Stocks May Not Fully Correct Until 2010

Common sense and prudence say stocks must experience a significant correction soon. Unfortunately, waiting for a correction to participate in the current stock rally has proved highly frustrating for many market participants. While it may not be what investors sitting on large cash positions want to hear, market history says a significant correction in stocks may not occur until 2010. Understanding and respecting that each individual needs to make their own decisions relative to market entry points, an open-minded review of the historical cases presented below may allow some to be more receptive to the possibility of bullish and correction-less outcomes for several more months. How things unfold in the coming months remains to be seen, but thus far the current rally has followed the new bull market script very closely.

In the context of an established and on-going bull market, it is common for traders and value investors to look for a pullback toward the 200-day moving average (red line in chart above) as a logical entry point for new purchases. What may be frustrating them in the current environment is that new bull markets, especially after significant bear markets, may not correct back toward the 200-day for an extended period of time. As shown in Table 1, in four similar instances, a significant pullback did not occur on average until 270 calendar days after the original cross of the 200-day moving average.

Table 2 uses the S&P 500’s July 10, 2009 cross of the 200-day to estimate hypothetically when a pullback might begin, assuming the market behaves in a similar manner relative to history. A typical path in 2009-2010 may not produce a significant pullback toward the 200-day until the spring of 2010.

More detail on this study and similar studies can be found in the September/October 2009 - Asset Class Outlook, which is available for download. Page 20 of the Asset Class Outlook covers "Monitoring The Health Of The Bull - Red Flags", which acknowledges the risks associated with blind investments in the current environment. Many problems remain.

Sometimes being able to see concepts illustrated on a chart can help us in our decision-making process. The following charts show how long new bull markets stayed above their 200-day moving average before beginning a significant correction back toward the 200-day (shown in red).

Possible Psychology Behind The Charts: It is important to recognize that the historical charts above represent shifts in the mass psychology of investors. If we can step outside ourselves in the current environment and examine our own thoughts, we may find that they are very similar to those of the majority of market participants. As slowly as stocks have continued to move higher in 2009, more and more market participants have accepted the possibility of a new and sustainable bull market, even if it only represents a shorter-term or cyclical bull market. However, many of the market participants who have now accepted the new bull remain largely on the sidelines in cash – waiting for a correction to enter. What most likely happened in the historical cases above, and is happening again in 2009, is that corrections are short-lived since many are looking for any glimmer of a correction to enter the market. When the corrections do not last, many buy fearing they are being left behind. The fear of being left behind will increase greatly for professional money managers should the rally remain intact through year-end.

Cyclical Bulls Can Last A While: Since numerous structural and fundamental problems remain, it is likely that the current bull market does not represent the early stages of a secular, or long-term, bull market. However, as outlined in the passage from the September 16, 2009 Los Angeles Times, waiting out a cyclical bull may be more frustrating than many believe:

Buyers are finding plenty to like: Rising stocks have outnumbered losers by more than 2 to 1 on the New York Stock Exchange in seven of the last eight sessions. That encourages bulls like Ned Davis Research, a well-known market research firm in Venice, Fla. that correctly called the rally earlier this year and has maintained the view that stocks are going higher. "So much money has been sitting on the sidelines and now is looking for a place to go" as confidence in a recovery rises, said Tim Hayes, the firm’s chief investment strategist. Ned Davis believes this is a "cyclical" bull market within a longer-term, or "secular," bear market. But given the firm's forecast for the S&P 500 to peak sometime in 2010 in the range of 1,200 to 1,300, it makes no sense to sit out the cyclical rebound, Hayes said.

When decisions are driven partly by the fear of being left behind, they may not appear to be prudent or based on common sense. Corrections tend not to occur in the early stages of a new bull market because there is so much cash looking for an opportunity to enter. Until cash positions move closer to bull market norms, which is not the case today, stocks may continue to surprise on the upside.

Above are excerpts taken from the September/October 2009 - Asset Class Outlook, which is available for download. The comments above and those in the outlook are intended for CCM clients, and thus investments or strategies described may be inappropriate for some investors based on their own individual situation and risk tolerance.

Disclosure: The author and CCM clients have numerous positions, including exposure to U.S. tech stocks, foreign currencies (long and short), emerging market stocks, foreign bonds, and commodities.

Comments

[Tony Petroski:]

The bull case. I expect you may be right.

You described "investors sitting on large cash positions." That's my goal. How can I get it?

Oct 01 09:53 AM

[Sold out:]

Become a bankster.


