Headed For a Fall
The market's stealth run-up has some fearful of a correction
If the stock market crash of 2000 taught investors anything, it's that eventually all good things must come to an end. The problem is, almost every type of asset class--from real estate to crude oil to gold to hedge funds to stocks--has been good to investors lately. The Dow Jones industrial average, in fact, recently touched a new six-year high and is within reach of an all-time record. So if another investment bubble is likely to burst, where will the first pop occur?
While all eyes have been fixed on the housing market, a growing number of market watchers are now convinced that the stock market is in for a major correction this year. Jeffrey Hirsch, editor of the Stock Trader's Almanac, thinks the Dow will peak at around 11,500 but could then plummet to around 8,500. This would represent a 26 percent plunge in equity values. "It could be a little more, depending on how ugly things get," says Hirsch.
Liz Ann Sonders, chief investment strategist at Charles Schwab, is not predicting a full-blown bear market (a drop in the major indexes of 20 percent or more). But, she says, "we may be in store for a midyear pullback that's a little more severe than we've experienced in the last several years." At the very least, says Jeffrey Kleintop, chief investment strategist for PNC Wealth Management, the market could give back the gains it has achieved so far in 2006. Blue-chip stocks are up about 5 percent, while shares of small companies are up around 14 percent.
Many investors don't seem to appreciate just how well the stock market has performed since the last bear market ended in October 2002. Equities have actually outperformed residential real estate since late 2002, advancing nearly 20 percent annually.
How much longer can this party last? James Stack, president of InvesTech Research, notes that bull markets are usually peppered with minor corrections and pullbacks. These short-term losses are important for the longevity of bull markets, as they tend to drive away investors who lack conviction and strengthen the resolve of the remaining shareholders.
But since the first quarter of 2003, stocks have not experienced a single pullback of 10 percent or more. "That's a long time, especially for an aging bull market like this," says Robert Doll, president of Merrill Lynch Investment Managers. In fact, this is now the fourth-longest uninterrupted bull market in history, according to InvesTech.
As a result, many think stocks are long overdue for a sell-off, especially with the markets about to enter the summer of a midterm election year. The stock market, too, has its seasons. Sam Stovall, chief investment strategist for Standard & Poor's, recently studied the market's performance in various years of a presidential cycle. The second year of a presidential term--the midterm election year--is historically the worst time for stocks. Since 1945, the S&P 500 has gained only 4.3 percent in such second years, versus 18 percent in third years of presidential terms. What's more, the second and third quarters of second years are the worst times to be in the market. Historically, stocks have lost 2 percent in the second quarter of midterm years and 2.2 percent in the third. "I'm thinking that the old Wall Street saying 'Sell in May and go away' might make some sense this year," says PNC's Kleintop.
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