Are we out of the correction woods?

 

I’d love to confidently tell you that the worst of this recent market correction is over but I’d have to be up myself or on self-delusional drugs to tell you to assume it’s all up from here. That said, I will build the case that we could be in for better times for stocks, after I deal with the hard to ignore negatives around at the moment.

Follow the leader

First, the S&P 500 index or Wall Street generally will call the tune on what happens to stocks this week and for the rest of October, which has a history of doing what it has been doing over the past four weeks — that is, losing ground quite spectacularly. The index is well below its 200-day moving average, which was 1905 when it dropped below this important gauge of stock market performance.

On Saturday, it closed at 1886.76, which, incidentally, is around where Morgan’s Michael Knox has been saying was fair value, and which I told you about a few weeks ago. ^[1]

And this near-technical correction actually dropped 8.9% from the index’s closing high of 2010.4 to its intra-day low of 1820.88, but the dip buyers could not resist the urge and they piled back in so it’s now down about 6%. Now it’s worth noting that the last time the index had a long run upwards, like the latest, it was at the end of the tech-bubble and the market dropped 22%! I don’t think we’re any way in a similar situation.

If the market wasn’t rescued on Friday on Wall Street with that big 24-point surge on the S&P 500 and 263-point spike on the Dow, the next possible support level was a scary 1740 but I just can’t see any reasons for such a hip-pocket crushing event.

I’ll point to the good stuff later to explain my tentative optimism, so stand by.

Second, respected market watchers, such as Denis Gartman on Thursday, were warning that the start of the bear market had been ushered in — Friday’s action would have surprised him but he could use the old dead cat bounce excuse to explain it. I’ll have to test out this proposition before I end this little note.

He sees a long sell-off period. “I don’t like to think about it – but this might be the very beginnings of a bear market that could last some period of time,” he suggested on CNBC. ^[2] He is holding 80% cash but he’s a trader and he could have changed his mind on Friday — traders can do that!

A lot of his analysis rested on a slower global economy so he was looking for a 15% sell off, but this analysis came before some Friday news that could change things.

There are many like Gartman who would cite Ebola, the Middle East, Ukraine, slowing Europe, Japan’s post-sales tax slowdown, the end of QE this month and the fact that interest rates will rise in the US in 2015. I suspect the last two are what most worries US investors, as every ending of QE has resulted in a big market sell off.

But is this time different? These are jinx-like words that someone like me should be careful never to think, let alone be silly enough to write!

And now for the good news

So what explains my cautious positivity? Try these:

• On Thursday, the head of the St. Louis Federal Reserve Bank said the Fed may want to keep up its bond-buying stimulus for now, given a drop in inflation expectations. So the end of QE is not a certainty and even QE4 is possible, pundits predict, if necessary.
• UBS Investment Research economist, Maury Harris, thinks the Fed could extend bond buying longer than expected.
• November to May is historically more rewarding than June to October.
• October, while known for huge volatility, is also known for creating a bottom.
• Fourth-quarter earnings in the US are continuing to impress on the high side.
• The run of economic data remains bullish, with the Thomson Reuters/University of Michigan October reading on consumer sentiment coming in at 86.4, the highest since July 2007!
• A Bloomberg poll says 100% of economists surveyed think US interest rates will soon rise and they would not hold this view if they didn’t believe in the American economic recovery.
• The price of oil is falling and this will be a cost-cutting stimulus for, not only the US economy, but worldwide.
• The third-year of a US presidency is historically the best.
• The ECB is now close to a new asset purchase program, which should boost stimulus to Europe’s flagging economy, which helped bring Italian and Spanish bond yields down.
• Positivity is coming out of talks between Russia and EU leaders like Germany’s Angela Merkel. Germany’s slowdown is partly linked to the economic backlash of sanctions put on Germany, with its forecasted growth number for 2015 a low 1.2%.

Sure, the market could easily test out this Friday bounce-back of stocks but if Europe can get its act together with Putin, and Draghi with his QE goal, then it could set us up for a strong end-of-year rally. And if the Fed also hoses down early interest rate rise talk, then stocks could resurge again.

This is clearly the scenario I like but I concede a few important decisions and agreements have to materialise. That said, if the short sellers try to test this market out again, I’ll treat it as another buying opportunity.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Follow the Switzer Super Report ^[3] on Twitter

Also in the Switzer Super Report:

• Paul Rickard: Who’s afraid of big bad hybrids? ^[4]
• James Dunn: Five companies to fly away on ^[5]
• Roger Montgomery: A key baby boomer exposure ^[6]
• Rudi Filapek-Vandyck: Buy, sell, hold – what the brokers say  ^[7]
• Penny Pryor: Shortlisted – Woodside and Carsales.com.au  ^[8]
• Staff Reporter: The next hot property spots ^[9]