It was long overdue. For weeks the stock market has registered overbought conditions and still it forged ahead. Investors had driven the averages back to yearly highs and only then did the rally run out of steam. Now it’s time to step aside and watch.
“Is this the start of something big or should I just stay put?” asked a retired client from Pittsfield who has recouped much of his 2008 loses over the last year.
“Stay put,” I said, “because this pullback will be short and unless you are a day trader, too volatile to do more than add to existing positions.”
I’m thinking we could see the stock markets drop as much as 5%, which from here isn’t such a big deal. Take the S & P 500 Index, for example. This week it hit an intraday high of 1,227 (almost 10 points higher than its peak in April). A 5% decline from that level would put the average at 1,165, a mere 30 points down from here. That’s not worth getting excited about.
As a rule of thumb, I believe that 5-10% corrections in the stock market are the “price of doing business” or the risk one must accept in equity investing. These kinds of corrections occur 2-3 times a year on average. And it is not just equities that are falling.
Commodities are also declining. As I look at the present spot price of gold, the precious metal is off over $40/ounce while silver is down $1.50/ounce and oil has plummeted over $3/BBL—in just one day. Commodities tend to have extremely sharp, if short, corrections that tend to wilt most amateur investors’ resolve to stay invested. It appears that once again those who have chased energy, precious metals and agricultural commodities are suffering big reversals this week. Rather than buy this weakness, they tend to sell in panic.
For those with bullish convictions, this pullback is a buying opportunity, not only in commodities but stocks in general. This coming week should provide further opportunities to establish new positions. Some of the areas I favor for additional investment are emerging markets, real estate such as REITs, commodities, commodity companies and selected technology.
As for the culprits that triggered the pullback, most of the negative events have something to do with governments. The on-again-off-again saga of the European debt crisis has reignited fresh worries over Ireland’s struggle to rescue its financial system. It has led investors to re-examine Europe’s financial situation in general.
At the same time, China is rumored to be hiking interest rates in an attempt to slow their economy. That would spell bad news for everyone since China has become the new locomotive of global growth. Over in Korea, where the G20 adjourned without agreeing on how to curb the growing currency war, left investors worried and disappointed over the fate of the U.S. dollar.
All of the above are serious issues but they have been with us throughout the year. China has raised rates before and emerging market growth is still quite healthy. The problems of Europe’s smaller economies will continue to plague the Euro and the European Community for the next few years, but has not stopped their stock markets from enjoying substantial gains over the last six months.
The financial world is fully aware of every nuance of the currency debate. The dollar has declined since late August, sending stocks and commodities ever upward. None of this is new. Consider this pullback a healthy correction and that’s all you need to know. All these reasons for the sell-off will still be with us a month from now when the averages have regained their upward ascent, so don’t put too much stock in today’s headlines. They are fleeting at best. Focus instead on the opportunities this sell-off will present.