Playing the Correction

Every year, I half-expect the predictable year-end rally not to happen. Well, it nearly always does. Through the years, I have come to respect seasonal patterns of strength and weakness. For instance, it's now quite widely known that the May-to-October period is unhealthy for stocks, but the other six months are very good.

This week (Oct. 27 to Nov. 2) is historically the single strongest five-day period of the year. Not one down week for the last 22 years! So what happens? Right out of the gate, the market falls flat on its face. I'm reminded of Yale Hirsch's dictum: "If Santa Claus should fail to call, bears may come to Broad and Wall!" In other words, if the market doesn't rally when it normally does, watch out.

I think the market will correct its sharp post-Sept. 21 rally by declining into an early- to mid-December low. When the market has a big bottom in October, it often follows that course. (One exception was in 1998, when the market was brought low by the Long Term Capital Management panic from August to October, and then exploded upward, with no pullback at all, in November and December. But that was still in the bull market, and I don't think the market has such power these days.)

One put/call indicator calling for a correction now is the "option premium ratio" which appears only in Investor's Business Daily -- as far as I know. It has been recording high levels as late as this Monday, and this is bearish. Further, in the stiff decline on Monday and Tuesday of this week, there were no high levels of put trading recorded. Higher levels of put trading are expected at the next low. It would seem the correction into a December low has begun. ...