Which Dip Will They Buy?

Let’s say you are not afraid that this is the correction Doug Kass has been calling for. Where do you buy? Think like a professional fund manager for a few moments and ask, “What are they doing and why?”

They are buying stocks because the environment is ripe for it. We’ve seen the recession trough and the earnings trough. The economy and stocks are recovering rapidly and will continue to do so until there is evidence of a coming double dip.

Interest rates will remain very accommodative, and contrary to the wishes of inflation hawks who want the Fed to put the brakes on, it ain’t gonna happen in the first quarter.

Finally, every portfolio manager is competing against some broad market benchmark and against his or her peers. Those who manage less than $1 billion are dwarfed by a factor of thousands. Combined with Fed-supplied liquidity, the question of which train you ride is clear—the bull train is safer.

So how far will the pullback go before enough institutional money sees bargains it can’t resist? Somewhere around S&P 1,040 is about as low as I think any pullback will go. Buyers will come in and wrestle with frenzied sellers before then, but the healthy back-and-fill process necessary to continued upside could take us back to test the October lows.

Is a bigger correction necessary to wash out “overdone” speculation and weak hands? I don’t think so because we are not really in an “overdone” stage of the upswing. We are still in the “wall of doubt” stage where lots of money on the sidelines can’t believe stocks can go back to pre-Lehman levels (1,250 on the S&P 500) because the economic environment is so bad. This is a good recipe for more upside.

Where is this “mild pullback” analysis wrong? If highly-correlated risk assets move in tandem, it could be confirmation of a bigger S&P move to 975 at the lowest. The VIX goes above 30, oil below $68, and the euro below $1.42 would be good examples.

It’s been easy to be a bull on this market for eight months. Maybe it does need to get hard again with a swing to more pessimistic sentiment. Your ace in the hole is the fund manager/V-recovery bull train that won’t exactly stop at your station at the lows before it heads back north. You may have to jump on early to make it aboard at all.