Barron’s drew a lot of attention over the weekend for its interview with Ned Davis. (Subscription might be required.) The highly-respected researcher said he anticipates a 20% correction coming in U.S. stocks. But his forecast isn’t as bad as the headline indicated. First, he doesn’t expect a long, deep bear market. He thinks when the drop comes it is likely to be around 20% and last for about 143 market days (based on historic averages). Also, he doesn’t think the decline is imminent but likely to happen sometime in 2014. Finally, Davis believes the decline will set up a great buying opportunity because it will be followed by several years of strong gains. If that’s the outlook, why bother trying to time an exit and entry point?
This is an interesting period. Interest rates are zero, so stocks look good, relative to other assets. But on an absolute basis, they’re not really so cheap. In 2007, some people said, yeah, stocks may be a little overvalued, but not relative to houses. Houses are way overvalued, so money will flow from houses to stocks. But stocks went down more than houses. Relative valuation is tricky. I trust absolute valuation more, and I’m hoping that, if we get a decline next year, it will make absolute values look better, while relative values will stay good. That would set up the buying opportunity we’re looking for. If the Fed does taper its bond-buying next year and rates go up, say, to 3.25% or 3.5% on 10-year notes, that may be enough tightening to create the correction we see coming. A lot of value players, even Warren Buffett, say they’re not seeing a lot of great values. Those are absolute values they’re talking about, and that’s a problem a correction would solve.