The Stock Market Correction That Hasn't Happened

US News

"Buy the dip" has become such familiar investment advice these days that some advisors have simply shortened it to BTD. There's just one problem: The dip everybody seems to be waiting for hasn't materialized.

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Since late last year, investors have had good reason to expect a stock-market pullback of 5 percent or even 10 percent. The fiscal-cliff battle at the end of 2012 could have been one cause of a dip, since it threatened another recession. The federal spending cuts that went into effect March 1 were another possible trigger. Then there's Europe, where pop-up financial crises have become a way of life. And every hint of a policy shift at the Federal Reserve makes investors antsy.

In mid-February, Bank of America Merrill Lynch predicted a 3 to 5 percent stock-market correction. In early March, investing firm PiperJaffray called for a brief 5 to 10 percent drop in the S&P 500 stock index, part of a "hop, drop and pop" pattern it sees emerging this year. Many other investing firms feel a dip is coming before stocks resume an upward trajectory.

But so far it hasn't happened. The S&P 500 index recently crested its 2007 peak to hit a new all-time high, and it's up 10 percent for the year. That follows the narrower Dow Jones Industrial Average, which has closed at several new highs recently, almost as if investors are mocking the spending cuts known as the sequester--which some politicians, including President Barack Obama, warned would cause widespread harm to the economy.

A market correction could still happen, of course, but forecasters seem to have gotten the timing wrong (at a minimum) because they've underestimated the eagerness of investors to get into the market. That's part of a broader misread of the entire U.S. economy. Since late last year, many economists have been predicting extremely weak growth for the first half of 2013, bordering on recessionary conditions. Yet the economy has held up far better than expected in the face of tax hikes, federal spending cuts and general fears about what could go wrong. Macroeconomic Advisers, a prominent forecasting firm, has raised its estimate of first-quarter GDP growth from 2.3 percent to 3.2 percent in recent weeks. Others have made similar upward adjustments.

[READ: Why the Dow Is Outperforming the Economy]

The most unpredictable factor has been the mindset of consumers, who have been much more willing to spend and commit to big purchases than many economists guessed they would be. With the economy improving--and many Americans simply getting tired of hunkering down--ordinary people seem increasingly comfortable risking money on stocks, after many bailed out of the stock market following the 2008 financial meltdown.

Another misunderstood story is the so-called "great rotation" in which investors supposedly sell bonds and buy stocks. The idea is that with interest rates at record lows, investors desperate for higher returns will increasingly feel more comfortable selling safe assets like Treasury securities or high-grade corporate bonds, and buying riskier assets like stocks. But the zero-sum outcome in which investors basically trade one type of investment for another isn't what has been happening.

Instead, a lot of ordinary people have been taking money out of the bank--where returns are typically negative, after accounting for inflation--and investing more in both bonds and stocks, usually through mutual funds. "The money going into stocks is mostly cash coming off the sidelines," says Russ Koesterich of investing firm BlackRock. "A lot of money that came out of the market is now coming back in."

There's a lot more where that came from, which is one reason many analysts think stocks will be a smart investment over the next several years. On the conservative end of forecasts, Wells Fargo Advisers recently raised its end-of-year target range for the S&P 500 to 1,575-1,625, which would be a modest gain from a base of about 1,565 today. PiperJaffray is far more bullish, predicting the S&P 500 will hit 1,700 this year.

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Many of those same analysts still expect a modest correction by summer, however, as stocks get a bit ahead of the underlying economy and some buyers reassess whether they've rushed into stocks too hastily.

"This is not a BTD opportunity (yet)," David Zervos of investing firm Jefferies recently advised his clients. "Rather, we might actually have an STD (sell the dip) situation brewing." Of course, there must first be a dip before you can buy or sell on it. A lot of people will keep watching for it.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.



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