It's a Correction!
I've been warning that a correction was coming for stock prices for a few weeks now. And no, I'm not trying to point out that I have any unique insight on this. It's just that when the stock market advances in a virtually straight line for 4 months, you start to think investors and traders will take some profits at some point.
Corrections are inevitable and healthy for stock prices, like a forest fire that clears out underbrush and old growth and let's new growth occur. OK, that may be a little dramatic, but you get the point.
I'll admit, the timing of yesterday's sell-off was a bit of a surprise. After all, Apple's 4th quarter numbers were phenomenal. Yet the stock reversed a gap up and finished the day lower. I've seen nothing in Apple's earnings or in the analyst community that suggests there are any looming problems with Apple's earnings or outlook.
If anything, Apple investors might be thinking that it just can't get any better for Apple. But the scary thing is, I think it can. Apple's market is the entire world. And there's a lot of people that don't own an iPhone or an iPad.
These mobile Internet devices are cheaper than PCs and don't require the same infrastructure commitments. Emerging economies will gobble them up.
*****It's important to remember that Wall St. has a herd mentality. They all buy the same stocks, and when the selling starts, they will all pile in.
I can't help but think the sell-off that hit yesterday will be short-lived. Not only was there virtually no immediate catalyst (other than weak bank earnings) for the selling, we are also up against January options expiration tomorrow.
To say that bullish options bets outweigh bearish ones right now could be the understatement of the year so far. And strange things tend to happen at options expiration.
*****I'd love to say that yesterday's correction was over and done, and it's time to deploy new money into stocks. But I suspect a little caution is in order. And I say that for two reasons: banks and China.
As I said yesterday, banks are not going to return to the growth they enjoyed in the last decade. Not only has the mortgage business essentially dried up, but increased regulations are also taking their toll. Don't miss the fact that Citigroup (NYSE:C) would not have posted a profit if it weren't for loan loss reserves being applied to earnings.
Of course, lower loan loss reserves is a very good thing. And that money that Citi can apply to earnings is almost like an earnings credit that was subtracted from prior earnings. But still, an operating profit is the goal. And Citi doesn't have one yet.
I have to wonder about the banks ability to reinstate dividends. That's been a major catalyst for the financials. And if they are deemed unable to raise dividends, it will be bad for the share prices.
One has to be a bit concerned about Bank of America (NYSE:BAC) ahead of earnings tomorrow morning. Don't forget the bank ponied up $3 billion to settle some mortgage put-back claims form Freddie Mac and Fannie Mae. That will likely come out of 4Q earnings.
But there are other entities who may demand a pay-off to drop their put-back claims. And then there's the issue of lower interchange fees for debit card use. All in all, it's hard to imagine a strong quarter and strong guidance from Bank of America.
*****Then there's China. Q4 GDP growth rose to 9.8%. Full year 2010 GDP growth 10.3%. Impressive. But inflation is also picking up, hitting an annualized 5.1% in December.
Now, China has been taking steps to reel in inflation. The central government has raised interest rates and loan reserve requirements for banks. There is still an obvious measure that China has yet to do: let the yuan appreciate.
I suspect another round of yuan revaluation is coming. But that doesn't change the need for China to slow its growth to combat inflation. And that should have a negative impact on commodity prices.
One of the nice things about writing the Daily Profit every day for the last 3 years is that I can look back and see what we were talking about last year at this time. And sure enough, it was China and whether or not its economy was a bubble.
For the record, I was in the "no bubble" camp last January when the correction began. And while Chinese stocks weren't great performers last year, the Chinese economy persevered and helped drive demand that pushed U.S. stocks higher.
The inflation issue has gotten more severe for China. And that's why I suspect yuan revaluation must be on the table for China. But that would be a good thing for the U.S. economy in general, though, again, it would have a negative impact in commodity prices.
Last year, the January correction lasted into the first week of February and took the S&P 500 down about 7%. A similar move would take the S&P 500 to 1,205, about 70 points lower than current levels.
I suspect that a drop that big is unlikely, but we should be on our guard, nonetheless.
*****As always, send your questions and comments to dailyprofit@wyattresearch.com.
