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Bulls Dismiss Concerns for a Short-Term Correction in U.S. Stocks

Cautious investors fearing a short-term correction are ignoring the big picture, a handful of market analysts said, and could be missing out on big gains.

The debate between the bears and bulls, which started in earnest when the Dow Jones Industrial Average surpassed its all-time high last October, reached full steam last week when the blue chip index carved out its 27th record high since then.

"I think it's very unwise not to be invested in equities," CIBC senior economist Avery Shenfeld told CNBC.com. "When the markets are climbing, there is always a wall of worry ahead of it but the walls ahead of this market don't seem to be particularly onerous to climb over. No market goes up in a straight line but the overall economic backdrop is still quite positive."

The markets reacted strongly to rosy comments issued by the Federal Reserve on Jan. 31. Although policymakers kept interest rates steady, as expected, their surprisingly positive view on a moderating economy, receding inflation pressures and a stabilizing housing market, addressed the three main concerns for investors.

Along with the Dow, the S&P 500 index reached levels not seen in six years and other closely watched indexes such as the Dow Jones Transportation Average, the S&P MidCap 400 and the Russell 2000 also rocketed to all-time highs.

But despite the bullish cues market analysts warned investors that unchecked gains leave stocks ripe for a pullback.

"Simply put, there is no investment merit to the stock market at these valuations," said John Hussman of the Hussman Funds, in a Feb. 5 client report. "The only reason to accept market risk might be speculative merit -- the belief that stocks could be expected to outperform Treasury bills, on average, under prevailing conditions."

But Paul Desmond, president of Lowry's Reports, said it appears that the biggest concern among investors is that "some people can't stand this much prosperity," in an interview with CNBC.com.

"They think sooner or later a 10% correction is going to come along," Desmond said. "But if you've taken that position at any time in the last four years you were wrong. So you have to look at the big picture, and it looks very attractive."

Desmond, a well-known market technician, said in the last six months his firm has been waiting for a short-term correction that has never materialized as buyers have stepped in at the slightest whiff of a buying opportunity.

"This market has been so strong that it hasn't been able to get from an overbought condition to a fully oversold condition," he said.

The last time this type of overbought action occurred, Desmond said, was in early 2003 when the market finally touched rock bottom following the dot-com crash.

"Seventy-five percent of the time in market history, you're smart to prepare for a correction, but this is just an unusual time when there is a huge amount of money flowing into markets and the buyers are swallowing up any short-term sell offs," he said.

Some analysts say the market climate is just right for stocks now.

"The recent economic data suggest a near-ideal backdrop for stocks, in my opinion: solid economic growth, sensible monetary policy, stable prices and good profits," Prudential's chief investment strategist Edward Keon said in a note.

Shenfeld points to historically low interest rates and strong corporate earnings growth as reasons why stocks remain "reasonably valued" and have room to grow.

But Mark Arbeter, chief technical strategist at Standard & Poor's Equity Research, said history indicates the Nasdaq could be poised for declines of 7% to 10%.

One technical indicator Arbeter follows is currently flashing a sell signal, he said, which compares volume on the Nasdaq and the NYSE. When Nasdaq volume is 40% higher than the NYSE on a three-week basis the S&P 500 fell 7% to 8% and the Nasdaq declined 13% to 17%.

"I just think that now is not a good time to be putting money into the market," Arbeter told CNBC's "Street Signs" on Monday. "I think that we’re very extended off the June and July lows and I see a minor pullback here and I think a better opportunity in a couple of months."

Jim Paulsen, chief investment strategist at Wells Capital Management, said on CNBC's "Squawk Box" Monday morning there was too much investor optimism right now.

"I think it's shallow optimism," he said. "There are a lot of people thinking the market will go up but if it goes down 2 or 3% for 20 trading days, it will be gone and will be pessimistic again. It wouldn't take much of a pullback to wipe out that sentiment."

However, near-term nervousness from Paulsen and S&P's Arbeter may be a case of wishful thinking; both have long-term bullish expectations for stocks with Arbeter expecting a 10% rise in the S&P by the end of the year.

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