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State of the market: in 2013, no crisis means no correcton

With the DJIA at fresh new all-time highs, all the major indices sporting new 52-week highs, and the S&P having finished in the green 8 of the last 9 sessions (and the last 6 in a row), it is obvious to anyone with an open mind that the bulls are large and in charge at the present time. In short, I'm not sure what more I can say. The trend is up, there is a wall of worry to climb, and there doesn't seem to be any new crises brewing.

On that last point, I should probably let you know that my working thesis for 2013 is that no new crisis means no severe correction. Yep, for me anyway, it's that simple.

Before you start accusing me of being naive or something worse, note that I included the word “severe” as part of my working thesis. Note that I am NOT saying that stocks won't experience a couple of “normal” corrections this year. It is important to understand that regardless of how strong a bull market may be, the market almost always sees a handful of 3% – 5% pullbacks during any given year. And the bottom line is a garden variety type of correction can occur at any time, for any reason.

No, I'm talking about a “severe” correction – something on the order of 10% – 19% (technically anything over 20% is considered a bear market by most people). I'm talking about the type of violent decline that has earmarked the last three years. I'm talking about the headline-driven misery that has caused the vast majority of investors to believe that this remains a lousy stock market. Go ahead – go ask 10 people what they think of the stock market. Before this week's new all-time highs, my guess is that 8 of them would have told you how tough it is out there and that the market is fraught with risk. And in my humble opinion, despite the fact that the market has more than doubled since the end of the Credit Crisis, the simple fact is the market HAS been fraught with risk since the beginning of 2010.

Lest we forget, the European debt mess was the primary trigger to the big dive of -16% that occurred during the “sell in May and go away” period of 2010. Back then it was worry about Greece, rate contagion, the state of the global banking system, and the fear that the Euozone was about to implode (something that would purportedly send the global economy into a tailspin, the likes of which we've never seen) that reminded investors of the dark days of 2008-early 2009. Then in 2011, it was a combination of Greece and the U.S. budget battle that caused the market to dive nearly 20% in something like 14 days. And then last year, worry over Europe once again sent the sell algos into high gear, causing investors to yet again equate the month of May with market misery (i.e. a decline of 10%).

So, with a clearly developed pattern now in place, every trader worth their keyboard knows to be on the lookout for the return of the European debt mess and/or the budget battle in Washington – especially with the market in an overbought condition and the month of May starting to creep closer. Thus, I can certainly understand why many investors remain skeptical of this rally and are worried about getting smacked around again sometime soon.

While history shows that “severe” corrections of between 10% and 19% have happened once a year on average, my belief is that this type of decline usually has a catalyst or a trigger. In other words, unless something comes along to cause investors (oops, I mean the sell algos) to panic, the market usually (key word) doesn't do a big dance to the downside just for the heck of it. And I believe this to be especially true when stock valuations are not excessive (think 1987 and 2000).

Dave Moenning

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.