Is a Stock Market Correction Looming?

Given the stock market's extremely impressive start to 2012, many participants are looking for a pullback. In fact, a correction appears long overdue, but it simply isn't materializing and the major averages continue to show persistent strength on an almost daily basis. The move higher has been more of a consistent grind as opposed to a series of sharp rallies and this could be signaling that the market's gains are here to stay. Nevertheless, there are plenty of indicators that suggest otherwise. Possibly the most concerning factor for investors is the continued instability emanating out of the Eurozone. On Monday, the German Parliament voted to approve a second $174 billion Greek bailout, but opposition to saving Greece has been rising. In the German lower house, or Bundestag, 496 members voted in favor of the package while 90 voted against it. Seventeen of the members who opposed the bailout were from Chancellor Angela Merkel's coalition. While the political will to bailout Greece is still considerable, the German people wanted lawmakers to vote down the aid package. The German newspaper Bild reported that 62 percent of citizens disapproved of the measure versus 33 percent who wanted it passed. In any event, the EU has still not found a long-term solution to its member countries' debt problems and the most recent bailout package is designed primarily to buy time. Lower bond yields in "too big to fail" countries such as Italy and Spain are a good near-term sign, however. Nevertheless, despite the day to day machinations, the macro risk that investors must contend with as a result of the European sovereign debt crisis is considerable and has the potential of triggering a very sharp pullback. Another major concern of market watchers is the price of oil which has been rising considerably as a result of tensions in the Middle East. On Monday, NYMEX crude futures are holding above $108. The fact of the matter is that at some price, oil is going to act as a major headwind on the global economy. Chances are that we are starting to get close to that tipping point. This is a very serious problem, and unfortunately, very little can be done about it. It would not be surprising in the least bit if continued increases in the price of crude oil are met with a sell off in the stock market. In part because of the steadily increasing price of oil, the Dow Transports have recently begun rolling over, and many market participants wonder if this isn't the first sign of an impending correction. If you pull up a year-to-date chart of the iShares Dow Transport Avg. ETF IYT and overlay it against the SPDR S&P 500 ETF SPY this divergence is very obvious. With the Dow Transports peaking at the beginning of February and now trading in a downtrend, one has to wonder if this isn't a tell on the broader market? Another major potential concern is the behavior of copper, which is normally an excellent indicator of the health of the global economy. While stocks have surpassed their 2011 highs prior to the August correction, copper is not confirming the breakout as it has come nowhere near its 2011 highs. Consider that the 52-week high in copper was $4.554 back in March 2011 versus the current price of $3.876. It is disconcerting that copper is not showing more strength in the current atmosphere and suggests that a correction in stocks may be looming. Treasuries are also not buying the stock market rally and yields remain extremely low. Historically, the bond market has been a better indicator of future economic conditions, and the outlook remains bleak as evidenced by a ridiculously low 1.92% yield on the 10-Year Note. Despite the excitement in the stock market, the bond market has remained subdued and is not confirming the rally in risk assets. There are other technical indicators that would also appear to be confirming this view. For example, over 70% of NYSE stocks are trading above their 200-day moving average and the most recent AAII sentiment survey shows bullish sentiment trending above the long-term average. Both of these metrics are often good contrarian indicators which suggest that a correction may be imminent. While the market rarely gives investors the "all clear" sign ahead of a sustained rally, the price action in stocks thus far in 2012 looks particularly suspicious given the uncertain macro environment. Even as the market continues to climb a "wall of worry" on an almost daily basis, many investors are choosing not to chase the move in the expectation that there will be better entry points down the road.