The markets had pulled back about 5% by Thursday. Technically, stocks were over sold. We were due for a bounce. “Buy the dip” was on everyone’s lips and then on Thursday morning, GDP for the third quarter came in at 3.5%–an upside surprise. Stocks exploded. Sounds easy, right? Think again.
Friday the markets took it all back and then some.
“What happened?” asked a client, who returned from lunch in South County and was totally baffled by Friday’s sell-off, “we wait for good news on the economy for months. We get it and bam, the market sells off.”
In last week’s column “Sell on the News” I explained that markets tend to discount news announcements before they happen and sell when the event occurs. This week we had a belated bout of this same kind of selling on Friday.
Now, there is no question that 3.5% growth in the economy, after four straight quarters of declines, was great news, but at least 3.3% of that growth was anticipated and priced into the markets. Maybe the extra.02% in growth represented an upside surprise, which could account for the 2% plus move in the averages on Thursday but by Friday investors were ready to sell.
I’m sure the market pundits will try to explain this behavior by telling you that a rising dollar was the culprit (maybe) or that consumer sentiment numbers fell in October (true) or that Goldman Sachs is forecasting that Santa Claus has H1N1 (a scurrilous rumor). Forget that stuff. The markets have been dominated by traders since the beginning of this rally. If you doubt that, just look at the anemic volume over the last eight months. Traders tend to rely less on fundamentals like GDP numbers, earnings and the like and more on momentum and technical indicators. They saw a big move up on low volume and decided it was time to take profits. Like it or not, that is the kind of markets we are dealing with today.
So are we facing the long-awaited 10-15% correction everyone has been predicting and waiting for? The bears say yes and argue that 1) the S&P 500 Index has broken technical support at the 200 day moving average at 1042. I have written about the importance of the 200 DMA in past columns but don’t worry –all you need to know is breaking support is a bad sign. 2) volume also seems to pick up whenever the markets decline and taper off when they move up, another ill omen. It means there is less conviction among investors as the markets move higher. And less and less stocks and sectors are participating in the upside. Finally, bears say we are long overdue for this kind of correction because stocks, bonds and commodities are all overvalued.
However, before we weep for the ghosts of profits lost, lets look at the plus side. We have had bigger pullbacks then this since March. In fact, one was almost 7%. As of Friday, the S& P is down almost 6% from its intraday high of 1101 reached on October 21st. So we could just as easily turn around early next week and regain these losses. Bulls so far have been right. Every time the markets have dipped since March, it has been a buying opportunity. I do think this pullback is another opportunity to buy stocks. I’m just not sure if I should buy them here. So I am going to take a cautious route and wait for evidence of further downside before committing capital.