Headed For a Normal 20-30% Correction

by: Roger Nusbaum

Add Luminent Mortgage (LUM) and Impac Mortgage (NYSEMKT:IMH) to the list of mortgage calamities. Also the market breadth has not been too hot.

Companies getting pasted and poor market internals is what happened back in the Internet meltdown too. This is just a little factoid, not an analysis or a prediction.

In terms of analyzing this, the market does not cut in half twice in one decade. I suppose it is possible but in terms of realistic probabilities; I would say no. However these little under-the-market's-hood items could, like before, lead to a sizable but probably overdue decline.

This year we have had two mid-single-digit dips and people freaked out. If you look at market history, get yourself a Trader's Almanac, you will see that 20-30% declines happen often enough that they should be thought of as normal. A decline of that size will happen at some point in some market cycle which will then help put a 6% decline in much better perspective than was portrayed last week.

Whenever the next bear market starts we should expect a decline of more than 20%. I have no idea if the current mortgage/liquidity issue will be the tipping point or not but the yield curve has been in varying states of inversion for a long time which is an unhealthy condition for financial stocks, and financial stocks are vital to the market and lubing the chassis for the economy.

Problems in the financial sector often come home to roost. This might be happening now or it might not. There are arguments on both sides of the debate and they sound plausible, but I can't get away from the fact that inverted curves lead to trouble. Combine that with money that was too cheap and too abundant for too long and you have a recipe for recession and bear market. NORMAL recession and bear market, not apocalypse.

I don't know, nor do I feel the need to predict the timing of the next recession. This merely pops us as a risk with a decent probability. For now stocks are flirting with rolling over but have not really done so yet.

Do what you want with this but I have been concerned about this for a while and continue to be so now.