Opinion: Dow Jones’ dive simply a corrective matter

What had elicited her call was the letter I wrote to our clients on Feb. 16. It read:

Here’s something you won’t hear us say very often: The market needs to correct.

This is one of the longest bull market runs without a 10 percent correction, or for that matter, even a 3 percent correction, and while we wish such occurrences weren’t necessary, they are an important part of long-term positive market cycles.

We aren’t saying that a decline of that magnitude is imminent – predicting such events is easiest done well after the fact – but that we would be neither surprised nor disappointed should a sell-off occur.

The economy remains in a steady, although not spectacular, growth mode, with low interest rates, low inflation and low unemployment. So why would the market decline? For any number of reasons, not the least of which is the above-mentioned duration of this bull market. Another is simply that markets sometimes get ahead of themselves and then pause, letting the fundamentals of earnings catch up with them.

During such periods, we normally find that the screens we use to identify undervalued issues produce limited results. That is the case now. Fewer and fewer issues meet our criteria. The positive side of that scenario is that very few issues on our watch list are near the full-valuation level. It’s a neutral area – call it a no-man’s land for the time being.

So, are we worried? No, just watchful. Very watchful.

We were not the only firm to identify the potential for a market correction, although I wonder how many wrote to their clients before it happened to prepare them for that possibility.

Was the sell-off caused by Alan Greenspan’s remarks about the possibility of a U.S. recession, the fear of an international economic ripple effect from the near 10 percent drop in the Chinese markets or the subprime mortgage companies’ write-off problems?

Some referred to it as a “perfect storm” of all of the above, plus the willingness, even eagerness, over the past several months for investors to assume more risk. One factor that wasn’t mentioned was what we see as an underlying and growing concern about the possible problems that Congress could create as evidenced by the Democrats’ protectionist proposals, tinkering with (think increasing) the tax rates on dividends and capital gains, government-run universal health care, and any number of other vote-getting positions that appeal to far too many voters who are susceptible to such populism.

Let me add to the “market is likely to correct” thinking by tossing in an indicator that is neither fundamental nor technical, can’t be quantified or shown on a technician’s chart, but which in the nearly four decades I have been in the business has never failed to indicate an overextended market.

It’s the “Why is there all that cash in my account?” indicator.

In spite of our best efforts at explaining to new clients that one of the advantages we have as a small firm is the ability to easily raise cash in uncertain times, we have a few clients who are contrarian indicators. In early February, we got calls from two of our early warning system clients.

So what’s an investor to do? Be aware that, in absolute terms, a 10 percent correction from the Feb. 20 Dow Jones industrial average closing high of 12,786.64 would be 1,278.64 points, a level as of the date of this writing that is 727 points lower. Sounds worse in absolute terms, doesn’t it? Sell-offs of that magnitude have occurred 29 times since 1950 and will happen again.

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.[[In-content Ad]]