Equity Market Correction a One Quarter Event

I believe equity markets (and riskier assets in general) are in the midst of a 10-15% correction that plays out within one quarter, which is normal, not at the onset of the next financial avalanche, which lasts many quarters.

There was never any question that the extraordinary policy maneuvers of 2009 would begin to be unwound in 2010. But the culmination of events in Europe, China and the United States over the last two months have brought this all to a head very early on in 2010. Profit taking after large, sustained bull runs is a natural reaction of investors to a bout of increasing uncertainty and higher risk recognition.

On the US equity side, the Institute for Supply Management (ISM) manufacturing index has a history of tracking the year-over-year rate of change of the S&P 500. Over the past three decades, a reading on the ISM above 45 has been associated with positive capital gains on the S&P 500. A reading above 50 (like last week’s 58.4) has been associated with equity market gains above the long-term historical nominal average of 10-12%.

Manufacturing Stock Gains

For this to be the onset of the next avalanche in equity prices, we would need to see the ISM composite index falling like a rock from its January high. That outcome seems unlikely with inventory rebuilding just beginning to kick into gear and leading economic indicators still on the rise.