Basking in the glow of a series of record-high feats and with the seasonal benefit of April - historically one of the best months of the year for stocks - the equity market has seemed unstoppable. Frustrated market watchers awaiting a correction from the sidelines may be asking what it would take to derail the market’s determined course to higher levels, if only briefly. The equity markets have done a stellar job navigating bad news over the last year, and adding the year-to-day gains in the senior averages to last year’s substantial returns, an argument could be made that, like a spoiled child, the market may be crying: More! More!
As seasonably favorable as April may be, the market is moving closer to a reckoning moment when investors will hold their collective breath to await evidence that the adage ‘sell in May, go away’ could have some validity in 2013. If the market retreats to a Missourian posture, the ‘show me’ restraint could be enough to slow momentum , cause the market to become more reactive to day-to-day news items, and send traders scurrying with their relatively ‘easy money’ profits to wait it out on the sidelines. Mindful of the rotational consolidations among several key leadership sectors, savvy investors may take advantage of some attractive opportunities making for a good stock-picking environment even if the major indices bend lower.
My correction antenna is up for the first time this year, and arguably for the first time in more than 15 months. A pullback is due. The CBOE Volatility Index (VIX) is highly oversold, pointing to possible traders’ complacency with the uptrend. I am only looking for garden-variety pullback for now – something in the 3 percent - 5 percent range. Still, timing even a moderate decline is tricky business and given my longer-term high side objective for the DJIA (18,000) the risk/reward ratio still looks pretty good here. Most stocks simply are not technically overbought to a worrisome degree. Furthermore, the technical underpinnings of many leading stocks are such that even if they were to sustain a sudden downturn it is not likely to be lasting. It is more likely that decline from here will prove to be a short-term buying opportunity rather than the start of a long and sustained period of consolidation. In other words, despite its moderately overbought status, the market’s underlying positive bias should be preserved and bolstered by a correction from its current levels.
At this writing, stocks are reacting negatively to weakness in the commodities markets. Gold had tumbled well below $1400/oz. – not entirely surprising since it broke below important technical support at $1575 recently. Somewhat more troubling is the selloff in West Texas Intermediate oil which has pierced its 200-day moving average, triggering technical selling. A loose correlation between oil and the stock market has prevailed through much of this market cycle. I have argued that the general behavior of oil is worth regarding as a measure of investors’ perceptions about global economic activity. Oil’s technical failure should be relatively short lived. And, to be sure, its weakness could benefit a number of sectors, including consumer discretionary, airlines and chemicals. But, the decline in oil may be a reminder that there are remaining concerns about growth that must be reckoned with. Since the weakness in commodities has not been accompanied by a surprise event, I think the commodity-driven weakness is likely to be contained within normal support boundaries.
When it comes to earnings results relative to Wall Street’s expectations, I am in the camp that believes first quarter results will surpass consensus expectations by a margin on par with the average beat-rate in the prior six quarters. First quarter earnings may stimulate individual stocks rallies and spur some sectors higher, but the major stock indices may not fare as well. While general market consolidation may not be attributable to a single factor or event at this juncture there may be considerable positive expectations already baked into the market with respect to earnings outcomes. A selling-into-good-news syndrome may apply here given the DJIA’s strong performance so far this year. DJIA support should fall in a range between14,000-14,500 short term. I do not anticipate such an intermediate correction will meaningfully alter leadership. Among my favorite categories are airlines, aerospace/defense, consumer staples, energy, financials, health care, media and entertainment, and railroads.
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Gene Peroni, Jr. is a well-known market strategist. His daily podcast and monthly "Peroni Report" offer subscribers a unique technical perspective on the equity markets. His highly regarded "Peroni Method" of selecting stocks is a methodology pioneered by his father over 50 years ago. He is a regular guest on CNBC and Nightly Business Report and has provided commentary on MarketWatch Radio and CBC RadioNetwork. He is a Senior Vice President and Portfolio Manager at AAM.