A Call for Correction

Now is a good time to lock in some profits, Helene Meisler says, since there will be better buying opportunities ahead.
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At the close on Monday, there was a parade of analysts saying they predicted the market debacle. Even after Tuesday's rally, there were still some skeptics. I heard several times how the market couldn't possibly make a "V" bottom in here. Wednesday's big up market brought about some bulls and fewer scoffers. With

IBM's

(IBM) - Get Report

huge earnings report after the close on Wednesday, there were no more doubters, and by the end of trading on Thursday, the bears had all gone into hibernation.

And why should they be bearish? For those who value fundamentals, earnings are beating expectations, and strategists all over the Street are raising their earnings forecasts. That's bullish. For those who are technically inclined, the advance/decline line has finally woken from its long slumber and appears to be in gear with the big averages for the first time in months. That too is bullish.

But we know the market better than that. The market doesn't like it when we feel all warm and fuzzy. It enjoys catching us off guard. It always does what it can to shake us out right before it rallies, just like it does what it can to suck us in right before it drops. I believe it may be in the process of sucking us back in after scaring us half to death on Monday. This process may take some more time, however.

For the first time in over a month, we have reached an overbought reading in the market. However, that does not mean there's immediate danger ahead. First of all, the overbought/oversold oscillator is a momentum indicator, and you can see how the momentum on this rally surpassed the early January rally highs. That tells us there is much more momentum in this rally than in any rally since the one off the lows in October. Typically, after reaching such an extreme overbought reading, the market will back off a bit and then come on again and rally to a lower overbought reading. That's when the correction sets in.

Take a look at the peak overbought reading in October. Note how it dropped off (the peak overbought was at

Dow

9000 -- we backed off to 8800 then surged on to 9400 at the lower overbought reading) and came on again to a lower high while the averages went on to new highs. That's when the next correction set in: The Dow went from 9400 to 8600 over a three- to four-week period (while the

Nasdaq

churned between 1950 and 2050 during the same time period). However, the real correction came at the highs in January, when we reached our third lesser overbought reading.

Since this current rally did not come off the same type of low we had in October, I do not expect it will take such an extended time frame before we see a correction. That high in January was two months in the making; I expect this one will take less time to develop.

Another reason I believe we are in the process of making a short-term high in the market is that the number of stocks making new highs has dropped off significantly in recent days. Oh sure, we all know that it was the cyclical stocks which helped power that indicator ahead, but there are so few technology names which appear on that list that I wonder how it will improve much from here. (Did you notice Big Blue's failure to make a new high on its big earnings news? It may still do so, but it's interesting that it couldn't do so immediately after its news.) If individual stocks are not making new 52-week highs, then they are not keeping pace with the market.

In order to find the trend in this indicator, I look at it on a 10-day moving average as well (new highs minus new lows). It has been moving higher for a few weeks now. On this chart, I tend to look at its direction; if we're heading higher, the market tends to follow suit. Since the raw data that go into this indicator have only begun to falter this week, I expect it will take some more time before it rolls over and points down. Unless that raw data pick up and provide a better reading, this indicator says a correction is coming.

Finally, there's the recent upside move in interest rates that's got me nervous. While a move above 5.7% does not appear imminent, the chart does say we're headed back into that general area, which may encourage my correction theory. This chart is still in the process of building a base.

My list of positive stocks hasn't grown much this week.

Hewlett-Packard

(HWP)

is still one of my best technology-stock charts. In addition, the oil-service stocks continue to have big bases and should be bought into corrections. I post

Halliburton

(HAL) - Get Report

,

Baker Hughes

(BHI)

and

Schlumberger

(SLB) - Get Report

and write them down on the positive side of the ledger each day.

On the negative side,

McDonald's

(MCD) - Get Report

is still shaky up here.

Delta

(DAL) - Get Report

seems to be struggling quite a bit at its old highs. Some of the retailers act tired and are due for a correction.

Dayton Hudson

(DH)

and

Gap

(GPS) - Get Report

look similar to the way several technology stocks looked in early January (

Intel

(INTC) - Get Report

comes to mind), which means a big sideways correction may be in the offing for them.

This is not a doom-and-gloom market call. It is a call for a correction. I expect this correction will set in sometime over the next couple of weeks. It's a good time to lock in some profits, as there will be a better buying opportunity out there after the correction is over. By then, perhaps we'll be wondering if there's a bull in the house.

Helene Meisler, based in Singapore, writes a technical analysis column on the U.S. equity markets on Tuesdays and Fridays, and updates her charts daily on TheStreet.com. Meisler trained at several Wall Street firms, including Goldman Sachs and Cowen, and has worked with the equity trading department at Cargill. At time of publication, she was long Hewlett-Packard, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback at

KPMHSM@aol.com.