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Craig Allen: Opportunity May Be Knocking, If Stocks Experience a Short-Term Correction

There are several signs that the markets are primed to lead a U.S. recovery

By Craig Allen, Noozhawk Business Columnist | @MPAMCraig |

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Stocks have made an incredible run over the past several weeks since the December lows. From both a technical and fundamental basis, stocks look poised for a short-term correction. For investors who have cash on the sidelines, this may be the best opportunity to get fully invested before the next up-leg of this bull market.

The Standard & Poor’s 500 set a low of 1,205 on Dec. 19. From that point, the index rallied to a high of 1,351 on Fe. 9 — a 12.1 percent gain in less than six weeks. During that same time period, the NASDAQ gained an amazing 15.5 percent. The October low for the S&P 500 was 1,100. Since then, we have seen stocks gain more than 47 percent in just five months.

I am bullish on stocks and the U.S. economy overall. I have a target for the S&P 500 of 1,500, which I believe the index will achieve sometime in 2012. However, I do not expect stocks to take a straight path up to that level. There are always short-term corrections during any bull market, just as there are always short-term rallies during bear markets.

From a technical analysis viewpoint, there is a huge amount of congestion around the 1,350 level. The high over the past 12 months occurred on April 29, at 1,364. I believe stocks will need to make several pushes up to the 1,350 area, before we will see stocks trade up through 1,350 and into a new, higher trading range.

If we review the charts, looking for downside targets, we can see support at 1,250, 1,200 and 1,150. I am looking for at least a 5 percent to 10 percent correction in the short term, which would take the S&P 500 down to around to roughly the 1,250 area. That is my minimum expectation for the correction, although I feel we could easily see the 1,200 level.

At present, I am holding about 40 percent of my stock allocations in cash, (for portfolios containing allocations to stocks). I also sold calls recently, with March expirations, against remaining stock positions. Should we have a correction, with stocks moving down to at least the 1,250 level on the S&P 500, I will begin to put my cash back to work in stocks. If we see the index fall to 1,200, I will be much more aggressive with my purchases, with a higher sense of urgency to get my cash back into the market.

Several fundamental factors could contribute to a short-term correction, including continuing problems in Greece and other deeply indebted countries across Europe, increasing tensions between Iran and Israel over Iran’s development of nuclear weapons, intensifying political unrest in Syria, and political and economic developments here at home. Stock valuations are also quite pricey at current levels, which causes many investors to have itchy trigger fingers, reacting — or perhaps overreacting — with any signs of trouble, selling stocks aggressively to lock in the paper profits they have accumulated over the past several months.

Should we get a correction in the near term, this could be the best and last opportunity to put cash to work before we move up into a new, higher trading range above 1,350 on the S&P 500. Once we push up through the 1,350 level, stocks should achieve that new, higher trading range, and, short of a serious hit to the economy, we should stay above the 1,350 level for a significant time period.

The areas of the market on which I will be focusing, should we get this short-term correction, will be those sectors of the economy that tend to perform best during an expanding economy: technology, financials, consumer discretionary and industrials. Financials are especially interesting since we cannot have a sustained recovery in the economy without the financials fueling it. Our economy operates on credit, not cash, so without access to credit, we will not see sustained growth. Stocks in the technology, consumer discretionary and industrials sectors tend to produce much higher revenue and earnings growth rates during times of economic expansion, which tends to make their valuations much more attractive as compared to stocks in other sectors. Attractive valuations tend to attract investor capital, which eventually pushes stock prices higher.

Predicting the direction of the financial markets is always challenging, and short-term moves are even more difficult to accurately identify. It is certainly possible that stocks will just keep going up and run right through the 1,350 level and never look back. I can only use my experience to try to identify opportunities for my clients to benefit from the opportunities I see. I could always be wrong, which is why I am still 60 percent invested in stocks. I’m certainly not always right, but I have performed well over the years for my clients using the same process and strategy. My MPAM Model Growth Portfolio is up about 200 percent since its inception in May 2004, with the S&P 500 up less than 16 percent during that same time period. Last year, the MPAM Model Growth Portfolio gained 13.5 percent, while the S&P 500 was flat.

As we look ahead, I am optimistic that the U.S. economy will be the first of the major developed countries to emerge from this long, painful period of economic strife. I believe our stock markets will also be the first to lead the world to strong returns, and that the optimism that results from a more positive economy and stock market performance will drive a long period of prosperity and full employment for the United States.

Craig Allen, CFA, CFP, CIMA, is president of Montecito Private Asset Management LLC and founder of Dump Your Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at .(JavaScript must be enabled to view this email address) or 805.898.1400. Click here for previous Craig Allen columns. Follow Craig on Twitter: @MPAMCraig.

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» on 02.13.12 @ 03:20 AM

Craig, you said stocks have gained over 47% in just five months. I can’t seem to reproduce your number. I come up with 22%.

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