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Correcting? Maybe

04/13/2011
This week, the capital markets are digesting some disappointing news which may initiate a modest market correction. The depth, duration, and confirmation of a correction remain to be determined. Attempting to answer those questions, I suggest that investors consider the following reference points:  From a technical standpoint, maintaining the S&P 500 Index above 1273.00 (Fig 1.1) will be important to the bullish structure of this year's advance. The end of any potential correction attempt will be confirmed with price action above Friday, April 8th's  1328.17 closing price (Fig 1.2).
 
Let's take a look at what is bothering the markets this week:
 
  • Earnings results from Alcoa (AA) and JP Morgan Chase (JPM) have not exceeded lofty expectations, therefore selling pressure has emerged in the financial and industrial sectors - 2011's top two sectors. 
  •  Oil futures have traced out a significant weekly reversal which is weighing on energy equity names. Keep in mind that with a S&P 500 Index weighting of slightly less than 13%, weakness in energy equity names will translate into broader market weakness.
  •  GDP estimates are being revised lower for the current quarter and Q2, on average about half a percentage point for each. This week's weaker than expected business inventories and export data combined with rising inflation will reduce output - I agree with the GDP reductions.

If a correction is unfolding, it is certainly long overdue.  I expect it to be shallow in terms of price; duration remains the open ended question, although I do not expect another Baseball Season of Frustration, circa 2010.

The capital markets are normalizing, anticipating the end of QE2 and a reduction in the size of the Fed's balance sheet. The overweight risky asset trade ended in late February. For those seeking an immediate opportunity, it is interesting how the emerging markets have regained leadership status as our market is potentially correcting. 
 
 
Fig 1.1 S&P 500 Index with critical 1273.00 support level highlighted

Source:  Bloomberg

Fig 1.2 S&P 500 Index with Friday April 8th 1328.17 closing price highlighted

Source:  Bloomberg

Fig 1.3 Exports Soften

Source:  Bloomberg

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