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Well, it's official -- January was a pretty big bust for the market. Although things looked good during the first week or so of the year, the market headed down after that, with the Dow losing about 3.5% for the month.
For folks who believe that how the market performs in January is a predictor of how it will fare for the entire year, the outlook isn't good. And there is currently no shortage of investment professionals calling for a significant market correction.
In a recent article for Investment News, Avi Tiomkin, chief investment officer of New York-based Tigris Financial Group, predicts that we could easily see the Dow Jones Industrial Average fall to 8,000. Tiomkin feels that the Federal Reserve and government stimulus programs have been the primary factors in propping up the economy and once those supports are removed, we're in for a world of hurt. He thinks the rally that began in 2009 is merely a precursor to another decline.
Supporting this hypothesis is the fact that volatility is increasing. The VIX, an index that measures volatility in S&P 500 options, jumped sharply in mid-January and remains above its historical average. Since the VIX, which is also known as the "fear index," has typically served as an indicator of market distress and the level of uncertainty in the market, its recent jump could portend some tough times ahead.
The silver lining
However, the outlook for the stock market may not be as dire as some would have you believe. First of all, for investors worried about how a lousy January will affect the rest of the year, remember that the predictive powers of January's direction are strongest when the month ends on an up note. When the month is negative, the correlation isn't quite as strong. Since 1928, there have been 30 years in which the market was down in January, and in only 18 of those years did the market finish lower than it started.
Similarly, while the VIX is a useful tool for judging how antsy the market is right now, it's important to remember that the index is a measure of short-term volatility only. It doesn't tell us anything about the long-term prospects or outlook for the stock market.
From a broader perspective, though, anyone who would be caught-off guard by at least a slight market correction hasn't been paying attention. Given how far and fast the market has climbed in the past year, a slight pause shouldn't be a surprise, especially as we begin to see the withdrawal of government supports this year. Investors will be waiting anxiously to see how the economy fares on its own, which could mean more volatility in the market.
However, I think Tiomkin's prediction of the Dow reaching 8,000 is a bit dire. I won't argue that there aren't significant risks out there for the economy, or that a financial relapse isn't possible, but so far, economic data has been encouraging.
Fourth-quarter GDP, for instance came in at a red-hot 5.7% rate, and while much of that was admittedly fueled by a slowing in inventory reduction, it still points to a growing economy. Likewise, new data show that activity in the manufacturing sector is at its highest level since 2004 and that banks are beginning to loosen up their lending. Odds are good that the economy will begin adding jobs in the next month or so, which should be the last piece that needs to fall into place to get this recovery fully on track. A dip may be in the cards along the way, but I think the market is more likely to end the year flat or just marginally positive.
Timing is everything ... or nothing
If a market correction is lurking out there somewhere, should you park your money in cash and wait it out? I don't think so.
While no one likes to ride out a bear market, most investors do greater damage to themselves by trying to time the market than by sticking to their long-term plans. The key here is to invoke that old "buy low, sell high" mentality and stock up on what hasn't done as well so far. To-date, much of the market rally has been focused on lower-quality stocks -- riskier small-caps and battered large-cap financials like Bank of America (NYSE: BAC ) , Wells Fargo (NYSE: WFC ) , and Goldman Sachs (NYSE: GS ) . But those aren't the companies that are likely to lead in the future.
They've been ignored for a while, but high-quality blue-chip stocks are due for a comeback. Many high-profile money managers are in agreement about this, and are adjusting their portfolios accordingly. To capture the gains of the next market leaders, investors should think about picking up top-quality stocks, like health-care names Pfizer (NYSE: PFE ) or Johnson & Johnson (NYSE: JNJ ) . In the consumer arena, Wal-Mart (NYSE: WMT ) and Coca-Cola (NYSE: KO ) are two other top choices. Companies like these with decent cash flow and meaningful market share should be well-positioned to ride out any bumps in the near-term.
I don't expect a Dow 8,000, but even if it materializes, investors should recognize it as the buying opportunity that it is -- as long as you know the right places to put that money.