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Correction Time? Listen to This Grizzly to Decide

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It's a good time to talk about the next stock market correction.

Why? Because the market has survived several months of trade-war fury and bluster, rallying all the way back to within less than one percent of its all-time high at S&P 2873.

And despite another decent Q2 earnings season and economic growth accelerating, there are few positive catalysts left this summer to get us over the hump to my year-end targets above S&P 3000.

In fact, there are a few negative trip-wires lurking about.

One is bullish sentiment. The most recent Investors Intelligence data from July 24 shows the infamous "bull-bear ratio" hovering near 3-to-1. This is above average bullishness.

And the "correction camp" was down to 26.5%, the lowest point this year. There is a long record of experience with this data, going back to 1987, that it is a contrary indicator.

In other words, when the investment newsletter writers get to one extreme or the other, pessimism or optimism, the market is usually about to swing back the other way.

This is not magical thinking either. It's a function of market liquidity that when most investors have bought-in, that there are fewer dollars to keep it in rally mode.

And that creates a skittish market, with recent retail buyers who get nervous, to say nothing of large pros with lots of old profits to bank near the highs.

In this scenario, the path of least resistance is down.

The lower high at S&P 2848 could ink the deal.

I show the charts and explain the data in my video attached to this article.

ICYMI, The End is Apparently Near

The other "trip-wire" I highlight is the cautionary tales from large investors and investment bank strategists, like several different teams at Morgan Stanley who have been sounding the alarm for months.

Bearish growls from the bank were heard beginning in April. I posted the following on Twitter April 17...

U.S. stocks may be near cyclical top, valuations past peak, per Morgan Stanley: "There’s less reason to behave like it’s 'morning in America' than 'Happy Hour' in America." Markets are “closer to the end of the day than the beginning."

That was my quick summary of a Bloomberg story titled "Morgan Stanley Warns Markets the Best Times May Be Near an End." The Bloomberg staff summarized the piece this way...

"Investors need to prepare for downside as the end of the economic cycle is near and U.S. markets are priced for best case scenarios."

And just when I thought all that gloom might be evaporated in the sunny month of May as the stock market made new 2-month highs, the Morgan Stanley Cross-Asset Strategy team led by Andrew Sheets further defined their bearish tilt.

In a report titled “The End of Easy,” Sheets and company wrote "2018 is seeing multiple tailwinds of the last nine years abate. Decelerating growth, rising inflation and tightening policy leave us with below-consensus 12-month return forecasts for most risk assets. After nine years of markets outperforming the real economy, we think the opposite now applies as policy tightens."

I covered all this in my May 16 video...

Should You Listen to the Big Bear on Wall Street?

My answer at the time, with the S&P at 2700, was "No." And I gave my forecast for the rest of the year: S&P 3000 Before 2400.

And despite Morgan Stanley's bearish warnings, stocks ground their way up above S&P 2800 in July.

The Selling Has Just Begun

But the bears at Morgan Stanley will be heard. Their latest grizzly missive comes from chief US equity strategist Michael Wilson who published a report on Monday citing "exhaustion" on deck for the summer rally...

"With Amazon's strong quarter out of the way, and a very strong 2Q GDP number on the tape, investors were finally faced with the proverbial question of 'what do I have to look forward to now?' The selling started slowly, built steadily, and left the biggest winners of the year down the most. The bottom line for us is that we think the selling has just begun and this correction will be biggest since the one we experienced in February."

That sums up the Wilson team's note to clients on July 30. They added that the coming correction "could very well have a greater negative impact on the average portfolio if it's centered on tech, consumer discretionary and small-caps, as we expect."

Be sure to watch my video where I show the relevant charts, including those for the Nasdaq and Semiconductors, poster boys for the strong and the weak sectors of the market.

I also try to explain why Micron (MU - Free Report) and Apple (AAPL - Free Report) may be better indicators of what is to come than Facebook (FB - Free Report) or Amazon (AMZN - Free Report) .

And I give my conclusions about the "coming correction." I'll give you a rough summary here...

There are more reasons for the market to correct right now than make new highs, given it's summer vacation time for the Wall Street-Hamptons crowd (which means less buying) and the bullish catalysts are sparse.

Plus, those grizzlies at Morgan Stanley won't go away.

But this bullish global technology cycle has not peaked. That's why I continue to recommend that investors own NVIDIA (NVDA - Free Report) as well as Micron.

And I don't see a 10% drop to S&P 2560 in August.

But I do see any of a number of possible negative catalysts as being enough to flush out all those exuberant bulls in the Investors Intelligence survey with a 5% market slide.

For a bigger, Morgan Stanley-level flush, we might have to wait for the midterm election noise to get raucous in September.

My bottom line remains that the S&P will make new highs near 3000 before we see anything ugly like a trip under 2500.

This is based on several factors, especially a bullish economic cycle that is not over and which will keep my favorite hedge fund managers buying their favorite names when they go on sale.

It is still "buy the dips" time. But you should wait for the next one that's coming.

Disclosure: I own shares of NVDA and MU for the Zacks TAZR Trader portfolio.

Kevin Cook is a Senior Stock Strategist for Zacks Investment Research where he runs the TAZR Trader and Healthcare Innovators services. Click Follow Author above to receive his latest stock research and macro analysis.



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