Market Correction Looming?

Today the S&P 500 (SPY) is flirting with new highs, based on our research this price action is to continue and should cause the index to close at a brand new high for the year. The technical picture looks bleak. For the last month, the market has continued its rally on lower than average volume. Fundamentally, the facts show that although there are signs of improvement in the economy, the full extent of the recent rally is unjustified. The consumer will continue to be a drag on the economy. The average consumer is still in a deleveraging/saving frame of mind and does not have a strong appetite for new credit to finance larger purchases. With unemployment continuing to be a threat, and consumers racing to either save or pay down debt, our view of economic growth seems to be temporarily constrained. A good percentage of this year’s market rally can be justified fundamentally, relative to the desperately oversold levels we were in during February. Most companies have cut costs which in turn, has increased profitability, but the real question, and what we believe will hinder positive results this coming earnings season is top line growth. After all the major cost cutting efforts that occurred throughout the recession, companies are poised to meet and possibly beat expectations on the bottom line. Our focus this earnings season is on new revenue. If companies don’t improve the top line it only shows that any good result is a function of cost cutting efforts that simply will not be sustainable in the long term.

We expect to see a near term shortfall in the market in the range of up to 10%. A way to hedge your portfolio or make a play on this information, would be to short the S&P 500 (SPY) or put on a contrarian position on the temporarily media, and investor hated US Dollar (UUP). Going long the US Dollar (UUP) would temporarily hedge you against a market shortfall because it has been trading inversely to S&P 500 (SPY). Our long term view on the US Dollar is bearish for obvious reasons, but in the near term a short term rally in the US Dollar(UUP) is rather probable. The chart below shows a comparison between the recovery periods. The 1974-75 upswing vs. this year’s market rally. If you notice, there are many similarities between both time periods. When we started comparing both upswing back in August we used it’s .93 correlation to project the future moves of the S&P 500 (SPY). As of now it has been fairly accurate and following its course. If this analysis holds true, there is a slight pullback on the horizon.