I pay a lot of attention (from a contrary perspective) to sentiment, and sentiment has become increasingly bullish, with "the consensus" being that any correction will be a slight one. So, my guess is that we either don't get a correction until much higher levels (which I don't see happening, in light of the increasing bullishness out there), or we get one hell of a massive "correction" which, based on the fundamentals, takes us back to the 600s (12x $50 GAAP earnings, which is where I think earnings will be stuck for the next three years) or maybe as low as the 400s (10x $45 GAAP earnings). That said, I've only begun legging into my short positions recently, putting 10% into SDS in the S&P 1040s, with 10% more to come at around 1100 and 10% more at around 1150 (if we get there). Meanwhile, I'm around 30% long (in special situation pharma, non-correlative to the overall economy) and 70% in cash.


On Sep 24 10:02 AM Terence Chan wrote:

> When I say demand and supply, don't misunderstand me. It's not the
> actual amount of shares out there. It's the desire to buy (demand)
> or sell (supply) stocks. The mutual funds ($11 Tril in assets) flows
> shows not a lot of people didn't buy this rally then (put it in money
> market) and even now (put it in bonds). So where do you get new
> people with intentions to sell now? Institutions smart enough to
> buy the last few months won't flip it since they are still underweight
> equities and need to add their weightings. They will buy more.<br/>

Sep 24 12:41 PM

[thiazole:]

Consensus of any correction occurring isn't bullish.


On Sep 24 12:41 PM logicalthought wrote:


> That's why I pay a lot of attention (from a contrary perspective)
> to sentiment, and sentiment has become increasingly bullish, with
> "the consensus" being that any correction will be a slight one.

Sep 24 05:05 PM