Stock Market Correction Coming? A Case of "Too Fast, Too Furious?"
THE US stock market has been soaring. It may have gone too far, too fast.

Gina Martin Adams, an equity strategist at Wells Fargo Securities, certainly thinks so. 'I would definitely tread very lightly in stocks,' she said. At the moment, there appears to be enough momentum to keep propelling the rally forward until it 'stumbles on some speed bumps', she said, but she warned that stocks were no longer cheap, especially with the economy still fragile.

At some point, she said, a host of fundamental problems would pull stocks back down to earth - but, of course, she could not say when. 'There's a difference between where the market will trade and where it should trade,' she said.

Stocks have certainly come a long way since their March 9 lows, with the Standard & Poor's 500-stock index rising 58 per cent in one of the most powerful upturns since the Great Depression. The recent rally, of course, followed the steepest decline in decades. The index stands at 1,068.30, still well below its October 2007 peak of 1,565.15.

A rebound of some sort was likely after the battering inflicted on financial markets during last year's panic. In a speech on Wall Street last week, commemorating the anniversary of the collapse of Lehman Brothers, President Barack Obama said the most acute phase of the financial crisis was behind us. But he cautioned that the economy remained weak with rising unemployment, and that a variety of emergency government programmes would continue to play a significant role. Ben Bernanke, the chairman of the Federal Reserve, warned in Washington that while the United States was probably out of recession from a 'technical perspective', the economy would still 'feel' very weak for some time.

Despite this grim backdrop, Laszlo Birinyi, president of Birinyi Associates, a stock market research firm in Westport, Connecticut, said he believes that we are in the early stages of a classic bull market that has plenty of room to run. 'At any juncture during a bull market over the last 50 years you could point to economic problems,' he said. 'The obvious problems aren't the ones that I worry about.'

In his view, the economic weakness has been documented so well that the market has already taken it into account. 'The negatives are right in front of your nose,' he said. 'The market is looking past it.' Unless there is another shock of some unknown kind, he said, 'I don't think we'll have a correction, not at this point of the cycle. It won't happen while everyone's looking for it.'

In fact, he said he was encouraged that 'there's continuing concern' - including articles cautioning that the market would stumble. 'Almost no one seems to accept and use the term 'bull market' for the current rally, Mr Birinyi said. That implies that there is plenty of cash still on the sidelines that will enter the market as it rises, he said, pushing stocks up even further.

Where Mr Birinyi emphasizes opportunities, however, others are focusing on the dangers. David Rosenberg, the former Merrill Lynch economist who is now with Gluskin Sheff and Associates in Toronto, did not expect so robust of a rally, and said that underlying structural weaknesses in the economy implied that the market was due for a big fall. 'What happened was that the economy received a heavy dose of medication from Uncle Sam,' he said. 'The reality is that no one has a clue as to what the economy really looks like because it's been so dramatically sedated by the federal government. It's as though we've received a massive tranquillizer,' he said, 'but eventually, tranquillizers wear off.'

Mr Rosenberg says we are experiencing 'an impressive bear-market rally' - a short-term upturn in a 'secular' bear market - that still had perhaps eight or nine years to run. He advised stock investors to take profits now. Energy commodities, he said, appeared to be a better value.

Ms Adams shares this bearish long-term view. Among the many worrisome signs s1he sees are Treasury yields that remain low, especially considering the enormous supply of bonds the government is auctioning regularly to finance its yawning deficit. This suggests that deflation continues to be a big worry, she said. If we lurch into deflation, it could devastate the economy and the markets.

Gold has prospered recently - it stands at about US$1,007 an ounce - partly because investors cherish it as a hedge against both inflation and deflation, said George Milling-Stanley, a managing director at the World Gold Council, an industry trade group based in London. 'One of the beauties of gold,' he said, 'is that it just doesn't have any statistical correlation with any other market or asset class.' There is one possible exception, he said: 'When the world's main reserve currency - now, the dollar - weakens, gold tends to strengthen.'

Because the consensus in currency markets is that federal borrowing will weaken the dollar, this, too, has tended to benefit gold.

The Federal Reserve is steering a tricky course, attempting to stave off deflation by creating enormous quantities of money and holding its benchmark short-term rate near zero. At the same time, Fed policymakers say they are preparing to reverse themselves to head off inflation.

Watch the 10-year Treasury yield closely, Ms Adams said. It's now 3.47 per cent. If it stays low, she says, it could be a sign that the economy and stock market are in real trouble.

In the meantime, enjoy the rally. -- NYT