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Current Correction Should Be Tamer Than Spring/Summer Plunge

We have some elements in place for corrective activity, including fundamental concerns in Europe and high levels of investor optimism. The spring 2010 correction was painful with the S&P 500 falling 16%. If history is any guide, the current correction will most likely fall into the 3% to 5% range, rather than the 8% to 16% range. All corrections are unsettling, but the current situation should not be as gut-wrenching as what transpired between the April 2010 highs and the July 2010 lows. Investors who were patient and rode out corrections in 2009 were rewarded.

S&P 500 - 2009 Corrections

Updated look at current support for the S&P 500 is shown below.

S&P 500 - Support

We have tailwinds coming from Fed policy (see videos & analysis). We also have a market that is in better shape to date relative to where it stood prior to the spring and summer correction. Prior to the spring/summer decline, the weekly chart of the S&P 500 showed significant bearish divergences between MACD and price (left side of chart below). Today's market has a much better looking weekly MACD relative to price (right side of chart below).

S&P 500 - Better Shape Than In Spring

Three to five percent pullbacks are to be expected during any market advance. A 3% drop from the recent closing highs would take us to 1,189 – this has already occurred with the close of 1,178 on November 16th. A 5% pullback would take us to roughly 1,165 on the S&P 500, which is near an area of possible support. A move back to the next logical area of 1,156 would result in a 5.7% correction from the recent highs. A move to 1,144 would be a 6.8% correction. A break below 1,132, especially on a weekly closing basis, would be concerning and would make us much more risk averse (see table for key areas of possible support).

In terms of seasonals, we have entered a favorable period which may provide tailwinds for stocks over the next six to seven months. Obviously, the situation in Europe needs to be monitored closely.

 

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