Market Correction Ahead
5-3-07: As the stock market set new record high, we wonder how long before the next correction will occur. Keeping in mind there has not been a market correction since the Chinese market sell-off a few months ago; the possibility of a correction appears to be on the horizon. While corporate profits and economic data suggest the overall health of the U.S economy is strong and still growing, we believed the stock market has gotten ahead of itself. As a result of the record breaking market level and the complacent attitude of investors, it our opinion a correction will soon take place within the next three months. When it happens, it could have a snowball effect.
The primary reason for our view is energy prices. This could be the catalyst that takes down the market. As the summer driving season approaches, we could very well see $4/gallon in states such as California. The chances of this happening are highly plausible as refinery capacity continues to be an issue. This is in addition to the geopolitical turmoil which continues to keep crude prices high. The demand for crude from China and India remains strong and continues to grow. Fact of the matter is our economy is heavily tied to oil and there are less of it to go around these days. Scarcity will only do one thing to prices, up it goes.
If gasoline prices head towards a new high, this will in turn dampen consumer confidence and inflation will again become a major issue. The Feds might have no choice but to raise interest rates to fight inflation. A higher interest rate would be a major blow to the securities market as people will choose to leave their money in the bank earning relatively high interest without bearing any risk.
Let’s not forget about the weak housing market as it is a huge part of U.S economy. Most experts would agree the housing slowdown is still in its infancy and could get worse. The bottom line is this market rally could be over any day. Take what you can now and wait it out until the next weakness.
Comments
Hi and thank you for a great and informative web site. My question is in regards to the oil sector. In the event of a correction caused by high energy prices, would energy stocks be a safe bet or do they face the same fate as the market due to the over whelming influence of the market?
Posted by: Farzad | May 4, 2007 05:11 AM
Hi Farzad,
Thanks for your question. In the event of a correction that is triggered by high energy prices, we believed the oil sector would also be hit as well.
The rational behind this is the market would expect the economy to slow, thus reducing some demand for energy. Moreover, an overall market correction will tend to affect every sector as people would sell and take whatever they can. This is why we believed it is prudent to take profit here and there. Good Luck.
Posted by: ibooyah | May 4, 2007 09:48 AM
Very sage advice fellas. I couldn’t agree with you more. Although Wall Street likes to climb a “wall of worry” I think the market is only giving token lip service to the concerns that you point out. The way these things seem to happen is that the correction will hit just when everyone believes that the market has made it out of the woods and has dodged all of the bullets shot at it. Dow 15,000 or 16,000 will be proclaimed by the media as not only being possible but inevitable; new stock guru talking heads will be anointed for their prescient picks that net double or even triple digit returns and friends or acquaintances that you know to be clueless about how the market works will be telling you either how well they’ve done in the market or provide you can’t-go-wrong stock tips.
People like us will be ridiculed for having taken some profits early and sitting on the sidelines while the market makes new high after new high. However, when it hits all of those new highs will be completely obliterated and will become major losses. While I cannot disagree with you regarding energy prices as being a catalyst for the correction I believe that the problems with the housing/real estate/lending area are slowly creeping through the fabric of the market and will be the impetus for at least a major correction if not triggering the beginning of a new bear market rivaling what occurred after the dot.com bubble burst. No, I am not a pessimist or doom and gloomer. These things just happen and they happen cyclically. It’s just getting close to the time for it to happen to this market; nothing more, nothing less.
One reason I feel that the housing situation will be the problem is how interconnected housing and the stock market have become. Why this is I couldn't begin to tell you although I have some ideas. However, what is significant about this connection is that for the past 10 years the National Association of Home Builders index has been a very good predictor of where stock prices are heading for the succeeding year. When a graph of this index from the previous year (in this case 2006) is superimposed on the current year this leading indicator suggests that there will be a blood bath in the stock market in the fall. No one is talking about this in these terms and if they are talking about it at all they are mitigating it by saying things like the problem is limited to the sub-prime market or that the strongest year in a bull market is this year in the presidential election cycle, things are different this time because (pick a reason), blah, blah, blah, blah, etc, etc. The bottom line is that when there are storm clouds that are this dark on the horizon should you go sailing?
Now I’m not saying one should be 100% in cash but cash should be raised by taking some profits and by limiting your losses. Investors should be vigilant for opportunities that present themselves that provide good risk/reward ratios. What these opportunities really boil down to are what an individual understands about what he or she is getting into and is comfortable with. While I agree with you that no sector will be spared in a coming correction there always will be opportunities in individual stocks to exploit for those who remain on the look out for them.
More later.
Posted by: Stock Detective | May 4, 2007 10:30 AM
Stock Detective, once again, well said.
Posted by: ibooyah | May 4, 2007 10:37 AM