It stands to reason that the stock market should experience a significant correction in the short-run. We have seen multiple new yearly, multi-year, and historic highs for stock prices of late, and the overall level of the Dow (12,000), and the S&P 500 (1,300) are at nosebleed levels.
Last year we saw stock prices drive strong gains in the Dow (up 11%), the S&P 500 (up 13%), and the NASDAQ (up 17%). Interestingly, the best performing sectors were Consumer Discretionary (+26%) and Industrials (+24%), while Technology was only up 9%, and the Health Care sector managed less than a 1% advance.
The real question is: where do we go from here?
I have been anticipating a sizable correction in the first part of 2011 for several months. Could yesterday's sell-off signal the beginning? Possibly, but we must keep in mind that earnings have been solid, and sentiment is fairly strong. GDP growth for the fourth quarter was reported to be 3.2% (initial reading; annualized) this past week, while growth for 2010 was reported at 2.9%.
Investors appear to be confident that stocks can continue to drive higher, and this could result in continued stock market advances. However, I believe that stock valuations are extremely expensive, and would not be a buyer here. Further, I do expect a correction of at least 10% to 15% to come shortly, and would not risk new capital in stocks at this time. I would also trim positions, particularly in those sectors that have shown the strongest upside during the rally.