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Third Time No Charm for Bulls

Liz Rappaport

Some say three of anything makes a trend. But three down days for the major U.S. stock market indices may not mean the market has broken its rally and embarked on a downtrend.

"We see no technical signs of a correction," says Louise Yamada, of Louise Yamada Technical Research Advisors. She adds that the markets would need to fall below key technical support levels like 4700 on the Dow Jones Transportation Average or 12,350 on the Dow Jones Industrial Average to indicate the market is breaking down. The only sign of weakness in the stock market is a slight dropoff in trading volume lately, Yamada says.

Indeed, the Dow transports bucked the broad market's trend Monday, ending its downward slope. The transports finished up 0.4% on the day to close at 4937.93, or 1.4% off their Feb. 2 all-time closing high.

But many investors are worried nonetheless, if only because the rally has been strong for seven and a half months.

"The market is overdue for a pullback," says Marc Pado, chief markets analyst at Cantor Fitzgerald. "This seems like a reasonable time for it. February is a historically negative month, and there is just this compelling idea that we've run the course here."

Pado notes that good news last week on the inflation front, including higher productivity and lower unit labor costs, couldn't spur the market to maintain its rally. Likewise, oil running into a wall at $60 per barrel didn't inspire buying last week or on Monday.

Major averages slipped Monday despite a 4% drop in the price of oil and a 6% drop in natural gas futures. The Dow ended the day down 0.2% to 12,552.55, and is now down 0.9% over the past three trading days. The S&P 500 closed down 0.3% Monday, and 1.1% over the past three days. The Nasdaq Composite fell 0.4% Monday and is off 1.6% since last Wednesday's close.

Energy companies fell along with the price of oil. Exxon Mobil (XOM Quote) slipped 0.8%, whileBP(BP Quote) and Chevron(CVX Quote) fell more than 1% apiece on the day.

News out of the biotech and health care sectors was mixed. Onyx Pharmaceuticals(ONXX Quote) surged 97% on news the company was successful in a trial for cancer drug Nexavar to treat liver cancer patients.

On the flip side, shares of Bristol-Myers Squibb(BMY Quote) slid 3.3% on news the company's merger talks with Sanofi-Aventis(SNY Quote) may have gone sour.

Concerns about housing bled into this week, as the selloff in the REIT sector continued. The selling was sparked when investors called a top for the sector after private-equity firm Blackstone Group agreed last week to buy Equity Office Properties(EOP Quote) after a heated bidding war.

Shares of S.L. Green Realty(SLG Quote) fell 2.9%, as did shares of Maguire Properties(MPG Quote) and General Growth Properties(GGP Quote).

Calling tops is something many strategists are trying to do these days. Jeffrey Saut, chief investment strategist at Raymond James, opens his Monday research note with the quote from Jack Nicholson's movie character Melvin Udall: "What if this is as good as it gets?"

Saut refers to several bullish news articles that "come around upside inflection points" such as recent Wall Street Journal pieces titled "Rising Stocks Kindle Worries of a Melt-Up," and "Dow Theory Seems in Play For Some Bulls."

In addition, he says the market feels "heavy," noting that "many of the market's darlings like MasterCard (MA Quote) got 'spanked' last week," and "that valuations are not particularly cheap." MasterCard slid 9.7% on Friday and another 1.5% Monday.

Sentiment may indeed be getting frothy. Merrill Lynch's U.S. sector analyst Brian Belski provided investors with a snapshot of European investor sentiment from his multicity tour last week. On market performance, the investors said the "likelihood of a price correction in U.S. market indices is severely discounted due to low volatility and increased liquidity; talk of a correction is increasingly diminished given consensus call for a correction in [the fourth quarter] that 'never happened,' " writes Belski.

The investors see liquidity as "the great equalizer," he writes. Any correction or pullback "will be easily sponged up by aggressive investors (hedge funds), with private equity trends providing a level of buying support overall," Belski continues.

These European investors are still pouring into energy and materials sectors, noting both that "global demand is too strong to ignore," and that "market leading performance the past fourth months is a call for continued global growth."

The bullishness about energy and materials comes despite a 10% year-over-year decline in earnings growth for the energy sector in the fourth quarter thus far.

Even with energy's weakness, investors can embrace what is shaping up as a 14th consecutive quarter of double-digit earnings growth, according to Thomson Financial. And, according to Citigroup's chief U.S. equities strategist Tobias Levkovich, six months after S&P 500 earnings growth is 8.46% to 12.81%, returns are positive 75.86% of the time. The returns average 5.21%.

Market top or not, the stock market certainly has much more information to work off of this week than it did last week. Investors are gearing up for Federal Reserve Chairman Ben Bernanke in his semiannual testimony to Congress on Wednesday and Thursday. Also, data streams in on retail sales, the producer price index and housing starts and permits, as the week progresses.

If there aren't any big surprises, three might just turn out to be a crowd.