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Farrell: The Terrifying and Ugly Truth About Corrections

Wednesday, 26 May 2010 | 12:18 PM ET

Nobody knows the trouble I have seen....

With almost 40 years of experience you think I would be calmer when market turmoil hits.

But I guess it's part of the human condition to forget the pain and remember the good times.

Corrections (and that's what I think we are in) come swiftly, they are ugly, and terrifying. You get to think there is nothing underneath and a little perspective is always helpful. Even if incorrect it'll stop you from rash actions.

Selling in a semi-panic is rarely the right move.

Let's review the bidding with what we know.

We know that the European response to their condition is uncoordinated and haphazard. Germany is trying to institute short sale rulesfor domestic political expediency with no advice or counsel from their partners, or even informing their counterparts in the EU. This move has forced the European regulators to engage in "intense discussions" (The Financial Times) about a wider European wide ban.

Oliver Quilla for CNBC.com

The markets don't like this as it appears rushed and poorly thought out.

The markets also don't like the government takeover of a Spanish savings bankthis past weekend.

Four other banks have apparently agreed to form a more perfect union, and Bloomberg reports 16 others are engaged in talks about combining.

I forget where I read it but piling junk together usually means just a bigger pile of junk.

No less than the International Monetary Fund honchos have warned that "Spain's economy needs far reaching and comprehensive reforms. The challenges are severe: a dysfunctional labor market, the deflating property bubble, a large fiscal deficit, heavy private sector and external indebtedness, anemic productivity growth, weak competitiveness, and a banking sector with pockets of weakness. Ambitious fiscal consolidation is underway...This needs to be complemented...with overhauling the labor market (yeah, right they can do that)...and time is of the essence." The Spanish Finance Minister admits investors are still worried about EU debt and "a lack of credibility in the sustainability of public finances."

Spain sold some 6 month notes yielding 1.26% compared to .74% just one month ago. You bet there is a lack of credibility.

EU countries said they may be forced to levy a fee on banks to raise money for future financial bailouts.

This comes at a time when European banks are being hit with higher funding costs. Three month LIBOR has moved to .54% and is a good spot indicator that takes the temperature of the situation. The Financial Times reports that the European Central Bank (ECB) might have to increase its bond buying plan since the $26 billion spent so far seems inadequate. This program was started impetuously and without being well thought through.

If they want to do such a program a minimum of several hundred billion will be needed. You can't go cheap in this league.

Investor Spring Cleaning - A CNBC Special Report
Investor Spring Cleaning - A CNBC Special Report

Then there is alwaysNorth Korea and South Korea squaring off.

North Korea picked the maximum moment of opportunity to sink the South Korean ship.

With the financial world in a spin they figured it was time to get some concessions. They didn't figure the smoking gun of torpedo remnants would point the finger at them, but they don't care. They know this will not trigger a military response. It will probably yield some concessions for a promise to be good. Iran figures the same strategy. Do what you want and get fronted by Brazil and Turkey so when the Big Three (the US, Russia, and China) issued their sanctions all they could do is "call for" nations to punish Iran. A weakened US in international affairs is not good.

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

Forget Greece.

I have been writing about it too often and it's clear to me an austerity plan will not be implemented and their debt needs to be restructured, if not defaulted on.

The Gulf oil spill and the soon to start joint Senate/House Financial Regulation Bill conference will undoubtedly be in the headlines for a while. The "flash crash" of a few weeks ago un-nerved me. That a computer mishap could do that is not going to bring investors streaming back into the market.

Tuesday's stock market action, though, holds out some hope we are discounting all of the above. The S&P 500 average went to 1040 during the day for a brief visit and a fast cup of coffee (the market had closed at 1073 Monday evening). 1040 is close to last February's low (1045, actually) and it is also a 1/3rd correction of the whole wonderful advance that started in March of 2009 at 666. 1/3 corrections of a full advance are common. They are awful to go through, fast, ugly, and terrifying as I have already said. I have the scars of more than a few of them on my back.

But they end.

Debtor Nations
Debtor Nations

If 1040 doesn't hold the next stop could well be 950.

That would represent a 1/2 correction of the advance.

While the one-third varieties are more the norm, you occasionally get socked with a one half job and it smacks your face hard and causes damage.

But it would not change a technicians view that an uptrend is still in place. I think/hope we will be in the 1/3rd category.

One of the reasons I think the damage is almost over is the valuation of the market. Consensus earnings estimates for 2011 S&P companies reached $98 recently. They have come down to $94. I have been using $90 and figured I was high. Let's say it's $85 just for fun. With the market now at around 1070, the price to earnings multiple is a modest 12.6 times. We can live with that.

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