Will There Be a Correction?

I posted the following as a comment to an article that I read on another Web site. I think the comment stands on its own (you don't have to read the original article). So I thought I would post it here as a little article, because it contains some information that gives insight into my philosophy.
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Let's get back to the point of the article:"The debate centers around two chief concerns: Have stocks jumped ahead of the economic recovery? And if so, Are they setting up for a big correction? "

The answer to the first question is easy: Of course stocks got ahead of the economy. They "always" do. That's the job of the market, to discount the future and set stock prices accordingly. Nine of the last 10 recessions (including this one) have seen significant market rallies during the recession.

The second question is harder. Will there be a "big correction"? I think that depends on whether the economy catches up to the market's expectations. More specifically, will corporate earnings rise enough to justify the prices that investors have placed on their stocks?Everybody has their own favorite indicator or three. Shipping statistics; the ISM; the LEI (either the Conference Board's version or ECRI's version); insider buying and selling; GDP (original and revised); labor and employment statistics; etc. There are scores of them.

All are subject to some degree of manipulation and error in methodology, and most everyone in the "efficient market" brings an unfortunate amount of preconceived spin to interpreting them.

Here's the true answer: We don't know. Last quarter was filled with upside earnings surprises (not to be confused with earnings that actually increased...they didn't). Why were genetically over-optimistic analysts surprised at the relative (not absolute) strength of corporate earnings? Because they apparently underestimated the speed and effectiveness of corporate cost-cutting in Q4 2008 and Q1-2 2009.

Q3 is ending. A new earnings season is upon us. We don't have to look at our favorite indicators any more. We'll have actual earnings to look at, plus the usual press releases, forward-looking statements, and the like.

Here's my guess, based on three factors: (1) If earnings again surprise to the upside, that will create "wanna own" pressure that will push against a correction. (2) If the forward-looking statements and guidance sound positive, that will have the same effect. (3) If revenues (which did NOT surprise to the upside last time) show signs of recovery, that will create the same pressure.

Of course, the opposite of any of those will create the opposite pressure, namely the pressure to sell and the liklihood of a correction. A big one? Maybe.

Me, I've got my exit strategy in place (sell stops). I won't try to predict, just wait for the turn, if there is one.