In case you forgot how painful corrections can be, this week reminded most folks that financial markets can move in both directions. Yet I’m not seeing any panic, which may or may not be a good thing. The best I can say for the markets right now is that we are at least half way through this correction.
For some investors, it is hard to imagine for some investors that a week that was practically full of good earnings announcements, many far better than expected, could be greeted by wave after wave of selling. Even Apple’s fabulous earnings and roll-out of their new Ipad failed to stem the tide of selling that the tech-heavy NASDAQ encountered. The confirmation of Ben Bernanke to a second term as Chairman of the Federal Reserve was met with a resounding “who cares,” although just days before traders warned that a failure to appoint him would be a disaster for the market.
Friday’s fourth quarter GDP number surged 5.7% far higher than economists forecasted, and still the markets faltered. President Obama unveiled a set of new initiatives to grow the economy, reduce unemployment and help small businesses. No one paid attention, except possibly me. Instead, investors chose to dwell on the problems surrounding some of the countries in Europe, especially Greece, whose sovereign debt is shaky at best and Japan, whose deficit rivals only the U.S. in magnitude. It is clear that investor psychology and sentiment have changed from “half-full to half-empty”. That should provide an opportunity for contrarian investors such as myself.
Last week, I advised caution and identified 1090 as a level on the S&P 500 index that had to hold or else. It broke that level and so far we’ve dropped to 1071. That works out to be a 6.3 % decline so from the top. I think the downside risk on this dip is S&P 1025-1035 or a total 10% correction. However, I’m not waiting around for that low because although I might be right, the markets could easily drop a few more points from here and then stage a sharp recovery.
“Never worry about catching the bottom or the top,” said one of my mentors back when I had hair and could still travel all night and work all day.
I try hard to follow that advice, so over the next week I would be putting some cash to work in the technology and commodity areas. Both have sold off far more than the S&P and yet, in my opinion, their future growth prospects are above average. Another area that looks quite attractive to me now is emerging markets. These markets started to correct about a month before the U.S. and have fallen far more; China, India, Brazil, even Russia, look tempting to me as does the rest of South East Asia and Latin America. I feel strongly that emerging markets should have a place in every investor’s portfolio.
It is also interesting to note that the tired old theme that most asset allocators try to sell you is not holding up in this correction. Their claim that a portfolio of bonds, stocks, commodities etc. will provide the best returns “over time” and a buy and hold strategy works best, held no water in 2008-2009 and it is leaking once again today in this correction. Cash and Treasury bonds are about it right now if you want to protect your principal (plus inverse securities), but how many advisors have done anything but blink at their computer screen and hide under their desk in the last week? Maybe that is unfair. I’m sure there are some advisors out there somewhere who have acted upon their own initiative to protect your portfolio.