So Where Is the Stock Market Correction?

By: Sy_Harding

There’s been a significant change in the mood on Wall Street and therefore in the financial media, in recent weeks. After perpetual bullishness for months, it seems that independent analysts, and even Wall Street spokesmen, pretty much now agree the market is overbought and overdue for a correction.

The only debate seems to be that those bullish on the market say it will be only a minor five or ten percent pullback, while bears expect something worse.

At first glance, it does make me wonder to see so many expecting a correction, the only debate being its severity, given the market’s history of doing whatever it takes to fool the majority.

But then when I look around, I realize that it’s Wall Street professionals and insiders, for instance Mohamed El-Erian, CEO of bond-trading giant PIMCO, Jeremy Grantham, chairman of giant money-management firm GMO, etc., long-term very astute and successful, so-called ‘smart money’, previously bullish, who have now turned bearish. It’s Sam Stovall, chief investment strategist for Standard & Poor’s, and Art Cashin, director of NYSE floor operations for UBS.

When we look at the so-called ‘not so smart’ money, the groups that are so often wrong at market turning points that they are known as a ‘contrary’ indicator, we don’t see expectations of a correction, but the excessive bullishness and confidence usually seen at rally and market tops.

For instance, the Investors Intelligence Sentiment Index is at 51% bullish this week, its highest level since December, 2007. Its bearish percentage is just 19.8%, its lowest level since the market top in October, 2007.

At last look a couple of weeks ago, traders at Rydex had two and a half times as much money in leveraged bullish funds as in leveraged bearish funds, a higher ratio of bullishness than when the market topped out into the four straight down weeks in June.

Then there is the VIX index, also known as the Fear Index, which is based on the sentiment of options traders. It has plunged from a record level of fear and bearishness, 81 on the index, at the market’s November low, to a benign and unworried 25.

So there we are, with the smart money warning of a correction, while the usually wrong groups are at high levels of bullish sentiment usually seen at market tops.

But it’s been that way for several weeks.

So where is the correction?

And indeed, why does the smart money expect a correction?

Well, not only does the market have a history of doing whatever it must to make the majority of not so smart money wrong at the turning points, but it also has just as clear a history of correcting its excesses. And it’s difficult to claim that there are not substantial excesses currently in the market.

The most obvious and frequent observation is the overbought condition technically, with the major indexes over-extended above their 20-week moving averages to an extreme degree. Historically that has usually resulted in a correction back down to at least retest the potential support at the m.a. But more often than not it overshoots on the downside as it did on the upside, and breaks below the m.a.

A decline just to their 20-week moving averages would be a 10% correction in the S&P 500 and Nasdaq, about the worst of what bulls expect. A break below the moving average would be something more, bears calling for a retracement of half the rally off the March low, or worse.

Seasonality is also often mentioned in the ‘smart money’ warnings, references to the historically most negative three-month period of August, September and October.

Then there are concerns that in its huge rally off the March low the market has factored in better economic conditions ahead than are likely to be seen.

So, a very overbought market, extreme investor bullishness, unfavorable seasonality, a market that’s ahead of reality, selling by insiders, and warnings from ‘smart money’.

So where is the correction?

Those expecting it are shaking their heads, wondering the same thing.

PIMCO’s El-Erian refers to the market as being on a ‘sugar high’, and says we know the letdown when we come off the energy created by a sugar high, but we can’t pinpoint the hour when it will begin.

Each week it has been said the market decline will begin the next week. Art Cashin’s favorite phrase each week for the last month has been “It should all become clear by next Friday.”

A few weeks ago the newly bearish (as well as the already bearish) were pointing to August as frequently being a reversal month into September, which in turn is historically the worst month of the year. Three weeks ago, after four straight up-weeks, the market was down for the week, and that was probably the beginning. Two weeks ago, it was the old adage of sell on the beginning of Ramadan (August 22 in North America this year). Last week, it was that once the positive activity associated with last Friday’s options expirations are history, the correction would begin this week.

But it hasn’t happened.

This week it is that typical positive action around the end of the month, and the lack of participants, is holding the market up. But when September, historically the worst month of the year, arrives next week, and big investors and institutional traders get back from their summer vacations, and volume picks up, watch out.

Well, maybe. Meantime, no wonder investors remain bullish and confident. Nothing is coming of the warnings, no matter their source.

Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily market blog at www.SyHardingblog.com.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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