While we remain bullish on the U.S. market longer-term, the market is obviously ready for a normal correction. This correction may only be a 5% pullback, or it may be slightly more. Therefore we have held some cash and short positions in order to hedge out the risk and provide liquidity to buy stocks after a correction.
Correction Indicators
Many of the areas which had been stronger have weakened, such as small stocks relative to large, as well as cyclical, industrial, and materials stocks. We believe that all of these sectors, as well as selected growth stocks, will do well after the correction has run its course.
Gold may finally be starting to respond to rising inflation pressures; we like both gold and bitcoin for the long term.
Of course corrections are natural and necessary for a market to move higher; it’s not healthy to have a market spike upward without a periodic correction. Therefore we welcome the expected pullback. Also, note that the U.S. and world economies are doing very well, and will continue to grow over the next few months.
Risks
We’re bullish, but we’re not chasing; here are some things we see that could occasion a correction:
- Political tensions between Iran and the rest of the world, between Russia and Europe, or between China and Taiwan;
- More onerous tax proposals to fund expensive government programs in the developed world;
- Larger deficits in the developed world that will be harder to finance (imagine auctions of government debt spurned by buyers);
- Chip shortages materially impacting some industries’ ability to take advantage of economic strength (guidance on first quarter conference calls should shed light on the severity of the issue);
- Margin calls, with market participants’ leverage and margin debt fueling the latest stock-market advance, and sentiment indicators suggesting that investors are all on one side of the boat;
- Inflation data in next few months hitting record highs on a year-over-year basis;
- Climbing rates causing investors to start extrapolating a steeper climb in interest rates, and the market to start discounting Fed balance sheet shrinkage in 2022;
- Further disruptive cyberattacks occur. (The NSA’s Tuesday warning about Microsoft Exchange raised eyebrows in our office, and was a moment of noteworthy and unusual transparency from an organization that usually maintains a lower profile. Investors should not forget that cyberspace is an active battlefield.)
- The arrival of what historical data suggest is usually the hardest six-month period of the calendar year to make money in stocks — especially likely after six months of above-normal strength.
But to be clear… this correction is more likely a “pause that refreshes,” though it may not feel like that while it happens. All the positives that we have noted week after week remain decisive: recovery and resurgent growth undergirded by unflagging central bank support.
Thanks for listening; we welcome your calls and questions.
