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Is a February Stock Market Flop Inevitable?

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Historically, Mr Market usually has a tough time in February.

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The dangers are as well publicized as they are threatening.

For weeks, strategists and technical analysts have warned investors of the increasing likelihood of a near-term correction for the stock market. They argue that this market has climbed real hard, real fast and appears poised for a pullback.

Technicians spell out their reasons for worry: many indices, such as the DJ Transports and the S&P Small-cap 600 have failed to follow the DJIA and the S&P 500 over the last week, a non-confirmation, they say, that could foretell a tumble; market sentiment is tilted very heavily toward the bullish camp, which, from a simplistic contrarian perspective, is bearish; and emerging markets such as China, India, and Brazil, which often-time lead markets during advances and declines, have been falling.

Mr Market, buoyed by the Federal Reserve's bond-buying program, positive economic data, and more optimistically-inclined investors once again putting money to work in domestic stock funds, has certainly enjoyed a hard run to the upper right hand corner of the chart.

The iShares S&P 500 Index ETF (IVV), which includes holdings like Apple (AAPL), Exxon (XOM), Microsoft (MSFT), IBM (IBM), and General Electric (GE), is up 8% in the past three months; up 16% in the past six months.

But now that same market, looking for an excuse to take a well-earned breather, found one last week in the streets of Cairo, where large-scale protests demanding the ouster of President Hosni Mubarak rattled global financial markets.

The S&P 500 was at a 29-month high last Thursday but finished the week with a decline of 0.5%. The "500" was down for a second straight week for the first time since late August. Seven of the 10 sectors and 75 of the 129 industries fell last week, according to Yardeni Research.

The bleeding could continue. Tom DeMark, the respected technician who created a set of market-timing indicators to identify market tops and bottoms, recently said that US stocks are approaching a market top that's likely to precede a decline of at least 11% in the S&P 500.

In fact, as we head now into February, skeptical strategists and technicians warning of a decline have another powerful ally in their cause for caution: History.

Specifically, a February flop is not an uncommon event. So says S&P's Sam Stovall, who notes that the S&P 500 has recorded an average decline in February whether you look back to 1990, 1970, 1945 or 1929. Since World War II, the market fell an average 0.4% in February, making it the 11th worst month of the year; it rose an average 0.7% in all 12 months.

In addition, the S&P 500 advanced in price during the month 50% of the time since 1945, versus an average 59% for all months.

"History would agree with those who believe we are due for a digestion of gains," Stovall says.



However, Stovall also still sees two reasons for consolation. First, he notes that the S&P 500 is likely to post an advance in January, which would trigger a favorable signal in the Stock Traders Almanac's January Barometer. Since WWII, whenever the S&P 500 rose in January, it continued to rise in the remaining 11 months of the year 85% of the time and posted an average 11-month advance of 11.6%.

The other favorable factor is that the S&P 500 posted an average gain of 0.6% in the February of a President's third year in office since 1945, and rose 56% of the time. Those results aren't great, he says, but they're not in the red either.

More broadly, the market has been trading on borrowed time, says Stovall, and was overdue for a digestion of gains. However, the strategist says that he believes a 5%-10% decline would actually prove healthy, as it would reset overly optimistic investor sentiment and bring full-year price appreciation expectations back in line with his 9% price appreciation forecast.

Fred Dickson, chief investment strategist at Davidson Companies, says that he is expecting a market pullback here, but one that should be limited to 3% to 5% unless the situation in the Middle East deteriorates.

"We had a big run between September and the middle of last week," Dickson says. "The major market averages were extended on a near-term basis, and ripe for some profit-taking and normal consolidation."

However, despite the potential for a near-term pause, Dickson remains confident that the US stock market will end the year higher.

"Number one, we see continued economic growth," he says. "Number two, interest rates still provide little to no competition for stocks. Bond money is moving into equity markets. Finally, we keep seeing these flash-fires erupting around the world and that pushes global investors into more stable markets. The US market could be a beneficiary of that as could gold."

Dickson's 2011 target for the "500" is 1400.


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No positions in stocks mentioned.
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