Thursday, May 26, 2011

Is the Market Due for A Correction?

Most of the research I'm reading these days has turned cautious on the stock market.

Many strategists cite the length of the current bull market - it has been more than 2 years since stocks bottomed early March 2009, which is longer than more cyclical bull markets have historically run.

There are also the concerns relating to weakness in areas like manufacturing and housing, where recent data would suggest the economy has been slowing.

Here, for example, is a paragraph from this morning's research piece from Mary Ann Bartels, Merrill Lynch's chief technical market strategist.

Note that Ms. Bartels views the consensus bearish view as mildly positive from a contrarian viewpoint:

AAII Bulls/Bears at lowest level since the Jul/Aug 2010 lows
Based on data from the American Association of Individual Investors (AAII), US investor bullish sentiment relative to US investor bearish sentiment is at the lowest level since the late August and early July 2010 lows. As an indicator of sentiment, the AAII Bulls/Bears ratio is at or near oversold or bullish contrarian levels and suggests that individual investors are the most bearish since last summer's bottom for the S&P 500 at 1040-1010. In our view, AAII Bulls/Bears is a potential positive for the US equity market. In yesterday's Chart Talk, we highlighted that Investors Intelligence % Correction suggests that too many investors expect a correction, which is also contrarian bullish for the US equity market. Our key support on the S&P 500 remains 1305-1294.

I went to hear Ed Clissold, Global Equity Strategist at Ned Davis Research (NDR) this morning.

I've written about NDR a number of times on Random Glenings. The firm does top-shelf research on the global equity and bond markets, based on their huge database of historic market data. The firm is not always right, but I find their research very thoughtful and useful in my investment work.

NDR is among those strategists looking for at least a pause in the market's bull phase. Ed noted that NDR would not be surprised to see a 5% or 10% decline in the markets over the next few months. However, given the positive backdrop of low interest rates and an accomodative Fed policy, NDR would also not be surprised to see stocks recover nicely by year-end.

In their opinion, NDR would suggest moving to more defensive stocks as a tactical asset decision. Specifically, they like the "SHUT" sectors: Staples; Healthcare; Utilities; and Telecom for investors who want to stay in the equity market.

However, NDR's overall asset allocation remains overweight equities, and underweight bonds. It is hard to get bulled up on bonds with rates so low, and while stocks are obviously more volatile they still offer better return potential than fixed income alternatives.