A Serious Market Correction Could be Underway

Feb 4, 2010

It is old news that the market has enjoyed a very strong rally since last March. In my opinion, it has occurred on the back of misguided confidence that the next economic boom would soon follow.  I give an abundance of credit to the news headlines, government stimulus, and market interventions for encouraging a short-term burst of economic activity which has everyone salivating again.

Like Pavlov’s dog, Americans have learned that when the NYSE’s bell rings or the government spends, they get fed.  We have been conditioned to think that this business cycle will unfold like other cycles in our recent past, a steadily rising market and a vibrant economy a foregone conclusion.  However, this cycle feels different and diligent analysis reveals economic circumstances are significantly more severe than anytime since the end of World War II.

After pausing to think, I believe investors are beginning to perceive the divergence between the stock rally and the economic reality.  The S&P 500 shed 7.6% over the past two weeks.  Maybe market participants realize that a recovery may not be sustainable without consumers, 18% of which are now under-employed and must spend sparingly while the other 82% have chosen to spend frugally out of fear that their incomes may be at risk.  To add insult to injury, credit and money supply continue to contract.

The market was overdue for a selloff.  Corrections of similar magnitude have given birth to a series of large rallies and higher stock indices since March, but my market indicators  have flashed an intermediate sell signal. If the market does not stabilize right now, you can count on a damaging selloff from these levels.  Investors should lighten stock and commodity holdings on any market strength.  Better yet, lighten anyway.  If you smell smoke in a barn full of dry hay, flee the barn.

Greg Mattlage