The Correction Is Coming, Right?

By David Moenning

Daily State of the Markets 
Friday, January 25, 2013

Good morning. Although there was a lot of carnage to be found in the stock market on Thursday if you owned anything remotely related to Apple, and the bears did do their darndest to create a reversal day after the S&P kissed the 1500 level in the early going, the DJIA actually finished with a decent gain yesterday (46 points or +0.66%). What's interesting is that the venerable Dow has managed to finish in the green for the last five days running as well as ten days out of the last eleven. And of the sixteen trading days in 2013, the DJIA has closed lower just four times, all the while tacking on 5.5% in the process. To which I'll say, not bad, not bad at all.

The problem is that the market technicians tell us that this has created an "overbought" condition in the market indices. In case you don't spend your days studying the wiggles and giggles on the charts, this means that stocks have run a long way in a short period of time. To hear the bears tell it, this suggests that stocks should move lower to correct the "excess" that has been created by the quick gains. And this is why stock markets tend to take "two steps forward and one step back."

However, I think it should be pointed out that up until four days ago, the Dow and S&P 500 found themselves at about the same place they stood back in early September. Thus, before breaking away to the upside this past week, stocks had essentially gone nowhere for four months.

Lest we forget, the market went into a mild state of depression during September, October, and early November over the fear that the U.S. Congress was going to send the economy over the fiscal cliff and into recession. If my math is correct, the S&P wound up losing about -7.6% during the two-month dance to the downside while the Dow shed more than 1,000 points or -7.85%.

My point is that while so many of the always breathless, "fast money" types are now pounding the table that stocks must go down because the indices have simply gone too far too fast, the market actually has only advanced about 2% over the past four months. In addition, I'd like to argue that maybe, just maybe, it was the nearly 8% decline that was out of whack with reality. As such, one could argue that the vast majority of the recent gain has merely "corrected" that misguided move.

So, while the fast money may be convinced that stocks can only go up so far without a pullback, or at the very least, a pause in the action, the big-money institutional players in Davos may have a different view of the environment . And if those institutions, who as a group are extremely overweight in bonds, are, as is being reported, indeed starting to "rotate" out of bonds due to extreme valuations, then we may not see the type of correction the bears are demanding. For the record, Goldman Sachs CEO Lloyd Blankfein was the latest to reference "the great rotation" (out of bonds and into stocks) in an interview this morning on CNBC and says there are reasons to be optimistic.

Yes, stocks are indeed overbought (I'm not competeley devoid of technical savvy). Yes, the sentiment indicators are indeed starting to move into the extreme modes. Yes, the cycles suggest that things could get dicey soon. And yes, I DO agree that a pullback would be logical right about now. However, without a "rasion d'etre" I'm just not sure that our furry friends are going to get anything more than a garden-variety pullback going.

You see, an overbought condition, in and of itself, is generally not a reason for stocks to decline. Typically, our furry friends need a catalyst in order to turn a strong trend around. And while the sell algo's were certainly active in the market yesterday and there is no reason the program selling couldn't continue for a day or three, I am going to opine that if the bears couldn't get something going after Apple missed (again), then investors may be well served to utilize a buy-the-dip strategy for a while.

But then again, this