On Oct 01 09:53 AM Tony Petroski wrote:

> The bull case. I expect you may be right.
>
> You described "investors sitting on large cash positions." That's
> my goal. How can I get it?

Oct 01 10:34 AM

[MarvinMBA:]

Certainly this is a frustrating market. Sit with the alternate currency, silver and gold is my best advice as the money printing continues. MarvinMBA

Oct 01 10:38 AM

[d8473572:]

If Chris is correct, what is likely is that the market will go down in the second quarter of next year. The old "sell in May and go away" may again apply. If you followed that this year, you missed a big run up. Next year it is likely to apply again.

d.

Oct 01 10:50 AM

[Chris Ciovacco:]

Note: We have incorrectly labeled 1942-44 chart above as being the "S&P 500". It should be labeled "Dow", since it is a chart of the Dow Jones Industrial Average. We apologize for the error.

Oct 01 11:00 AM

[Mistrofan:]

Chirs - it is frustating to predict. taking the David Rosenberg point we should have been up only 15-16% by now from the bottom (DJIA around 7400-7500) - and that would have been a "normal" case for where the economy is right now. But we are up 50%! So, according with Rosenberg a correction is brewing and imminent.

But I can also se your point: and maybe no one explained properly. When we reached 6440 on DJIA maybe the market overshoot on the downside. Maybe we cycle low should have been only 9000 on DJIA. And if that is the case, what we have seen last 6 months was nothing else then a reversion to the mean (the "mean" of a bad bear market - as categorzied by me as -30%). And then I would agree with you that markets can stay in a cyclical recovery for another 12-18 months.

But the current credit crash is not a "normal" even for the bad bear markets: we had a credit growth explosion over the last 20 years. And that is the main problem. Because now we have a credit contration is is going to bring, sooner or later, the credit exposure wher it should be. What we are seeing is for sure the worst credit crunch since '29-'32.

So, for me, another crash of the stock markets is in fromt of us - and for those of you looking for exact numebrs I am expecting DJIA to reach 5000 before we enter again into a secular bull market.

When we will reach that 5000? most certainly not this cycle - and probably the next one (2012 probably).

Oct 01 01:41 PM

[MikeX:]

Don't stay in the market as it corrects! It is a deflationary crash! The crash is going to worse than Great Depression! The problem is too big to solve. Housing numbers are a death spell for the economy! Buckle up, we are going down fast. Home sales are the engine of this economy! When we borrow, banks create new money. They do not lend existing money.

Here is how banks create money:

www.tradingstocks.net/...

New money makes the economy good. Whatever good days you have seen in your life was because people borrowed more and more exponentially! Read about the way government and the FED uses home sales as a way to create money and inject into economy:

www.tradingstocks.net/...

This is why the government is trying to propel the home prices up again! They don't want affordable housing! They want EXPENSIVE HOUSING. Home prices MUST go up and we MUST keep buying faster and more to sustain the fake recovery. That is not happening. The crash will be worse than Great Depression. Some are shorting the market:

www.tradingstocks.net/...

Deflation is a MAJOR threat now! All the money FED prints is not making a blip in inflation! There is still a bubble in housing and stocks. It is a bubble that was inflated for 50 years! make no mistake, it will deflate.

www.tradingstocks.net/...

GDP requires exponentially more borrowing for each unit of increment. That is not going to happen. As deflation sucks the money out of the economy, people will SELL EVERYTHING to pay off debt. Gold, Silver, Currencies, Stocks, Houses, anything. And they will buy USD. Why? Debt is denominated in USD. To pay it off you have to have USD. Debtors! Go to cash while you can. Sell all assets now before the crowd does.


On Oct 01 01:41 PM Mistrofan wrote:

> Chirs - it is frustating to predict. taking the David Rosenberg point
> we should have been up only 15-16% by now from the bottom (DJIA around
> 7400-7500) - and that would have been a "normal" case for where the
> economy is right now. But we are up 50%! So, according with Rosenberg
> a correction is brewing and imminent.
>
> But I can also se your point: and maybe no one explained properly.
> When we reached 6440 on DJIA maybe the market overshoot on the downside.
> Maybe we cycle low should have been only 9000 on DJIA. And if that
> is the case, what we have seen last 6 months was nothing else then
> a reversion to the mean (the "mean" of a bad bear market - as categorzied
> by me as -30%). And then I would agree with you that markets can
> stay in a cyclical recovery for another 12-18 months.
>
> But the current credit crash is not a "normal" even for the bad bear
> markets: we had a credit growth explosion over the last 20 years.
> And that is the main problem. Because now we have a credit contration
> is is going to bring, sooner or later, the credit exposure wher it
> should be. What we are seeing is for sure the worst credit crunch
> since '29-'32.
>
> So, for me, another crash of the stock markets is in fromt of us
> - and for those of you looking for exact numebrs I am expecting DJIA
> to reach 5000 before we enter again into a secular bull market.<br/>
>
> When we will reach that 5000? most certainly not this cycle - and
> probably the next one (2012 probably).

