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Should Investors Really Expect a 20% Stock Market Correction This Year?


That's what Marc Faber stated last week. But is a warning of this magnitude really necessary?

What we see depends mainly on what we look for.
-- John Lubbock

On Thursday of last week, Marc Faber, the Swiss investor and editor of the "Gloom, Boom & Doom Report," stated in a phone interview on CNBC that the market is ready for a 20% decline in the back half of this year, and compared today to the period of 1987. This sort of analysis is typically found as rallies flourish and investor complacency stretches for the sky. 1987 seems to be the foremost comparison when doomsayers, or maybe just realists, are attempting to make their point. Maybe it's because 1987's drop was 36% in only two months. That's definitely enough to get some attention and end investor complacency.

My firm's stance has been one of caution as this market seems to be full of hot air. Nonetheless, is it really time for a warning of this magnitude? As interesting as the comparison was, we thought it prudent to investigate further. The following weekly chart represents a 4-year overlay of the S&P 500 Index (INDEXSP:.INX) (9/2009 to today, blue line) and the S&P 500 Index for the 4- year period 9/1983 to 12/1987 (black line). The dates have been set up to be exactly the same month periods.

Click to enlarge

Illustrated in the chart, the period prior to October of two years ago and to the same period in 1985 shows only a slight correlation of trend. It was similar, but the volatility of the millennium period is much greater, thanks to Greece. Astonishingly, the two-year period following is similar to the point of a 91.4% correlation. Faber not only drew the correlation, he also discussed the exuberant buying that's driving the index well above its moving average trend to extremely overbought levels. And he didn't stop there. He also outlined the breadth of the market and its health. In an expanding market, there should be a correlation of trend; higher highs in the primary index (the S&P 500) should have an increasing trend in breadth.

Interestingly enough, this is not the case. The chart above depicts the new high/new lows going back two years, the correlated period discussed previously. As you can see, since late May this index has not regained new highs and, in fact, has been trending lower since mid-July. With that said, this is not intended to be an alarmist piece, nor a plug for Faber's report. It's merely an attempt to look at the investment landscape through someone else's glasses.

Hope this helps and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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