Stock Market Correction By Time Is Bullish
Nothing goes up forever… Heck, even the strongest bull markets have to take a break from time to time.
The question on everyone’s mind is… Is the market’s recent weakness simply a correction within a bull market or is it the start of a new downturn?
First off, don’t forget what was driving the markets higher in the first place. It was bullish investor sentiment.
Sure, third quarter earnings were strong. And the leading economic indicators are showing improvement. But it was really bullish investor sentiment pushing markets higher. The Fed’s second round of quantitative easing (QE2) was the wondrous future event that had everyone looking through rose colored glasses.
Fed Chairman Bernanke even said he wants QE2 to trigger a “wealth effect”. And just so we’re all clear… wealth effect means higher stock prices.
This kind of thinking drives investors into risky assets. As a result, the US Dollar plummeted 9% since the Fed began hinting at QE2 in August. And the S&P 500 was up 18%!
Now QE2 is reality. Investors are now searching for the next smokin’ hot catalyst to propel the market even higher. It’s been difficult to find! Instead, bullish investors have been dealt one blow after another.
Here are just a few of them…
Bullets are flying on the Korean peninsula. Inflation is heating up in emerging markets. European sovereign debt problems are bubbling up again. QE2 is being called ineffective. US housing prices took another downturn. State and local governments are slashing spending. Federal government is in gridlock. Currency wars are hurting globalization and free trade. And now WIKILEAKS is exposing top secret diplomatic wires.
Whew… Those are some serious headwinds any way you slice it.
One thing’s for sure, it’s made things riskier. These headwinds are sending safe haven investments like the US Dollar higher. It’s rallied nearly 7% since QE2 was announced.
But here’s the good news…
The S&P 500 is only down about 3% over the same time frame. In light of all the negative news and the rally in the US Dollar, the mild pullback in stocks is outright bullish!
In fact, this is the most bullish type of correction. A correction by time. It’s a sign bullish investor sentiment could send this market higher in short order.
You see, corrections can occur in price or they can happen by time. A typical correction by price means the market will retrace some percentage of the previous rally. The smaller the retracement of the previous rally the more bullish the correction.
Obviously the most bullish correction is one where the price doesn’t fall at all. Rather the market holds near the highs and consolidates over time. It allows the moving averages to catch up to the price. It’s called a correction by time.
Take a look at this chart of the S&P 500…
You can see the big rally in September and October. But the market has been relatively flat over the last month. It’s allowed the key 50-day moving average to catch up with the price.
This is a classic correction by time. And it’s a very bullish technical indicator.
But we’re not out of the woods just yet.
We still need to see the market bounce off the 50-day moving average. When we get a solid bounce, buckle your seatbelt… bullish investor sentiment could send this market into overdrive.
Category: Stocks
