waiting for the correction

The long bull market in the United States remains intact but there have been some recent stumbles. We would like to see some further selling in order to correct some of the overly optimistic sentiment (a contrarian indicator) that's built up. The Ned Davis Research Daily Crowd Sentiment Poll recently hit its most optimistic level since the end of last year, near levels that have typically preceded a relatively decent pullback.

Additionally, midterm election years (like 2014), have historically brought decent-sized pullbacks in each year going back to 1962—ranging from -8% to -38% with the average decline being -19% (thanks to Strategas Research Partners), but those pullbacks have been followed by substantial rallies over the subsequent 12 months, ranging from 12% to 58% and averaging a whopping 32%.  We haven't seen that type of pullback yet, and history doesn't always repeat, but it does often rhyme.  Bottom line—in our view the possibility of correction is elevated, but we would view such an occurrence as a buying opportunity for those who have been under allocated to equities.

Valuations are being debated, with concerns about overvaluation growing—exacerbated by comments from the Fed related to biotechnology and social networking stocks.  Given continued low interest rates and inflation, the market can likely maintain higher valuations, and current levels are roughly inline with where history has shown they should be.  So while the market is no longer a significantly undervalued story, we don't believe valuations have become an impediment to this bull market.

-- Schwab Market Perspective, July 18, 2014