Stocks have risen for so long that it’s almost puzzling when they fall for any period longer than a couple trading sessions. And that’s what made the last few days somewhat shocking.
The S&P 500 has declined 1.1% (so far) this week, the largest pullback in nearly two months. Though a 1.1% pullback isn’t true cause for concern, the timing of the decline is a bit peculiar.
Alcoa (NYSE: AA) kicked off second-quarter earnings season with a bang after the close on Tuesday. The aluminum maker blew Q2 earnings expectations out of the water. Its EPS of 18 cents was 50% better than consensus analyst estimates.
Alcoa is traditionally an earnings-season bellwether. When Alcoa’s earnings are strong, it’s a sign that other companies’ earnings will likely be strong too. As a result, an Alcoa earnings beat is typically good short-term news for the market.
Instead, stocks have gone the other way in the last few days.
What does that mean? Possibly nothing. We’ve seen mini pullbacks before amid this furious rally. In January, the S&P fell 5.5% in two weeks. The index declined nearly 4% in late September and early October. There was also a 4.5% correction last August and a 5.7% pullback last May.
But 4% and 5% drops are not true corrections. They’re momentary blips. A true market correction requires a drop-off of at least 10%, and that hasn’t happened since late 2011. These mini pullbacks have been little more than the bulls catching their collective breath before pushing stocks further still into uncharted territory.
Is there reason to believe the recent mini pullback will be any different? Not yet.
Time and again over the past two years, Wall Street pundits have cried wolf about a mass correction. Every time stocks start to pull back for more than a few days, bearish analysts deem it unequivocal evidence that a long overdue pullback has finally arrived. They’ve been wrong every time.
At this point it would be foolish to doubt this rally. It has blown right through a number of supposedly catastrophic events – sequestration, ongoing European debt concerns, a decline in U.S. GDP growth, Fed “tapering.” Investors have tuned it all out, pushing stocks to new record highs on almost a weekly basis.
If this recent pullback reaches 6%, then there might be something to this correction. Stocks haven’t pulled back more than 5.7% since November 2011. It will happen eventually. No rally lasts forever. And with the S&P 500 trading at close to 17 times forward earnings, it’s much higher than its 10-year (13.8) and 15-year (15.8) averages.
The valuation isn’t close to the crazy forward P/Es around the turn of the century, when stocks were trading as high as 25 times forward earnings. But it’s higher than it’s been at any point in the last decade. That’s difficult to sustain.
I wouldn’t go selling off all your stocks just yet, though. A few down days is nothing to be terribly concerned about. Chances are, this is just another mini speed bump slowing what has been a virtually unstoppable rally.
Sooner or later, though, a correction is coming. When it happens, you’ll know it.
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