Correction Ahead?
Research for Online Investors

by John Dalt

1/26/10

Trading stocks can make a person humble. The market has had a great run in the last nine months. We took some nice gains. Sometimes, you feel like you can see the future, and when the market moves as you expect the verification is a heady rush. It is not hard to predict the market, just hard to be right.

We have to be careful to not let our bullish sentiment override a detached view of what is occurring.  “Rose colored glasses hide all the truth,” to take a line from an old country music song.

Where do we think the market is now?  On a precipice.  The price advance has outrun the underlying fundamentals of many company’s earnings power.  Quarterly and end of year earnings statements are generally in line with expectations, but where does the growth come from to justify the earnings multiples the market is trading at now?

Historically the market trades at about sixteen times earnings, we are now at twenty. This means investors have priced 20% earnings growth into the present market.  This would allow earnings to catch up with current stock multiples.  This doesn’t mean the market has to fall tomorrow, or next week. What it does tell me is the day of reckoning is coming, probably just in time to catch some scared investors that are just starting to enter back into the market.

One thing that worries me is the time of the year. Last year we were happily cruising along toward March 6th. We managed our stop losses and watched incredulously as stocks broke down and set new lows after new lows had been set.

The last two days the market has set new lows since 11/12/09  We just lost two months!  I saw a statistic that a Dow close in the first quarter below the December low predicts further lows 93.5% of the time.  Since 1950, this occurred 31 times, 29 times the market continued to decline.  All is not lost though, as about half the time the market ended higher for the year.

Over the last sixty years, two months average losing money.  September is the worst, and February comes in a close second as the weakest months of the year.

What is the take away from all of this?  Be careful; don’t rush to buy what appear to be wonderful deals on your favorite stocks.  They are probably going to get cheaper, maybe a lot cheaper.  You may also want to look at some of your biggest gainers in the last nine months, and take a little money off the table.  Dry powder is always a nice commodity to have in uncertain times!

The Labor Department reported that nonfarm payrolls (jobs) decreased by 85,000 in December while the data for November was revised upward and now shows a gain of 4,000 jobs. Today's chart illustrates the percent increase in the number of jobs for every decade since the 1940s (the data goes back to 1939). The number of jobs at the end of a decade has been anywhere from 20% to 38% greater than 10 years prior. That 20% plus growth has been the case until the last decade, during which the number of jobs basically ended the decade where it began. This subpar job growth is particularly noteworthy due to the fact that the US population has increased by 10% (illegal’s?).  There has also been a significant increase in global wealth during the same time frame.

The President delivers his State of the Union address Wednesday night.  We should be mindful of the potential impact on the markets.

"When you subsidize poverty and failure, you get more of both."  - James Dale Davidson, National Taxpayers Union

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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