A Warning Shot For Investors?

By: Sy_Harding

Many important global stock markets, including China, Brazil, India and Hong Kong, have been in fairly significant corrections since November, down between 12% and 17%. Their major concerns have been rising inflation and the resulting monetary tightening by their central banks to combat the inflationary pressures.

The U.S. market has had no such worries, and has continued its non-stop bull market to new highs.

But it did stumble a bit this week, spooked by the spike-up in oil prices created by the spreading unrest in oil-producing countries, notably Libya. Yet in the week’s decline the Dow and S&P 500 fell less than 3%, hardly a blip on the long-term charts.

And short-term, the next ‘monthly strength period’ has arrived, when the market tends to be positive for the five-day period from the last trading day of the month through the first four days of the following month.

As I have written before, it is a quite consistent pattern. For instance, in 2010 the S&P 500 gained 143 points, or 12.8% for the year, but its gains on just the first three days of each month amounted to 229 points, or 20.5%. The pattern has pretty much continued so far this year, with nice gains in the first weeks of both January and February.

That raises the odds for a return to a positive market next week.

Yet, the events of the past week may have been a warning shot. There had already been enough potential catalysts for a market correction. This week added several more.

As most investors are aware, investor sentiment has been at levels of bullishness and confidence usually seen near market tops. And the major market indexes are as over-extended above their long-term 200-day moving averages as they usually get without at least a 10% to 12% correction down to retest the support at those moving averages. As noted, many important global stock markets, including China, Brazil, India and Hong Kong, have been in fairly significant corrections since November, and global markets, including the U.S., tend to move in tandem with each other in both rallies and corrections.

Now we have spiking oil prices. The 2003-2007 bull market ended in October, 2007 when the price of oil reached $96 a barrel. The 2007-2009 recession began three months later. After trading briefly above $100 a barrel on Thursday oil pulled back, but was still trading around $97 at the week’s end.

On Thursday it was reported that new home sales plunged an unexpected and huge 12.6% in January. It was not a good start for this year, after 2010 was the worst year for new home sales in almost half a century. Not providing much encouragement for coming months, it was also reported that applications for mortgages are at a 15-year low.

Then, on Friday it was reported that the economy was even weaker than previously thought in the December quarter. Gross Domestic Product (GDP) growth for the quarter was unexpectedly revised down to only 2.8% from the previously reported 3.2%.

These events and reports - turmoil in the oil-producing countries that is more likely to spread than go away; spiking oil prices that tend to cut into U.S. economic growth (and add to global inflation pressures); news that the economy grew significantly slower in the 4th quarter than previously thought – were more than enough reasons for the market to nosedive this week. But it only stumbled for a few days.

Yet it was enough to cause some concern and nervousness. That could be seen in the sharp drop in bullish investor sentiment, and the upturn in the number of pundits declaring the end of the bull market. The poll of its members by the American Association of Individual Investors (AAII) this week shows the percentage of those who are bullish plunged to just 36.6% from readings above 50% just three weeks ago, and the near record high of 63% in late December.

Sentiment does reverse from high levels of bullishness near tops to increasingly pessimistic expectations as corrections develop.

So was this week’s stumble the beginning of a more serious correction?

The events and reports this week did provide more evidence that the stock market may be ahead of reality regarding prospects for the economy, and therefore corporate earnings, going forward, which should at least limit the market’s upside potential.

Limited upside potential – more downside risk?

It might be wise to lighten up some into strength that may develop over the next few days during the ‘monthly strength period’.

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