Current Stock Rally Has a Little More
Legs, But a Correction’s Imminent

sovereign debt crisisThere is a good possibility that the stock market will experience a major retreat/correction in the near future, as it has done so over the last two years starting in late spring. It’s related to the old stock market adage, “Sell in May and go away,” and it’s likely because the current stock rally has been going on very consistently since the beginning of the year.

This is another reason why I’m not very enthusiastic about being a buyer in the stock market at this time. A big change in investor sentiment at the beginning of the year fostered the current stock rally, aided by the Federal Reserve, temporary action on Europe’s sovereign debt crisis, and reasonable stock market valuations. The market expects good results this earnings season, as well as decent visibility. Without it, the currently stock rally will be over.

Even with good corporate news, this is a stock market that’s in need of a break—just like precious metals a little while ago. A lot of good news is now priced into stocks and I think it’s likely this year’s stock rally will take a break in the next month or so for the rest of the summer. Then, before the election, the stock rally should resume its final leg. That’s my best guess for the rest of this year. For 2013, all bets are off.

Without question, investors do not need to be buyers in this market. It might seem odd for a stock market analyst to advocate not investing in a stock rally, but the current environment is a time to reap, not sow new positions. A stockbroker always advocates taking on new positions when his or her clients “have the money.” But the current trading action suggests to me that a correction is on the horizon. Trading volume is declining and institutional investors have already placed their bets ahead of first-quarter earnings season.

I expect the S&P 500 Index to form a top in the fourth quarter this year, possibly early in 2013. The road for stock market investors has been pretty smooth this first quarter. It should be increasingly bumpy as the election approaches. I reiterate my view that a conservative investment stance is warranted and that this year’s stock rally should soon experience a correction. If the price correction is strong enough, I would consider adding to higher dividend paying stocks and some more gold/silver exposure as well. (See Why the NASDAQ Blasting by the Dow Jones Is Another Positive Signal.) It is my view that, next year, the sovereign debt crisis in both Europe and the U.S. will haunt stock markets around the world. It is getting to be time for governments to start paying the piper.

Very near-term, investor sentiment is strong enough to carry this year’s stock rally further. The financials report first and, if their news is good and dividends go up, the stock market will move higher. Expectations are strong in the technology sector and these companies will have to prove themselves. As far as the industrial’s are concerned, they are likely to keep reporting solid earnings growth.

I’m not bearish on the future, only realistic. A correction followed by a resumption of the current stock rally is my outlook for 2012. I also believe that the stock market is in the process of topping out and that the U.S. economy is due for another recession soon.