Monday, February 4, 2013

Everyone Is Ready for the Market to Correct in February - But What If It Doesn't?

The financial press is full of opinions about whether January's strong rally will continue in February.

Strategist Gemma Godfrey of the UK investment firm Brooks Macdonald, voiced a view last week that seems to be shared by many.  Here was her quote in The Guardian:
As investors dismiss the economic contraction to focus on the resilience of consumption, they miss the risk that this will come under pressure over the coming months as fiscal cliff measures come into play.

Market rallies have been driven by the fear of an imminent risk receding, but growth is now needed for another leg up in markets. Instead, the ‘pain trade’ is now missing out on equity upside, implying fear of underperformance may be driving investment versus conviction in the outlook for markets going forward. Exemplifying this is the recent rotation by Hedge funds into financial stocks, following the positive earnings momentum, which of course is backward over-the-shoulder looking, rather than based on confidence in the future.

Strategist Mary Ann Bartels of Merrill Lynch also believes that we are headed for a "correction" but worries that her view has become too consensus. Here's what she wrote this morning in her weekly piece:

February a risk month but becoming consensus  

Our roadmap for 2013 has called for a seasonal February correction and the sentiment data still supports this. Also the RSI for the S&P 500 has peaked revealing slowing price momentum on the rally. Our concern is that the correction call appears to becoming a consensus. So the risk to our call is that a correction begins much later in the month of February and into March pushing the S&P 500 toward 1576-1600 before a pullback. If a correction occurs soon we expect 3-5%, but if the rally is extended it would then call for a deeper correction of 5-10%.  
However, blogger Joshua Brown writes on his blog The Reformed Broker that too many people are convinced that bullish sentiment is too widespread.  
Brown goes through numerous examples from the press that indicate that sentiment towards stocks is more ambivalent than bullish.  Accompanying his montage of news articles from around the country Brown writes:

So as proof, I offer up the following "Main Street" coverage of the Dow's ascent above 14,000 from newspapers around the nation this weekend. There was hardly a single article that didn't immediately warn readers about the likelihood that stocks were at a top. When the papers begin buying into the boom, acting as though it's a given that you should be in and sharing stories about newly-minted tycoons, that is probably when you're closer to the euphoria stage.

But that is not what Main Street is hearing upon this milestone, they are hearing skepticism and disbelief and warnings..

If you have the time, please click through to Brown's compilation, and I think you will agree that there are warning signs aplenty.
I don't really know whether we get a correction this week, or this month.  I have been telling clients to focus on the longer term picture, which I believe points to a much larger upside in the next couple of years from stocks.