The Correction is Almost Over

03/22/2007 12:00 am EST


Tobin Smith

Founder and Chief Research Analyst, Transformity Research LLC

Tobin Smith, founder and chairman of ChangeWave Research, argues that fear in the market is overdone, the economy is strong, and we’re close to the end of the market correction that followed the big selloff in Chinese stocks.

The market correction that started on fears of a Chinese stock meltdown continued last week as investors wigged out on the sub-prime mortgage contagion scenario.

In the meantime, low trading volumes on our favorite stocks on down days tells me we are close to getting through this correction. According to the American Association of Individual Investors' (AAII) index of bullish vs. bearish sentiment, we are back to a majority of bears—46% bulls vs. 67% bears/neutral—meaning we have enough fear to put in a final bottom.

We should expect at least one more retest of the correction before earnings season, which you should view as nothing less than a great opportunity to add to your positions.

The good news?

We have four super-strong supports to the market for 2007:

1. The private equity put, i.e. the exploding buyout market for strong-cash-flow companies.

2. The growth stock bias. With GDP [growth] hovering around 2% and a five-year economic expansion, it's finally time for secular growth stocks to outperform value stocks.

3. Corporate mergers and acquisitions. The slowing GDP growth and high levels of cash make deals like Hercules Offshore’s agreement to buy competitor TODCO for $2.3 billion in cash and stock look cheap.

4. The Fed effect. Fed Chairman Ben Bernanke will undoubtedly wait until the Consumer Price Index drops (on lower rental/housing prices) and then reduce short-term rates to 4.75% or so. This will help stabilize refinancing in the mortgage industry and result in 15%-20% undervaluations in stocks. Moreover, I see the amount of stock buybacks beating their 2006 record this year.

Now, let's put the sub-prime loan mess in perspective:

• More than 38% of homeowners don't have mortgages

• 57% of homeowners have traditional mortgages

• 95% of homeowners are paying their mortgages—about the same percent as in 2001, during a real recession

On a brighter note, the IRS reports a 9% (about $9 billion) increase in direct-deposit tax refunds in 2007. This number is a fairly good predictor of increased consumer spending in the near future in the face of low unemployment rates and higher consumer earnings—especially without a significant risk of recession around the corner. So, consumers continue to form the backbone of economic growth.

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