The Current Correction Is Merely A “Mean Reversion”

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In his Daily Market Notes report to investors, while commenting on the mean reversion, Louis Navellier wrote:

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Merely A Mean Reversion

The stock market is famous for predicting recessions that never materialize. My favorite economist, Ed Yardeni, called the current market action a “panic attack.” The $64,000 question is will a silver lining or critical path emerge for investors to follow? So far, companies that announce positive sales & earnings, plus positive guidance, are faring well and we have a lot more quarterly announcements in the upcoming weeks. I am still counting on the fourth-quarter sales and earnings announcements to dropkick and drive our stocks higher.

The truth of the matter is that the current correction is merely a "mean reversion" and that many of the stocks that have been rallying, with the exception of many energy stocks, are expected to fizzle in the upcoming weeks. In a severe correction like we have been experiencing, most stocks get hit, but the fundamentally superior stocks that we own should bounce like “fresh tennis balls,” while many other stocks will bounce like “rocks.”

After last week's brutal sell-off, the Nasdaq finished the week 3.3 standard deviations below its 50-day moving average (DMA). It may sound hard to believe, but the last time the index was as oversold based on this measure was during the COVID crash in the second half of March 2020. Going further back to the end of the Financial Crisis, there have only been a handful of other times that the Nasdaq has been more oversold than it is now (blue line below red horizontal line in the chart below).

I should add that I am keenly aware that many folks are in shock at the magnitude of the recent correction. Essentially, when the stock market corrects 5%, fundamentally superior stocks can be resilient. However, when the overall stock market corrects 10% or more, essentially nothing works, and Wall Street starts throwing out the baby with the bathwater. The truth of the matter is that due to the fact that most of the selling pressure is emanating from ETFs and index funds, all stocks end up succumbing to the selling pressure.

The Fed Is Widing Down Its Quantitative Easing

The Fed on Wednesday clarified via its Federal Open Market Committee (FOMC) statement that is going to wind down its quantitative easing in early March, which will effectively set up the Fed to raise the federal funds rate to 0.25% at its March FOMC meeting. The FOMC statement referred to a strong economic recovery and cited “solid” job gains in recent months. Specifically, the Fed said “With inflation well above 2% and a strong labor market, the committee (FOMC) expects it will soon be appropriate to raise the federal funds rate.” In my opinion, the Fed is maintaining its “Goldilocks” environment of low-interest rates amidst strong economic growth.

At his press conference on Wednesday, Fed Chairman Jerome Powell confirmed that inflation continues to exceed his expectations. There is no doubt that due to rising energy prices in January that the consumer and wholesale inflation announcements in February are going to be truly horrible. The most important thing that Chairman Powell said at his press conference was that low yields overseas would likely cause the Fed to effectively cap how much the Fed can raise interest rates. Specifically, since the Fed is telegraphing that it will be raising key short-term interest rates, the U.S. dollar continues to strengthen, which in turn, just attracts more foreign buying pressure for U.S. Treasury securities.

The stock market is essentially a manic crowd that is not smart, since it likes to “react” versus think. Now that we are in the midst of another strong earnings announcement season, it is finally time for the stock market to get “smart” and for new market leaders to emerge. Fortunately, Microsoft’s better than expected results on Tuesday after the close are now helping to lift the overall stock market. Additionally, Tesla's better than expected results on Wednesday also helped and will be followed by Apple on Thursday. If these three bell weather stocks can all beat analyst expectations, it will certainly help the overall stock market rebound impressively.

Consumer Confidence Declines

The Conference Board on Tuesday announced that its consumer confidence index declined to 113.8 in January. Interestingly, the Present Situation component rose to 148.2 in January, which is a good sign. However, the Expectations component declined to 90.8 in January. In summary, consumers are doing better, but are less optimistic about the future. Clearly, inflation may be damping consumer expectations.

The Labor Department reported that new weekly unemployment claims came in at 260,000 in the latest week. Continuing unemployment claims came in at 1.675 million in the latest week. This is the second week in a row that weekly and continuing unemployment claims have been elevated. The rise in weekly unemployment claims to the highest level in the past 3 months may be related to severe winter weather. Since the freezing weather in the Northeast and the South persists, these elevated unemployment claims may continue for a bit longer.

The big surprise this week was that the Commerce Department announced that its preliminary estimate for fourth-quarter GDP growth was an annual pace of 6.9%, which was well above economists’ consensus expectation. For all of 2021, U.S. GDP grew at a 5.7% annual pace, which is the strongest annual pace since 1984. Overall, the GDP report was simply stunning and is likely causing “demand push” inflation, which is why the Fed will start tapping on the brakes a bit.