Five Reasons Why The Market Correction Is Over – Bull Rally Continues But With Increased Volatility!!
by Ian Harvey
July 03, 2013
After months of warnings from various quarters – investors, traders, analysts, strategists, hedge fund managers, etc., -- that a market correction was imminent, the long overdue pullback finally arrived. The S&P 500 fell almost 100 points, or 5.8%, from its all-time high of May 21. It was the first 5% correction in over 200 days.
It appeared that stocks might be going to have some further suffering for a while, but this was not to be. Last week the markets recovered. The S&P is up 3.3% in the last five trading sessions, reclaiming most of the losses suffered during its month-long mini-slump.
Five Reasons to Believe the Market Correction is Over :
1. Investor Fear is Fading
“…..The CBOE Market Volatility Index (VIX) ), widely considered the best gauge of fear in the market, plunged 7.8%, or 1.6 points, to close at 18.90, after Thursday's spike higher that took it above the 20 threshold….Still, the VIX surged 10.2% for the past week.”
--The Past Week in the Stock Market – June 24, 2013
Two weeks ago, the CBOE Volatility Index (VIX) - a.k.a. the investor fear gauge – managed to climb above 20 for the first time this year.
The long-awaited, much-forecast market correction had finally arrived on that Thursday, 20th June, 2013. In the 25.5 hours since Ben Bernanke took the stage Wednesday, stocks had nosedived, falling 4% on Wednesday and Thursday. Stocks weren’t the only assets dropping, however.
Here’s a full breakdown of that day’s market collapse – the biggest one-day market correction of 2013:
• The Dow Jones Industrial Average dropped 353 points, the index’s biggest one-day decline since November 2011. All 30 Dow components fell at least 1%.
• The S&P 500 had declined 3.8% in the two days (Wednesday and Thursday), erasing all of May and June’s gains in one fell swoop. Since May 22, the index had now fallen 5%, breaking a streak of more than 200 days without a 5% drop-off.
• Commodities fell dramatically. Gold dipped below $1,300 an ounce for the first time since September 2010. Silver prices declined 7.6%. Oil tumbled 3.8%.
• The VIX skyrocketed. The CBOE Volatility index shot up 23% on the Thursday, topping 20 for the first time all year. It was now up 64% in the last month. Investor fear had most definitely returned.
• Small caps declined even further than the broad market. The Russell 2000 fell 2.7%.
The Friday following turned out to be a much better day!
The VIX had been rising steadily for more than a month, advancing 64% from May 17 to June 20. Talks of the Federal Reserve "tapering" its $85 billion-a-month bond buying fueled investor fear leading to the market correction, peaking in the days after Ben Bernanke's recent confirmation that the Fed does indeed plan to put an end to QE3 sometime in the next year.
In the last week, however, that fear disappeared - perhaps because investors are coming to terms with the idea that less money printing is actually a “good” thing. In just five days, the VIX fell 20%. That's a trend in the right direction.
2. U.S. Stocks Remain Cheap
“…..But the earnings reporting cycle is about to take the spotlight with Alcoa’s (AA) release on July 8th….. As has become customary at the start of recent quarterly earnings cycles, expectations for the Q2 earnings season remain quite low. A major driver of these low expectations is company guidance during the Q1 earnings season, which was overwhelmingly on the negative side. Total earnings for companies in the S&P 500 are expected to be down -0.3% from the same period last year on -0.5% lower revenues and almost flat margins. This is sharply down from +3.9% growth expected in the quarter in early April….”
- The Week Ahead in the Stock Market – July 01, 2013
Second-quarter earnings season begins next week. As of now, however, U.S. stocks are trading at an average of 15 times what companies have earned in the past year. That's below the median 16.1 price-to-earnings ratio of the past decade. Comparatively, stocks are still cheap - even as they approach record highs again and no market correction in sight.
3. According to History
According to the Stock Trader's Almanac, July is the best month for stocks in post-election years. Since 1950, the S&P 500 and the Dow Jones Industrial have risen by an average of 2% in the year after we elected a president. The Nasdaq has performed even better, advancing an average of 3.1%. There's another positive historical trend working in the market's favor this year. When stocks rise in January and February, as they did this year, the S&P posts an average full-year return of 24%. That would be another 10% rise from today's prices.
