This column originally appeared on Real Money Pro at 7:50 a.m. EDT on Aug. 19.NEW YORK ( Real Money) -- Was last week's market drop the real thing (a harbinger of a more significant market decline), or will it just be another nervous market breakdown (which will/should be bought)? This is the important question that investors and traders are asking themselves this morning.
Economic data appear mixed. For example, unlike any time over the past 18 months, housing appears to be stalling, and so do the rate of growth in jobs and the improvement in retail sales appear to be slowing, while some of the manufacturing data have improved modestly. In terms of the catalyst of liquidity, we are obviously closer to a tapering of quantitative easing and normalizing monetary policy than at any time during the corrections of the past two years. The uncertainty of who will be the next Fed chairman looms as a different headwind as well. Dissimilar to previous corrections (since 2010), interest rates are climbing swiftly higher. The yield on five-year Treasury notes has more than doubled, and the yield on the 10-year U.S. note is moving to 2.85% from 1.35%.
Above all, as we begin to exit the earnings reporting period, we have to closely monitor the economic data. At the core of my topping thesis is that the public and private sectors' dependence on (and addiction to) low interest rates will be reflected in slowing global economic growth over the balance of 2013 and into 2014. This will likely weigh on corporate profits (estimates of which remain too optimistic). Looking forward (and away from the fundamentals), rallies should also be assessed by observing the leadership, market breadth and investor sentiment, which are key determinants of if we can reach new bull market highs or if we experience a rally failure and put in a more meaningful top. One of the most important keys that I will be looking at in order to determine this would be a more confirmed leadership shift (better relative and absolute strength) into economically sensitive industrial shares. If this occurred, it would be a market positive and would favor the notion that the recent market drop is but another correction in a bull market. If not, look out below! I will be watching rallies. So, too, watching market breadth will be significant in assessing the balance of the year. As well, investor sentiment as measured by the ratio of put/call buying and/or bullish and bearish sentiment (in surveys) should be assessed. My base case is that, given the body of evidence today, a correction to the S&P 500 uptrend leg (1550-1600) that began in November 2012 is likely.