Correction seen as welcome

By a variety of measures, the U.S. equity market is poised for some kind of a pullback, but that isn't necessarily a bad thing — a fact that underscores the kind of momentum driving stocks these days. “I don't know what it will take to trigger a pullback, but as soon as we get a correction of 3% or 4%, it will be short-lived because that will be an opportunity for more investors to get in,” said Kevin Mahn, president and chief investment officer of Hennion & Walsh Asset Management Co. Even as stocks showed signs of volatility last week, and with most major U.S. equity indexes at or near record highs on a nominal basis, analysts and professional investors such as Mr. Mahn insist that things are progressing in a normal pattern. “Right now, investors are looking for any crack or any kind of reason to start taking some profits before the long-awaited pullback,” Mr. Mahn said. “I think investors should reset their expectations in terms of how much more stocks can grow from here.” In essence, at this point in the cycle a small correction is likely and maybe even necessary, but it isn't a reason to panic. “Medium to longer term, I'm pretty comfortable with the stock market, but in the short term we're going to have some kind of pause,” said Chris Wallis, chief executive and chief investment officer of Vaughan Nelson Investment Management LP. Although stocks could undergo a sudden correction, the market is already “trying to pause through some consolidation and choppiness that lets it correct with time rather than price,” he said. In the absence of a major trigger to start a pullback, choppiness will have to do, Mr. Wallis said. Early last week when the government of Cyprus threatened to tax savings deposits in an effort to help finance a bailout of the nation's financial system, initial concerns were that such a move could spark a stock market reaction in the United States.

CYPRUS AND BEYOND

But as Mr. Wallis put it, the markets quickly realized that “Cyprus is like a fly on an elephant's [butt]; it's not big enough to matter.” However, one way that Cyprus could matter eventually is if a run on the banks in that country led to a run on banks in countries across Europe as savers frantically moved money in search of a safe haven. “Cyprus is small, but the potential ripple effect could be much bigger,” Mr. Wallis said. “But those kinds of bank runs and transferring of accounts can take weeks to unfold, so it might not be very abrupt.” As brutal as the Cyprus proposal might be for Cypriots, it still sounds like more of the same old news out of Europe for most U.S. investors, according to John Carey, a portfolio manager at Pioneer Investments. “The eurozone stories are getting kind of old to most people,” he said. “Of course, it remains to be seen what would happen if there were some new types of stories and headlines to worry about.” The market got a small taste of new information last Thursday when some bellwether companies reported disappointing first-quarter earnings. Caterpillar Inc. (CAT), FedEx Corp. (FDX) and Oracle Corp. (ORCL) all fell short of analysts' expectations. “We are starting to see some indications that all is not well with the global economy,” said Hugh Anderson, a managing director with HighTower Advisors LLC. Among the key indicators is the 6% drop in the price of copper since the start of the year, he said.

PULLBACK NOT UNEXPECTED

“We're beginning to hear some whispers and questions of whether, when the Fed finally pulls away the punch bowl, the economy will be able to stand on its own,” Mr. Anderson said. “It's been more than 500 days since we've had a correction of 10% or more, so to have any kind of pause at this point would not be unexpected.” Paul Schatz, president of Heritage Capital LLC, also thinks that a “healthy correction” is in order, but he calculates as “even money” the chances of the stock market gaining or losing between 5% and 8%. “I don't think there are enough warning signs to warrant a full-fledged correction of 10% or more, but we certainly should be closer to one of those garden-variety healthy pullbacks,” he said. “We are getting to the point where emotion and a manic state takes hold, and the higher you push from here without a pullback, the more dangerous and ugly will be the ultimate downside.”