Kass: The Sideways Correction

This blog post originally appeared on RealMoney Silver on May 21 at 7:42 a.m. EDT.

I had previously suggested that the second derivative recovery could result in an extended and vulnerable market, with a 5% to 8% drop in the cards.

After a two-month period of improving breadth and an advance that approached 38%, it appears that the upward momentum of the market is finally being tested. Typically, overbought markets are corrected in brief order, and four to five weeks seems to be the historical precedent.

This may still be the case, but I am beginning to view the possibility of a sideways correction, in which market sectors "recycle" within the context of only a modest move lower in the market indices.

Some fundamental factors and sentiment considerations lead me to this conclusion.

Though the availability of bank credit remains too tight, most impressive to me has been the improvement in the credit markets (particularly spreads). Indeed, Libor as well other credit spreads and gauges are equivalent to their fall 2008 numbers, when the S&P 500 stood at approximately 1,040, almost 15% higher than current levels.

I am also impressed by the appetite, receptivity and the ability of the markets to absorb hefty equity offerings, which not only fills company financing gaps and provides capital for growth but it speaks volumes regarding investors' propensity to accept more risk.

Finally, from a sentiment standpoint, I have previously written that, unlike previous market "takeoff" periods in the 1970s and 1980s, the dire sentiment existing in early March has not been materially reversed towards bullishness, which another good sign. Anecdotally, my hedge fund cabal remains materially underinvested and skeptical about the recent "bear-market rally" -- and very frustrated!