Why Any Stock Market Correction Could Be Fast And Furious

by: Altitrade Partners

We are currently seeing three factors which lead us to conclude that any stock market correction could be quick and deep.

Stock ownership by U.S. Households is at levels not seen since the dot.com bubble era of 2000.

The use of leverage, through margin, continues to register extremely high readings.

Investors have taken on a short-term trading mentality when it comes to equities, and may be quick to exit the market at the first sign of trouble.

We recently said in response to a comment from one of our previous articles on Seeking Alpha that we do not believe that the mere telegraphing of the Federal Reserve's intentions to the markets, ahead of time, will necessarily mitigate the historical reaction, by the markets, to rising interest rates.

In our statement, we said "The fact that everybody believes that the end of QE3 has already been fully discounted into equity prices tells us that the opposite of what many think will happen. Too many people leaning to one side of the ship will cause it to list, and ultimately sink. Consensus thinking NEVER works in the stock market."

For all the machinations these past six years by the Federal Reserve, can we really say that we have experienced the kind of economic growth that a ZIRP environment was thought to have been able to produce? We think not.

However, what the Fed has been able to produce, through cheap money and abundant liquidity, is a return to excessive speculation in both the housing and financial (stock and bond) markets. We've all seen this picture before, and we know how it usually ends, but somehow those four most dreaded words on Wall Street --- It's different this time --- still have managed to creep into the psyche of investors.

History is littered with examples of the cycle that fear and greed produce. What makes it especially worrisome, to us this time, are three things --- the level of stock ownership among households, the leverage that has been used to purchase stocks through margin, and the very short holding period that investors have become accustomed to when buying and selling securities.

First, the level of stock ownership among U.S. households reached a new high recently, as indicated by the chart below. Ownership has reached the levels we saw back in 2000, just before the collapse of the dot.com boom.

Secondly, the amount of margin debt is also at near-record levels as many investors have used leverage to enhance their returns during this prolonged bull market. Leverage is great when prices are rising, but it's a two-edged sword, when prices begin to collapse. Mass liquidations through margin calls can bring a market to its knees faster than anything we've ever seen.

Lastly, today's retail investor has a very short time holding horizon when it comes to stocks. As this chart below shows, there has been a steadily decreasing mentality among investors of stocks as being long-term investments. Instead, they have become insignificant pieces of paper that should be traded over and over with impunity.

In the 1960's investors held their stocks for an average of just over 8 years. In the 70's that declined to a shade over 5 years. During the period of the 1980's the average holding period for stocks was approximately 2 years and 9 months. By the 1990's that holding period dropped to about 2 years. During the decade of the new millennium the holding period decreased, yet again, to about 1 year. Beginning in 2010 we saw investors hold their stocks for only about 6 months. We wouldn't be surprised if in 2014 that has declined even further.

This short-term focus, combined with highly-leveraged portfolios, and near-record holdings could portend the perfect storm for another stock market decline of major proportions. We hope that is not the case, but there is no doubt in our minds that we are in a very dangerous transition period in the markets.

Making the transition to higher interest rates has always led to a correction in equity prices. No one know for sure the extent or magnitude of that correction, but not having experienced any kind of normal correction (a measured move of 10% or greater) for almost 1,100 days, we think that when it finally does come, it is going to be fast and furious.

There's an old adage on Wall Street about bear markets that says "When the paddy wagon comes, they take everybody, good and bad. This time will likely be no different.

Disclaimer: The opinions expressed herein are exclusively those of Altitrade Partners. We do not provide investment advice, and do not offer buy and sell recommendations on any securities mentioned in our reports. For additional information, including our full disclaimer, we invite you to visit Altitrade Partners.

Disclosure: The author is long SPXS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.