Oct 01 02:22 PM

[Carl Spackler:]

Nice call. You pronounce no correction coming and we get a good 2.5% throttling. I should have guessed this. For the most of 2009, most SA articles were bearish. In the last month, most have been bullish with many predicting a further move up. I should have had my radar ears tingling with this fact.

Oct 01 04:31 PM

[Mistrofan:]

Thank you - while I think you are right, I also think that Chris is right with this article and this cyclical bull market will overshoot on the upside for another 2-6 months. Of course, I might be wrong - I promise to exit the markets when they will reach 10500-10700 on DJIA.


On Oct 01 02:22 PM MikeX wrote:

> Don't stay in the market as it corrects! It is a deflationary crash!
> The crash is going to worse than Great Depression! The problem is
> too big to solve. Housing numbers are a death spell for the economy!
> Buckle up, we are going down fast. Home sales are the engine of this
> economy! When we borrow, banks create new money. They do not lend
> existing money.
>
> Here is how banks create money:
>
> www.tradingstocks.net/...
>
> New money makes the economy good. Whatever good days you have seen
> in your life was because people borrowed more and more exponentially!
> Read about the way government and the FED uses home sales as a way
> to create money and inject into economy:
>
> www.tradingstocks.net/...
>
>
> This is why the government is trying to propel the home prices up
> again! They don't want affordable housing! They want EXPENSIVE HOUSING.
> Home prices MUST go up and we MUST keep buying faster and more to
> sustain the fake recovery. That is not happening. The crash will
> be worse than Great Depression. Some are shorting the market: <br/>
>
> www.tradingstocks.net/...
>
> Deflation is a MAJOR threat now! All the money FED prints is not
> making a blip in inflation! There is still a bubble in housing and
> stocks. It is a bubble that was inflated for 50 years! make no mistake,
> it will deflate.
>
> www.tradingstocks.net/...
>
> GDP requires exponentially more borrowing for each unit of increment.
> That is not going to happen. As deflation sucks the money out of
> the economy, people will SELL EVERYTHING to pay off debt. Gold, Silver,
> Currencies, Stocks, Houses, anything. And they will buy USD. Why?
> Debt is denominated in USD. To pay it off you have to have USD. Debtors!
> Go to cash while you can. Sell all assets now before the crowd does.
>

Oct 01 04:49 PM

[swisswiss:]

Two words: Persian Gulf

Oct 01 08:36 PM

[swisswiss:]

Two words: Persian Gulf.

Oct 01 08:36 PM

[untrusting ...:]

Carl,
This article takes only 4 examples of past % over the 200MA and attempts to justify a continuation of this for many more months. Think we saw another article (think it was Bespoke) like this that showed all % over the 200MA and there were something like 10-15 cases. One can hardly put much stock in an article that "cherry picks" only 4 examples to attempt to support the author's bullish outlook.

There are literally dozens of really top notch long term money mangers (Kass, Hussman, Rosenberg, Mauldin, etc) that totally disagree with the bullish outlook of the markets at this point. In addtion, virtually no traditional market metrics such as valuation, PE's, PE10, past recession lows, volume, high insider selling, etc. that support stock prices at the levels they are at.

What is clear is that this "recovery rally" has been driven by some very unusal (many claim manipulated) factors such as: unheard of massive Fed liquidity, exceptional trading domination (50-70% of entire volume) by a tiny handful of 2% of big traders, rapid dollar devaluation, exceptional low interest rates, etc. None of these can continue for any extended period.

In short, it certainly appears much more reasonable that very limited upside potential from here is heavily outweighed by serious potential downside risk. Further there are profitable but much safer ways to play the market, make money, and not take very high risk long positions.


On Oct 01 04:31 PM Carl Spackler wrote:

> Nice call. You pronounce no correction coming and we get a good 2.5%
> throttling. I should have guessed this. For the most of 2009, most
> SA articles were bearish. In the last month, most have been bullish
> with many predicting a further move up. I should have had my radar
> ears tingling with this fact.

Oct 02 12:10 AM