A pull back is necessary to shake the weak hands out of the market. From mid July to mid August US stock markets have advanced in a rather parabolic fashion with barely a negative day worth noting. So a pull back in the market should be seen as necessary and healthy. In fact we would not be “moved” if there was at least another 5% downward movement in the S&P (to the 950 level), and would see the weakness as a buying opportunity rather than selling.
What would make us “scared” about the longer term prospects of the stock market? The key to understanding the true intention of the market is to observe how markets work off an overbought or oversold position. With respect to a bull market, if the pull back in the major market indices is accompanied by a lack of conviction in the overall market (i.e. the advance decline line holds out or at least shows a general reluctance to participate in the downside of the S&P 500) then we would conclude that the weakness in the S&P 500 is merely a short term correction and unlikely to result in any material (albeit tradable) downside.
Below is the NYSE Advance Decline Line and the Value Line Index. Note how the Advance Decline line is virtually unchanged and the Value Line has already pulled back all of Monday’s losses. If the market was genuinely bearish then we should have already seen a breakdown in the AD line and the Value Line should not have been so quick to pull back the losses sustained on Monday.
Granted it is still early days but given how the market has behaved over the last few weeks we see the weakness in the S&P 500 as nothing more than a correction in an “ongoing” bull market.
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