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Jeff Saut: A Correction in the Cards?


We may be on the edge of a real market pullback.

Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

The Dow Jones Industrial Average (DJIA) has enjoyed the longest buying stampede of my lifetime. Indeed, the stampede is now legend, at 48 sessions, without anything more than a one- to 3-session pause/correction.

Surprisingly, however, despite all the snorting, cheerleading, and animal spirits, the last tranche of index positions I sold in mid-April are virtually no higher now than they were back then. History shows that, if a stampede is able to extend for more than the typical 17-25 sessions, the momentum peak tends to come between the twenty-fifth and the thirtieth session; it's extremely rare for a stampede to extend for more than 30 sessions. In this case, it appears the momentum peak came on April 17, with the S&P 500 at 876. Currently, the S&P 500 (SPX) resides only 6 points above that level.

Accordingly, I have counseled caution over the past 4 weeks, and -- despite the hate mail I got for saying so -- I don't think a whole lot of money has been made since the April 17 momentum peak - which just so happened to be session 29 in the stampede. That being said, I can find no instance where the equity markets sprang from such a generational oversold reading into a straight-up 6-week buying stampede, then came right back down and tested, or broke, the recent reaction price low in anything less than 12 weeks (3 months). It's just the nature of the beast that most participants missed the lows, have been sitting with too much cash, and are now forced by the performance derby to commit that cash - which is why the dips are being bought.

Indeed, ISI's survey of hedge funds shows that their net exposure to equities is still well below benchmarks. And that's why the pauses/corrections have been shallow and fleeting. Three months into the skein, however, the environment could change, setting up the potential for a June swoon. That would also be in keeping with the astute Dines Letter: "April has been a month with a pivotal reversal of the March trend 67% of the time since 1963; and, at least a semi-important top has been reached in virtually every April or May since then." And don't look now, but the early May "highs" felt pretty toppy to me.

So far, any downside correction since the early March lows has been contained to between 5% and 6.4%. That suggests any correction of more the 6.4% could imply more of a correction than any I have seen since the demonic S&P 500 low of 666. Measuring from the May 8 closing high of 929.23, a greater-than-6.4% price decline yields a failsafe point of slightly below 870 on the SPX. If that level is violated, it would suggest a decline to at least 830 (the 50-DMA is near 832), and maybe more.

Moreover, last Wednesday's wilt (-184 DJIA) was a 90% Downside Day, meaning that more than 90% of downside vs. upside volume, as well as downside vs. upside total points lost, were both skewed more than 90% to the downside.
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No positions in stocks mentioned.
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