The Kneeling Bull

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Includes: DIA, SPY
by: Peter Brock

Looking back at the stock market in the month of May, we saw the giddiness that marked the first quarter of the year give way to a steep correction. As the market fell, the usual "reasons" were trotted out: sovereign debt burdens, weakening BRICs, and slow jobs growth. Never mind that only a few short weeks prior, these same factors were blithely ignored as the market vaulted higher in a bout of spring fever.

To everything there is a season, and apparently now is the time to wring our hands and worry all over again about the fate of the global economy. Personally, I don't buy it. Investors and commentators see a half-empty glass and want to play a game of "what if". What if China has a hard landing? What if we see a repeat of Lehman, only in Spain? What if the US stops growing? What if that person I don't approve of gets elected?

I don't make predictions, so I can't tell you the answers to any of these questions. What I can tell you is we are still in the hangover phase of the recovery. We still reacting to the crisis. For that reason, it doesn't take much to scare investors.

Click to enlarge.

Source: BEA.

The chart of nominal US GDP doesn't get much attention in the press. If anything, charts of GDP will show the first derivative, the rate of change, which usually makes the economy look weak and directionless. But the economy is not as bad as most people like to think. GDP continues its climb up the stairs, even if the last riser was a little shorter.

When investors are really worried, they don't want to own corporate bonds. We saw a moment of unbridled panic in late 2008, when Moody's Aaa spiked. What we're seeing now is mild risk aversion. Investors are not sure about stocks, but they're okay with corporate bonds.

You know we're suffering from a bad hangover in the stock market when prices linger far below fair value. In the wake of a great fall, you expect tentative stock markets. Every burst bubble follows the same playbook. But in spite of the overall moodiness, bull and bear markets still come and go.

In every bull market, the wall of worry is bound by natural boundaries. Those channel lines you see in the chart above are the product of considerable hindsight. That's not unusual in itself, because market participants tend to look behind for clues about the future.

What the trendlines suggest to investors in broad market ETFs is that the correction doesn't have much downside left. Unfortunately, the same lines give a warning. If the support doesn't hold, then it means the bull is not kneeling anymore. It means the bull has rolled over.

Either way, the takeaway idea is the same. Every time investors witness a price correction, fears arise about its meaning. The fears are predictable, but the correction is not, so don't take dire forecasts as fact. They may not come to pass. Monitor support instead.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.