Dow Jones Industrial Average, S&P 500: Is The Correction Over?

market correction bearLance Roberts: After months of slumbering complacency, market participants have been awakened by the stark reality of market risks. What goes up, it seems, can actually come down. However, we need to put the current market correction in some context given the nearly 30% run in 2013. From the peak of the market to Wednesday’s close, the S&P 500 has fallen by roughly 4%. If you have been listening to media you would have likely assumed a much bigger rout had occurred by all of the speculation, hand-wringing and excuse making. Of course, as investors, what we need to know is whether the current correction will devolve into something much larger.

I have spent much time recently pointing out the extreme levels of market deviation and valuation elevation. By these very measures, one should, at some point, expect a much larger mean reversion process in the markets. However, as John Maynard Keynes discovered after being wiped out in a currency trade gone wrong:

“The markets can remain irrational longer than you can remain solvent.”

Therefore, the real trick of investing, and winning the long term investment game, is determining when the “light at the end of the tunnel” is not benign. While valuations do eventually matter, and matter quite a lot, they are a very poor portfolio risk management tool. In the short term, it is price which most clearly reflects market sentiment and investor actions. Therefore, in order to determine whether the current correction is near its end, or signaling a bigger move, we can only really make assumptions based on historical precedents.

Argument For The End Of The Short Term Correction

Last night on the “Lance Roberts Show I stated that the market was likely to rally rather sharply from Tuesday’s closing levels. This statement was based on the short term oversold condition of the market as shown below.

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The current concern, for me, is the failure of the market to exceed the top set at the beginning of this year. That “double top” will now present important overhead resistance to any subsequent rally. However, on a short term basis the market has now sold off to 2-standard deviations below the 50 day moving average. The market is also defending support at the December lows.

Price movement in the market is somewhat constrained by the laws of physics. Prices, like stretching a rubber band to its maximum length, can only move so far above/below their longer term moving average before a mean reversion eventually occurs. These extensions can often last longer than expected but are always resolved eventually.

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