Market Correction Ahead?

Despite the market’s buoyancy lately, there is much for investors to worry about near-term, particularly dysfunction in Washington. Be ready for a possible stock retreat in the 10% range, which signals a correction. The market’s pullback over the past couple of days may portend weakness ahead.

The Dow Jones Industrial Average and many of the other major indexes powered their way through January, producing the best return for the January indicator since 1997.  The enthusiasm carried over into February, with the Dow reaching 14,000 for the first time since October 2007 (the beginning of the fiscal crisis), bringing cheers from many investors.  The Standard & Poor’s 500 also hit a five-year high a few days later. 

What’s not to like about this market and the economy, especially after the government revised last year’s employment numbers upward by over 400,000 new jobs? In the long run, earnings drive the market, not the headlines from day-to-day. Even at today’s numbers, the market trades at a reasonable level based on historical averages. 

We have reason to worry, though. Over the next few weeks, Congress will grapple with sequestration (automatic federal spending reductions), budget cuts and higher taxes. President Barack Obama’s State of the Union address solidified the extremes between the two political parties, which might make all that is to come even more difficult. 

On March 1, sequestration sets in.  Then in May, the debt ceiling is back in the news. All the while the president is pressing for more taxes, mostly in the form of closing “loopholes,” but tax increases nonetheless. All this will eventually weigh on the minds of Wall Street and Main Street. 

Consumer confidence fell as Congress stumbled through a yearend debate over the tax increases. Of course, every working consumer has 2% less each month to live on because the temporary Social Security payroll tax reduction expired.

By no means do we want to diminish the massacre at Newtown, but all of the time spent on gun control (which can be done at any time), or anything else, takes time away from Congress’ ability to pay attention to the economy, which should be its number one priority at this time. 

The concern over the fiscal cliff in the fourth quarter last year led to the lowest defense spending since the Vietnam War ended, and along with Hurricane Sandy, helped take us to a modest decline in gross domestic product for the first time since 2009. 

While long term we continue to see a slow and steady economic recovery, it would not take much for it to retreat, just as we saw in last year’s fourth quarter. 

Although the recent gains in the market are make investors happy and there does seem to be a new enthusiasm for equities, you need to focus on the long term and not the short term. 

At some point, the market is going to take a breather and perhaps even drop by more than 10%.  That is when it will be important to stay the course. 

Although investors poured money into equities during January and early February, they still found a way to increase their investments in bonds, as well. Yet if investors retreat quickly from bonds and put that cash into equities, the bubble may burst on the bond side and a bubble form on the stock side.  It will feel good on the way up, but it could be ugly on the way down, so we remain cautiously optimistic. 

The rest of this year has potential for growth, and if the jobs number were to pick up it would be a healthy sign leading into 2014.    

 

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V. Raymond Ferrara, CFP, CSA, is president and chief executive of ProVise Management Group LLC in Clearwater, Fla. 
 
This material represents an assessment of the market and economic environment at a specific point in time. Due to various factors, including changing market conditions, the contents may no longer be reflective of current opinions or positions. It is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Please remember that past performance may not be indicative of future results.
 
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