The correction target has been reached?

What kind of mood changes just a few days could make! Here is my note to friends sent about 10 days ago:

 

Jan 29 (Monday morning)

This market has done something really unprecedented, giving the herd the impression that it can continue with the parabolic move forever. But history has taught us any parabolic moves always end badly. It’s just when not if. No one knows for sure when this will happen but the market usually needs some catalysts as excuses to trigger the move. We have all sorts of potential catalysts this week. Trump’s State of the Union speech is on Tuesday. The FOMC decision on interest rates is Wednesday. There are about 100 companies reporting earnings this week. And, we get the jobs report on Friday.  Do I know if this the end of this run? I’m not so naive to say that. But some caution is definitely warranted as the black Monday for a 20% crash in 1987 didn’t give anyone a pre warning when it hit.  Again I’m not saying sell everything but just advising for caution.

 

A big drop of the marketed stated next day, Jan 30 and then really got intensified on Friday after the job report as it was interpreted as too strong for inflation and higher interest rates moving forward.  Since then, the market has lost 10% from its high, wiping out all of its gains of this year! The timing for my warning call seems perfect as if the market was whispering to me to give me a heads up. Of course, it was a pure luck but ultimately it was a contrarian call based on the extreme sentiment I had seen. It usually works but not necessarily always in the exact timing which is a lot to do with luck. So the million dollar question now is: Has the correction already done and passed by now? Of course I don’t have a crystal ball to call that but let me provide you a bold prediction: I think the correction target has been reached! Why would I think so? Well, it is again something to do with the contrarian thinking as well as the fundamentals. While I have expected for a severe correction for quite some time, I was only thinking about a 5-7% correction, not as much as 10%. While this 10% plunge is certainly painful for investors, the panic it has caused is quite extreme, felt almost like the end of the world. The fear index, VIX, jumped to over 40, a very rare occurrence in the history. All the sudden, there is a widespread concern that we may get another 10% drop to end this a decade long bull market and start a bear market. I really don’t believe so. Fundamentally the economy is doing very well and inflation is far from high enough to significantly dampen the stock market immediately. Yes, as I have said, we are now entering into a high interest rate era (see here) but at the moment it is still at the historically low level. The real impact may only start to come when  the 10 year Treasure yield reaches 4% and going up. My guess is that we are still about a year or so away from that and I think we will likely see new highs this year. With this consideration, I personally feel the current S&P level just below 2600 is likely the bottom area for this correction. Now it is a good time to start to do some bottom fishing.

 

Having said that, I don’t mean the correction is over. Rather it is still in the correction process trying to find the exact bottom as a support for recovery. Here is what I think may happen in the next few weeks: S&P will chop around in a wide range, e.g. a 100 points up or down but mostly sideway moves. During this period we will likely see at least one more test for its recent low, or probably more. This will provide a strong technical support for the market to accumulate sufficient strength for its new highs. That’s why it is a good time to start looking for good stocks you want to own for long term. Given the high chance of continuing great volatility in the next few weeks, using dollar averaging to gradually build up your positions is a wise way to do so. No one knows for sure in advance what is the actual bottom. So don’t try to go all in at once. For me, I prefer to sell puts for the stocks I want to own, which will give me good chance to buy stocks at the price I want to have and with much lower risks. I have already started the process. Yesterday when Dow plunged another 1000 points causing extreme panic with everyone running away, I happily sold a lot of puts for more than 10 stocks in a day, something I have never done before. I bet these will be big winners for me in the months ahead when the market calms down and start to move up again. As I have told friends, selling puts during high volatility, especially at its extreme level like over 30 or 40 is the best strategy for making money with much low risks. The key is to only sell puts for the stocks you want to own anyway and with appropriate position size. If you overleverage with naked puts, it may kill you. Just be aware!