Does The Stock Market Need A Correction?

As the Dow Jones Industrial Average fulfilled its month long mission and breached 11,000 for the first time since 2006, we began thinking: Is the market's rally really sustainable? Is it backed by fundamental macro-economic reasons? Is the giddy sentiment between the media and market commentator's fully rationale? Can they all be correct at the same time? Are future corporate earnings really going to support the current P/E ratios of their stock prices?

Over the past few days, we here at SafariResearch.com have become slightly bearish in the near term. By constantly paying attention to market price action, sifting through countless economic and company specific data, scouring the internet for as much information as possible, and keeping up with the content distribution by the mass financial media outlets, we have taken notice of the ultra positive market sentiment and have began to question it's validity.

Although it is extremely difficult to be bearish, specifically in a period of free liquidity and extremely low interest rates, we believe that the last 5-10 percent of gains have been brought on by performance chasers buying in fear of being left out. These types of buyers are of the least conviction as they buy simply to ride the wave ignoring any intuition or fundamentals, they are also the first to head to the exits as soon as the tide turns.

We broke out our top three reasons for pessimism into each of two categories: Fundamental & Sentiment

Fundamental

1.) Current P/E ratios of the S&P 500 are 21, the long term average is 16 (mean reversion)

2.) As the S&P 500 approached 1200 in 2004, Trailing Operating Earnings Per Share were $68 and today they are $58

3.) Consumer confidence has not rebounded near as strongly as it is being represented by the price action in the market.

Sentiment

1.) As we entered the week, nearly every financial news front page had a reference to the Dow Jones Industrial Average nearing 11,000

2.) The VIX has signaled nothing but complacency.

3.) Recently on CNBC's Fast Money, Robert Prechter was verbally shut down by the show's wildly bullish commentators as soon as he began to share his pessimistic view.

For these and other reasons, we believe that equity markets may be headed lower in the near term. A 5-10% correction would be nothing but healthy as we enter the Q1 earnings season. Results will most likely be mixed as some businesses will surprise while other miss. All in all, the long term prospects will most likely be bullish as long as unemployment begins to trend lower and top line revenues begin to grow.