Do You REALLY Want That 10% Correction?

Many have been calling or looking for that big drop as an opportunity to get on board.  But as we know, markets rarely accommodate, adding to the frustration of those who continue to miss out.  Of course, the longer term market trend has always been up (we’re talking since the beginning of time), but the trickier part is when to get in.  Market timers claim to have an advantage of jumping in/out at exactly the right time, but that has consistently proven wrong.  They will be right sometimes, but like a broken clock that is always right twice a day.

So, if you’re on the sidelines waiting is there really a number that gets you back into the game?  Historically we have seen big drops like 10-20% (typically, the bigger number designates the start of a bear market) but were not immediate buying chances.  As this week was the five year anniversary of the low point of the SPX (666 on March 6, 2009) following the financial crisis, that drop from the peak just less than year prior was far deeper than 10%.

As the volatility rose the fall became precipitous and deadly to try an entry.  How many of you were in the hole by the time the bottom actually occurred?  I know many strategists, analysts, experts and pundits advocated getting in at every drop from Oct 2008 through Mar 2009.  Down 10%, then down 20%, then down 30% – you get the picture. At some point they are right, but how far behind are you before that miracle hits?

Today, with markets at/near all time highs, no big correction for many months it seems we are set up for something big to happen.  Since 2011 the best correction we could get was around 6-7%, and that didn’t happen often.  But there has been a pattern of buying 3-5% dips that has worked out nicely – SEVERAL times.  But if you had said each time ‘this was the big one, I’ll buy down 10% or so’, then you lost an opportunity, and if you went short looking for more downside at the down 3-5% drop you got burned – FAST (see the recent fast recovery from that late January fall into new highs in mid February).  I suspect the next 3-5% drop may be bought up again, but at some point that pattern will fail.

A 10% drop can happen fast but would do more damage than anything, eroding confidence and creating doubt.  That confidence is the very thing shored up by an aggressive Fed, and fortunately they have not sacrificed the dollar and buying power to achieve it.  We would see a rise in fear (via the VIX), puts being bought with reckless abandon, selling pressure and buying of protection.  But a substantial drop would pile on selling not just from retail clients but from institutional investors.  There would be a significant shift in sentiment, character, market structure and of course – the chart.  For the SPX 500, a 10% drop from here merely gets the index back to 1690, we were just there a month ago – so no harm, right?

Well, not so fast.  We’re talking confidence, behavior and commitment here.  I can see many ‘waiting’ to jump back in before seeing a big drop settle out.  A pause in the buying, dip buyers used to smaller drops would wait.  In addition, we pay attention to volume – the key to knowing where the money is flowing.  If the volume starts to rise sharply and consistently – then we’ll know distribution is of the institutional variety.  The trend would likely turn down and that would be ideal for finding some short or put plays, looking for that momentum to continue.

That being said, I would mostly stand back until the smoke clears, which would likely be further down than 10%!  Be careful what you wish for.  As I rarely look for tops and bottoms (that is a loser’s game), waiting it out for a rise back up or playing it short for continuation would be my play.   Bob Lang,