Editor's Note

06/07/2007 12:00 am EST


Howard Gold

Founder & President, GoldenEgg Investing

Thursday, June 7

Is this finally the correction we've been waiting for?

It's been going on for only two and a half days, but the stars may be lined up for an orderly, temporary retreat in share prices.

If that's what we're looking at, we should all cheer, because it means the market ultimately will move a lot higher-and those of you who've been sitting on the sidelines watching its improbable rise may finally get your chance to buy.

The Dow Jones Industrial Average and the Standard & Poor's  500 are off around 2% from the record highs they registered Monday.

Foreign markets also have been hit. The FTSE 100 index of the UK's leading stocks is off 2.3%, while Brazil's Bovespa index has tumbled 2.6%.

Is this all a delayed reaction to the 15% selloff in the Shanghai Composite index after the Chinese government trebled its stamp tax on securities transactions? No, I argued here last week, and I still think the timing is coincidental.

This may turn out to be more of a mirror image of last May's mini-correction, when the Dow fell 8% and hot foreign markets like India lost 20% of their value-before a new rally began.

That correction, you'll recall, was triggered by worries about higher interest rates and higher oil prices. This year, it's all about interest rates, interest rates, interest rates. 

What touched off the current selling were remarks made by Federal Reserve chairman Ben Bernanke to a conference of bankers in South Africa. In his comments-which reflected long-held views-he indicated that the Fed was likely to keep short-term interest rates steady for the time being.

While expressing concern about the inflationary potential of "shortness of slack in the system," Bernanke said that the weak housing market could offset that. But he added, "the risks to this [inflation] forecast remain to the upside."

Translation: No rate cuts are likely soon.

I don't know why that should have surprised anyone--who has been banking on a rate cut lately? But it came just a day before the European Central Bank, as expected, hiked its key short-term rate by 1/4 point to 4%.

That shouldn't affect the US much-the Euro zone's economy is expected to grow faster than ours, so rate increases there are pretty normal. But over the past few days the ten-year treasury note's yield also approached 5%. (It jumped above that Thursday morning.)
Five percent is the key number at which some strategists say bonds become a more attractive investment than stocks, which has probably triggered some selling.

Also, the Dow has risen 12% from its March low just above 12,000 and a whopping 28% since last July. That's a huge run without a significant correction and some big holders may have seen it as a chance to lock in some big gains.

And oh, yes, it's June, part of the worst six-month period for stocks historically. The old saw, "sell in May and go away," didn't quite work this year (although it did last year-if you remembered to buy again in July). But these things aren't precise, and June is close enough. 

Put this all together and you have a four-letter word: f-e-a-r. Investors, spooked by the prospect of higher rates, carrying the weight of the calendar on their shoulders and looking to convert paper gains into real money, have decided to reduce risk for a while and step aside.

How long will this last? Don't ask me. It could end early Friday or next week or stretch into the fall.

How far will it go? Again, I don't have a clue. A 10% correction from the peak will get us down to Dow 12,300. I don't expect it to fall that far. Mark Leibovit of VRTrader.com thinks it could drop as low as 12,800-a correction of around 6%. That sounds about right to me.

After that, though, the market could go much higher. In a piece excerpted in Gurus' Views and Strategies on Monday, Leibovit set a 12- to 18-month Dow price target of 14,800.

And why not? I don't think inflation or interest rates are going to spike, nor do I expect the dollar to collapse. Yes, US economic growth will weaken, but as of now the housing market's problems won't be enough to push our $13-trillion economy into recession.

Also, US corporate profits should continue to grow nicely this year, and there's still enough money sloshing around-and low enough interest rates-to make sure that plenty of deals will get done.

"I have never seen so much cash available to purchase stocks and companies," writes Donald Rowe, publisher of the Wall Street Digest, as excerpted in Wednesday's Gurus' Views.  Put that together with a shrinking supply of stocks and the market should head higher.

If this selloff continues, some bears will emerge from deep hibernation and proclaim the great bull market is over. Don't believe them. Yes, this bull market will end some day, but not now.
Rather, what we're seeing is a combination of factors coming together during the worst season for stocks and giving investors an excuse for what they really want to do-take some money off the table. The rest is just noise.

Comments? Please email us at TopProsTopPicks@intershow.com.

Howard R. Gold is editor-in-chief of MoneyShow.com. The opinions expressed in this commentary are his own and do not represent the views of InterShow.

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