Classic 'Warriors' movie has lesson for market

The stock market could learn a lot from Swan, Ajax and the rest of the gang from the 1979 cult favorite "The Warriors."

So goes the thinking from Convergex's chief market strategist, Nick Colas, who sees parallels between the retreat the headline gang from the movie had to beat back to Coney Island, and the pullback stocks need if they are going to remain in a healthy state. "The Warriors" begins with a gang summit in New York during which the leader is murdered and a rival gang wrongly blames the Warriors, who then have to battle their way back home.

In his daily note Tuesday, Colas recalled that "The Warriors" closely mirrored a story from ancient Greece called the "Anabasis," which tells of how 10,000 Greek mercenaries caught in the Persian Empire fought their way to the Black Sea.

With that in mind, he provided both a movie synopsis and a dissection of the market's current condition:

A small gang (of) petty thugs has to make its way from the northernmost bit of the Bronx to Coney Island in south Brooklyn after being wrongly accused of killing a powerful gang leader named Cyrus. On the way, they encounter other gangs, police, and all the mayhem for which 1970s New York was rightly known. They do eventually make it back to the shores of Coney Island, just as the 10,000 made it to the coast of the Black Sea. Yes, "The Warriors" is a direct take-off of the "Anabasis," right down to the shout out for the long dead Persian King Cyrus.

The message is therefore the same in both narratives: a successful retreat in the face of overwhelming odds can be rightly considered a victory.

Colas believes the "retreat" the market needs is a correction, or a 10 percent drop in the S&P 500. That hasn't happened in nearly four years, one of the longest streaks ever.

A still from the movie "The Warriors"
Source: YouTube
A still from the movie "The Warriors"

The index currently boasts a high valuation—about 18 times earnings—even though corporate profits have slowed to a crawl. Large-cap companies showed just a 3.2 percent gain in the first quarter from a year ago, with respective declines forecast for the next two quarters of 4 percent and 0.3 percent. Revenue actually fell 1.7 percent in the first quarter and is likely to be down 1 percent for the full year, according to the latest forecasts from S&P Capital IQ.

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"Just as an army—even a retreating one—travels on its stomach, equity investments need earnings to survive a long march," Colas wrote. "More particularly, they need the promise of future earnings growth. And that ingredient is missing at the moment."

Colas is not alone in talking up a market correction, but the discussion more often revolves around the probability of, rather than the need for, a correction.

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The latter point not only takes valuation and momentum into account but also accounts for the need of a re-entry point for investors who may have sat out the rally or gotten out too early.

Of course, the wild card in all of it is the Federal Reserve. While the U.S. central bank has kept short-term interest rates anchored near zero, the S&P 500 has surged nearly 220 percent. Zero interest rates make valuations easier to justify, but with the Fed expected to start hiking soon, that equation will change.

Colas advises investors to watch Friday's nonfarm payrolls release. A strong number could push the Fed to hike sooner, while a weak number could feed into the "bad news is good news" scenario that has characterized much of the past 6 ½ years.

"The 'Anabasis' is probably good reading not only for U.S. equity investors, but for the Federal Reserve as well," he said. "Investors should remember that sometimes a small retreat on your own terms is better than a long march to the sea."