Rumors of the bull market's demise may have been greatly exaggerated by perennial bears intent on reciting the same tired saws that have failed to hit pay dirt for years. These bears must have felt they had finally grabbed the brass ring with January's so-called "rout" that was, in reality, anything but. Broader market indexes such as the Russell 3000 and S&P 500 fell little more than 3% while the Dow Jones Industrial Average surrendered just over 5% — all within my "garden variety" correction parameters.
While the selling persisted into early February, the turning point came on a snow-bound Monday on the East Coast. On Feb. 3, the Dow tumbled 326 points to close at 15,372.80. In that session, fear hit crescendo levels as evidenced by the CBOE Volatility Index, which climbed to 21.44 (far above its January lows near 12). Since that day, the DJIA has not looked back, marching instead above 16,000 little more than one week later. It accomplished this with the strength of resilient sector leadership that was, in turn, bolstered by better-than-anticipated earnings and ongoing Fed monetary accommodation.
The technical earmarks of a normal correction were evident based on several factors besides the modest percentage retreat figures alone. For instance, most of the stocks and sectors that drove the market higher in 2013 were collectively the horsepower for the major stock indexes' rebound earlier. The market precept that those sectors leading the market higher before a correction often are the same sectors that lead the market out of correction was eloquently acknowledged years ago by renowned portfolio manager Peter Lynch, who stated that it is not "timing the market" but "time in the market" that makes for successful investing. Of course, this assumes that we are in a secular bull market cycle, which I think is fair to assume based on the market's gains since March 2009 alone. This bullish cycle continues to be reinforced by accommodating and transparent Fed monetary policy, as well as by better-than-expected earnings expectations quarter after quarter … after quarter. So, holding steady through this chapter of market volatility may have proven to be the best tactic.
Another item that redoubled my position that stocks are merely in the throes of an intermediate consolidation was the trading action in West Texas Intermediate crude oil. Since the start of this cycle, there has been a general correlation between the price of oil and the direction of the equities markets. Oil did not breach significant technical support at $90 per barrel in January and has since rallied above $100 to reclaim its 200-day moving average. This may not serve as stand-alone evidence of a "normal" correction but when combined with other constructive elements of January's retreat, it does line up nicely with my prediction that the year-to-date trading vacillations are a healthy technical interruption of the uptrend. Another one of the other bullish features of the pullback was net money flow, which continued to indicate an accumulation-on-weakness trading bias. I also believe the leadership of the Dow Jones transportation average presents Dow Theory confirmation that the bull market remains in force.
Not surprisingly, the implications of this year's January effect are being actively debated up and down Wall Street. While some technical levels were momentarily breached, these fleeting violations should be inconsequential to the longer-term outlook. January's market was likely more predictive of the heightened volatility we might experience through much of 2014 rather than a harbinger of year-long decline. The DJIA made an impressive comeback from its lows just below 15,400. This established a "V"-type formation, which I find somewhat less desirable than a "saucer" or "cup" bottom that establishes a base through gradual and orderly backing and filling movements. The "V" movement reflects rapid vacillations in investor sentiment with an institutional trading bent. Inasmuch as the market may have reached a short-term selling extreme, completion of a bottom may necessitate further expansive trading swings that test and secure support in the DJIA's upper 15,000s. This possible downside risk compares with my upside target of 18,000, or higher, by the end of June.
With the Feb. 3 decline, I believe the worst of the short-term correction is in the rearview mirror. It seems likely that the elusive 10% correction will be postponed once more. It is my recommendation that investors not obsess with this prospect. The market's ongoing self-policing exercises have significantly addressed near-term technical overbought movements, thereby forestalling or eliminating altogether the need for a double-digit setback from these levels. In fact, my prediction is that a 10% retreat may not ensue until the DJIA is at substantially higher levels (something possibly approaching 18,000) before such a risk might become more practical to factor into equity investment strategies. It is also worth noting that with so much discussion of a big pullback, the market is apt to defy the consensus view.
Finally, consider that the technical foundation of this market cycle is built upon the strength of many attractive individual stocks representing broad and diverse sector leadership, which has not changed meaningfully with this latest routinely timed correction.
Gene Peroni is senior vice presidentfor equity research at Advisors Asset Management Inc.