4. The Influence of the Apple Factor on a Market Correction!
Most stocks have thrived this year. Apple (NASDAQ: AAPL) has not been one of them.
Apple continues to follow a pattern of falling lower every time Wall Street’s talking heads insist it has hit a bottom. The stock mounted small rallies in January, February and March, a better rally in May (twice) – only to fall back each time and sometimes further than previously.
This chart demonstrates Apple’s two-steps-forward, three-steps-back performance so far this year:
But Apple’s decline extends back further than the beginning of the year. Right now it’s at seven months.
Here’s a timeline of Apple’s performance since late September:
• Sept. 18: Apple shares top $700 for the first time in their history.
• Sept. 24 – Nov. 15: The stock loses 175 points – a 25% drop-off in less than two months.
• Nov. 19 – 26: A Thanksgiving week resurgence! Shares shoot up 12% in just five trading days.
• Dec. 3 – Jan. 25: A steady decline. Apple shares shed another 147 points, dropping to a 52-week low of $439.
• Feb. 4 – 11: Is the rally on? It looks like it after the stock advances 8.5% in a week.
• March 4: Never mind. The stock hits another year low, settling at $420 per share.
• March 13 – 25: Another false alarm. The stock reclaims the $463 mark. Alas, the rally was again short-lived. A new decline began the next day and shares haven’t been this high since.
As can been seen above, shares of the world's largest company have been mired in a nine-month slump, falling 41% since last September. During that time, the S&P 500 has advanced 10% and the Nasdaq is up 7%. Not too long ago Apple essentially was the market. When it rose, so did other stocks. Lately, however, the market has risen in spite of Apple - not because of it. Despite its recent struggles, Apple still remains large enough to have a major influence over the market. If Apple ever gets out of its current rut, which will likely give the market another boost.
5. QE3 Hasn’t Been Stopped
“…..On Wednesday, after the Fed met, he put more details around the plan and said if the economy improves enough, the Fed could begin to wind down its $85 billion in monthly purchases before the end of the year and complete the program by mid-year 2015…..The Fed also released an improved outlook for unemployment, with its range of estimates falling below 7 percent in 2014 and to 5.8 to 6.2 percent in 2015. The Fed forecasts also showed that more members see an early 2015 move to raise the target Fed funds rate…..Even though the economy hasn’t been great -- employment is still high and U.S. growth has been anemic – the situation could have been a lot worse. Investors were confident enough in a growing economy that the Standard & Poor’s 500-stock index hit an all-time high of 1,669 on May 21.”
-The Past Week in the Stock Market – June 24, 2013
QE3 isn't ending anytime soon. It could be another year until the Fed pulls the plug on its stimulus program. Until then, the bull market will continue to move upwards. Stocks tend to rise during periods of quantitative easing. During QE1, the S&P returned 37.3% in 16 months. In QE2 (Operation Twist), the index gained 10.2% in eight months. Since QE3 was announced last September, stocks have risen 10% in less than 10 months. With another 10 months - or more - remaining until QE3 disappears, it's reasonable to expect stocks will keep rising.
Conclusion to Stock Market Correction
Volatility is expected to continue however, and will be particularly volatile in the next two trading days of this week due to the fact that a great deal of data will be released before the Friday’s job report. A further market correction is not expected anytime soon!
With stocks still testing a breakout above 1620, the fireworks may come on Wednesday July 3rd. That is especially true with 2 heavy weight reports on the docket -- ADP Employment and ISM Services.
Also, since stocks remain trapped in this recent range of 1600-1625 on the S&P 500, the options market is signaling a big move in macro securities (i.e. bonds, gold, silver, etc.) this week. For this reason, expect the shortened trading week to be fairly eventful but no major market corrections are on the horizon.
The summer can be a slow period for the market. But there is compelling evidence that investors will continue to favor stocks over bonds.
With stocks up considerably in 2013, the rapid rise for the market may slow down a bit. But even so, stocks are attractively priced, offer attractive yields, and are positioned for profits in the coming six months.
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