10 Reasons To Worry That Stocks Will Fall 10%

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The recent weakness in stocks could just be the start of what to expect in the weeks ahead.  It is early May and already we have seen the Dow Jones Industrial Average close down at 12,723.58 after peaking at 12,928 and closing at a high of 12,810… There is a chance that the markets could be setting up for another 10% pullback.  For starters, this would put the DJIA down at 11,529 to 11,635.  Sound extreme?  The DJIA closed out 2010 at 11,577.51, so a 10% correction would hardly dent the market’s performance in 2010.

If we were to use the same calculation for a 10% correction from the high point and the high close of the S&P 500 Index we’d get a range of about 1,227 to 1,233.  The S&P 500 Index closed out 2010 at 1,257.64 and Wednesday’s close was 1,347.42.  Suddenly, a 10% correction doesn’t sound so damaging after the markets have roughly doubled from the peak of the early 2009 selling.

We have focused on ten key points that may derail the stock market rally.  A pullback of any size could easily reach 10%, and it might not even matter all that much in the long-term.  It might even be yet another buying opportunity for long-term investors seeking value.  Call this “Ten Reasons for a Ten Percent Correction”…

First off, SELL IN MAY AND GO AWAY!… There has long-been a saying of “Sell in May, and go away.”  The calendar is against the stock market.  As summer nears, many businesses see their businesses slow. Summer is also when investors are taking their longer vacations and can be out for one week or even two weeks (or longer in Europe).  This all leads to thin trading volume and a general disinterest in stocks.  Trading volume was already slow this year before summer has even started.  Just go back one year and you had the DJIA drop from a peak of about 11,200 in May on the heels of a large rally to a low of just under 9,600 in July.  It was also in May of 2010 that the Flash Crash came about. Just this week came word from Doug Cliggott, equity strategist at Credit Suisse, that we could see a 10% correction this summer even if he raised his price target objective on the S&P 500 Index to 1275 from 1250 for year-end.

Precious Metals… Gold was the old darling in 2010, but then it was replaced by silver in 2011.  Many investors and speculators became enthralled with the devil’s metal as they bet on the death of paper money and to hedge against inflation and uncertainty.  Last week silver peaked above $48.00, and the calls became crazy enough that we even saw “$80 silver” predicted. But silver was back under $39.00 per ounce by mid-week.  The iShares Silver Trust (NYSE: SLV)  fell about $10.00 right after trading volume on the way up reached historic highs.  The losses and margin calls here in silver have probably created a few orphans and widows in the trading circles.  The drop in silver is a good thing for the economy, but this is just one more damaging move for the nervous speculators.  Those who might have rotated into equities may be forced to seek the safety of the boring bond market.

Topping Out or Stalling…The stock market and many of the key leading companies you would expect to lead the market have seen a stalling out as we led up to May.  In fact, these have been a dull three months if you just measure gains.  Market leaders like Apple Inc. (NASDAQ: AAPL), JPMorgan Chase & Co. (NYSE: JPM), and General Electric Co. (NYSE: GE) had all risen steadily up until the last ninety days or so.  Now it is food, consumer products, and utilities hitting 52-week highs.  It is hardly fair to assume that a bunch of defensive stocks will drive the broader stock market higher.  The DJIA acted like it was topping out when it hit 12,800 in late April and the trading action shown in the “Sell in May…” comes right back to mind.

Market Confidence… Investors remain  concerned about the integrity of the stock market.  Many feel that the stock market is rigged with Goldman Sachs Group Inc. (NYSE: GS) and others knowing how to make money at your expense.  There is still a lack of confidence about the integrity of the system, understandably so.  While the Raj Rajaratnam insider trading case is embarrassing for regulators and while the Bernie Madoff case is outright infuriating, the latest trading scandal with Berkshire Hathaway Inc. (NYSE: BRK-A) is just another psychological blow to the integrity of the stock market. If the great Warren Buffett is getting duped into believing what his cronies are telling him about companies and he is still drinking the punch, how does the retail investor class know when they are being duped?  The little investor has so far not participated as much as the broad market recovery, and that group of investors may not be back in the market if any more confidence issues arise.  The first anniversary of the Flash Crash is just one more reminder and many feel that the same thing can occur again.  It is possible that the recession might have even removed an entire generation of investors from wanting to invest in the stock market.