Farrell: We Are Overdue For A Market Correction

The market is up some 40 percent from the low it reached just last March. Rallies like this are wonderful, but this one, on consistently light volume, makes me nervous. While the equity market has done well, commodities, especially oil, have risen, and bond yields have backed up.

The ten-year Treasury has risen in yield from 2.08% at the end of last year to the current level around 3.7%. Commodities have risen in price and yields generally have risen at the beginnings of economic recovery. But income, production, employment, and sales usually have risen as well, and what we have seen recently are that these indicators are just less bad.

Initial unemployment claims were announced Thursday and were in line with recent weeks at 621,000. The four-week moving average was up a bit to 631,000. These numbers have flattened over the past few weeks, and that would ordinarily be viewed positively. With the recent auto bankruptcies and the likelihood that some auto suppliers might follow, we fear that claims might move higher over the next few weeks.

The rise in rates might be viewed as a sign that the economy is improving, but, as stated above, the substantive parts of the economy haven't moved. But even if that is the case, that rising yields are a good sign, the lift in the 10-year Treasury yield directly lifts the 30-year conforming mortgage rate.

Higher rates at this "delicate" time take away the favorable arithmetic that has allowed mortgage applications for refinancing to rise. Mortgage applications fell this past week, and, with last week's average rate at 5.29% according to Freddie Mac, applications are likely to keep falling.

Oil prices have spiked, and gasoline hit an average of $2.50 a gallon nationwide and will move higher yet again if Goldman Sachs's recent prediction of $85 oil for 2009 is correct. Rising mortgage rates and higher gas prices are not conducive to rising consumer spending. The savings rate has moved from zero to 5.7 percent and, in our opinion, will move higher.

All of this makes me think we have gotten ahead of ourselves in the stock market. There is an ocean of cash on the sidelines earning close to nothing, and the thought is that will power stock prices.

It might, but investor caution is more etched into our psyche, and we are overdue for a bit of a correction. Significant rallies usually have had a one-third correction of the advance, and that would be healthy.