This blog post originally appeared on RealMoney Silver on May 21 at 7:42 a.m. EDT.
I had previously
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
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
Mr. Market typically does his best to harm the most investors, and a sideways correction would likely continue to keep the skeptics out of the market and poorly position those investors for the next leg higher.
In this framework, a two-sided market becomes our investment reality, in which money can be made in "playing" the sideways consolidation (both long and short). This means that tactically I plan to be bolder in buying sector- and stock-specific ideas on dips, while continuing to short extended areas and stocks rather than waiting to buy on a sharp correction.
Incidentally, this scenario also provides a good backdrop to sell option premium in both calls and puts.
Color me less bearish on the market averages now and a bit more opportunistic in buying/shorting.
While the world's stock markets are no longer on sale, I continue to see improving credit spreads, a general skepticism surrounding the "bear-market rally," growing signs of economic stability, upward corporate profit revisions and a reallocation of large U.S. pension plans out of fixed income into equities as the proximate catalysts to the next leg up in the S&P 500 to around 1,050 by late summer.
Doug Kass writes daily for
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Know what you own: Some of Thursday's most active stocks in midday trading include Regions Financial (RF) - Get Report, Bank of America (BAC) - Get Report, Direxion Daily Financial Bear 3X Shares (FAZ) - Get Report, Direxion Daily Financial Bull 3X Shares (FAS) - Get Report, SPDRs (SPY) - Get Report, Financial Select Sector SPDR (XLF) - Get Report and Citigroup (C) - Get Report.
At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Long/Short LP.