"Something Wicked This Way Comes" is a 1962 novel by Ray Bradbury about two boys who have a harrowing experience with a nightmarish traveling carnival that comes to their town. I've always loved the title and posit it may be apropos for the upcoming summer earnings season. A seeming plethora of dark clouds on the horizon portend the possibility of bad things happening to good companies when summer rolls around. I see a correction on the horizon. Rocco Pendola recently penned an article where he details his plan for a major crash or correction. I really enjoy Rocco's articles and feel his third scenario applies to my style of investing. The following is my case for a correction and how I would respond to each scenario.
Market Has Risen Too Far Too Fast
The U.S. stock market is off to a strong start in 2012. The Nasdaq (QQQ) is up approximately 17% year-to-date, the Dow (DIA) is flirting with 13,000, and the S&P 500 (SPY) is up 10%. Even Europe and Emerging Markets have been on a tear since the start of the year. Europe is up 10.6%, India is up 26.8%, Russia is up 26.3%, Brazil is up 22.5%, and China is up 15.5% so far in 2012. These rates of ascent are unsustainable and a near-term correction is both logical and healthy. After the run up a period of consolidation would be normal.
There is much debate as to whether we are in a bull or bear market. I am not a technical expert, but it would seem both parties have a case. One thing I do know is the seasonal play of "Sell in May and Go Away" has worked well for the last two years and I don't see any reason for it to be different this year.
Middle East Turmoil
The nuclear weapon issue between Iran and Israel seems to be coming to a head. The current saber rattling by Iran has already put a 20% premium on oil. Gasoline is expected to hit $5.00 a gallon by the summer driving season and is nearing $4.00 as of today. Based on this fact, the U.S. consumer who is the bright spot and primary driver for the U.S. markets may begin to curtail spending. Historically, whenever gas prices have reached this level consumers seem to shut down. One stock I feel has a high level of exposure to this phenomena would be Open Table (OPEN). OPEN has a forward P/E of 21.15 and a PEG ratio of .97, according to Yahoo Finance. As an online restaurant reservation company, I see a high level of risk they may miss earning with people going out to eat less based on high gas prices.
Another suggested play based on Middle Eastern turmoil causing an oil supply disruption is to invest in a domestic oil and gas producer such as EOG Resources, Inc. (EOG). EOG is primarily involved in the exploration, development, production and marketing of crude oil and natural gas primarily in the United States. EOG has a forward P/E of 16.68 and a PEG ratio of .33 according to Yahoo Finance.
China's Hard Landing
China's trade sector dropped severely last month after having massive trade surpluses for years. This recent news coupled with last week's 7.5% 2012 GDP projection and slowing car sales data has raised concerns the country's economy is tapering off more swiftly than expected. Here is a short excerpt from a Wall Street Journal article detailing the decline:
The weekend report of a $31.5 billion trade deficit in China for February was substantially larger than most analysts expected and followed a string of other disappointing economic data, including weak growth in car sales, industrial production and retail sales, and the continuation of a steep fall in property sales. The only bright economic star was that inflation slackened more rapidly than expected.
China has quite a conundrum on its hands today. They are a major driver for the global markets. Nevertheless, its major customers in the U.S., Europe and the emerging markets are struggling and consequently ordering less while the costs to produce goods is rising. The emerging middle class of China is demanding higher wages and better living conditions. They no longer wish to live next to toxic waste dumps. Chinese exporters will pass these costs along to retailers. The company I see in this segment with a great deal of exposure is Wal-Mart Stores, Inc. (WMT). One of Wal-Mart's major suppliers is China.
Let's see, we have a market at multi-year highs which has run up extremely fast over the last few months coupled with a slowdown in China and Europe. Top that off with prices at the pump nearing $5.00 and the "Sell in May and Go Away" phenomenon on the horizon and think you have a recipe for a correction. The saying three strikes and your out comes to mind for me.
The calls I've made are trades. If you review the history of the market, the market has always bounced back and soared higher after each correction. The market is up more than 10 fold since the Black Monday crash of 1987. So if you are a long term investor, use a correction as a buying opportunity to dollar cost average down your investments and hold on tight. Corrections are healthy for markets and offer opportunities for short and long term investors. Use this information as a starting point for your own due diligence and research methods.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.