Is the Market Poised for a Correction – or a Collapse?

February 19, 2013

At the end of last year, CNNMoney took a survey (Stocks ‘need to be corrected’) wherein they polled more than 30 investment strategists and money managers as to where the S&P 500 would finish 2013. The realistic consensus was a valuation of 1,490, up just 4.5 percent for the year, given the multiple headwinds of debt, Europe, tensions in the Middle East, slowing GDP, and the pending implementation of ObamaCare at year end.

That was the last week of last year. Today, the S&P 500 is already up 6.8 percent year-to-date, and while some are celebrating the reacquisition of former highs, many are doubting the sustainability of the rally. First, it’s a tame one at best: Since 2009 investors have withdrawn over $150 billion from stock mutual funds, whereas this rally has seen only $10.3 billion buy back in.

So what is behind this rally? Many have been asking this question and the brokerage-employed “economists” on Wall Street are ready with a Happy Days Are Here Again answer, replete with rainbows and lollipops and the usual optimistic spin. Professionally, I believe the following to be legitimate reasons for what has transpired thus far:

Late last year, many companies paid accelerated dividends ahead of the looming Fiscal Cliff, so that recipients could pay 15 percent, rather than the current 23.8 percent, capital gains tax on that money. Since many recipients reinvested those dividends, the resulting rise in share prices lifted the market.
Insurance claims in the aftermath of Hurricane Sandy have resulted in increased sales of cars, furniture, and other boosts to the economy, an artificial one-time stimulus that will go away once those homes are rebuilt.
The Federal Reserve’s $2 trillion bond-buying program was continued “for the foreseeable future,” giving stock buyers confidence that “Helicopter Ben” would keep their party going well into 2013.

Given the chatter online about a correction, few now doubt that we are in for a pullback. The only questions are when—and by how much. Here are the worrisome signs:

Corporate insiders (executives and board members) were nine times more likely to sell shares than buy them last week (report released last Wednesday), a clear sign that those with the most information about the inner workings at their firms know what’s coming and have already gotten out of the way of it.
CNNMoney’s Fear & Greed Index, which looks at the Volatility Index (VIX) and several other indicators to measure market sentiment, has been firmly in “Extreme Greed” mode since the start of the year. However, it was mired in neutral for months just before the resolution of the Fiscal Cliff, an issue we’re about to revisit before March 1st.
The yield on the 30-year U.S.Treasury bond is rising, up nearly 10 percent of its January 1^st value in just 6 weeks, to a 52-week high of 3.48 percent. When investors can get the certainty of 3.48 percent amid a climate wherein 30 money managers see only a 4.5 percent gain with risk, this will be a drag on equity valuations. According to a valuation warning issued last week at ValuEngine.com as reported in Forbes, “Stocks are currently overvalued and will become (more so) as long as the bond yield remains elevated and rising…”
The last two times the market hit current valuations, in 2000 and 2007, the markets fell sharply (51 percent and 57 percent respectively) and recovering those values took nearly five years each time. The psychological reminders posed by these levels should not be quickly dismissed by forgetful investors now caught up in the current celebratory fervor.

As many of our readers, clients, and listeners know, none of our more than 600 clients have lost money in that tumultuous 13-year period. Paul Farrell of MarketWatch reminds us that,

“…During the last 50 years, we have had 12 bull markets and 11 bear markets. The bull markets averaged (gains of) about 100 percent and the bear markets, on the average, declined 25 percent to 30 percent, and the typical bull market lasted 3.75 years. …Get it? This aging bull is now way past retirement age, ripe for a lengthy bear…” (my emphasis).

Farrel continues: “…More likely, (investors will be lured) into a suckers rally, where the bulls just keep hyping the good times so every naive investor left will finally pile in, fearful they’re missing the race to 17,000 … forgetting the dot-com disaster in 2000, forgetting the huge losses after the subprime mortgage disaster of 2008…” Many are beginning to believe that this market has nowhere to go but down.

Breathe easy, don’t get suckered, and spread the word.