It looks to me that we have had our dip and like several dips before it, the S&P 500 will return to the 1,150 level, which should happen sometime next week. Right now after six straight up days all three averages are overbought and prices are extended but that condition can last for some time. As I’ve said before, if the markets do pull back and you have money to invest, invest it.

Friday’s better than expected job report was the trigger that sent investors back into the market with renewed conviction that the economic recovery is on course. In addition, the Federal Reserve’s policy of low interest rates continues to provide a floor under the markets. In the meantime, debt-ridden Greece survived a crucial test when it raised $6.85 billion in a bond sale this week. Although analysts still believe there may be difficulties ahead, the successful bond auction puts much of the risk of sovereign debt default behind us.

Clearly, the good news on the economy continues to mount. Consumer spending has been the lynchpin of economic growth in this country since WWII. Given the drubbing the Man from Main Street has taken over the past two years, I am surprised that the consumer is managing to both save while beginning to spend a little in 2010. In the first two months of the year the consumer has begun to shop, despite February’s terrible snow storms, and from the data, appears willing to buy spring merchandise at almost full price. So after spending most of 2009 in the trenches, the consumer appears to be returning to a more normal spending pattern.

Given the data and this week’s market action, my overly-cautious stance that the markets might resume their decline and test the 1015 -1,035 range on the S&P was just plain wrong. I will bow to the tape every time and let the realities of the market dictate my next move. My mistake was not recognizing that the 10% decline we’ve had since the beginning of the year was about as deep a correction as we were going to get right now.

Still, better safe then sorry, I always say, especially after a 60% rise in the stock markets over the last year.
So now what? Obviously, we march higher, at least to 1,150 where the markets began their latest dip. That’s only 16 points away. It would appear logical that we have a bit of profit taking at that point. The S&P should continue higher after that, toward my next target of 1,200 on the Index. We may experience yet another dip that may be even deeper at that point. But we’ll worry about that when the time comes. For now, don’t fight the tape.

That does not make me a bear, just short term cautious, and I still think that a further decline to the 1,015-1,030 range of the S&P presents readers with a buying opportunity. Once we reach that level, I think the markets rally to a new yearly high around the 1,200 level.

For long-term investors, these mini-corrections should not matter at all, unless you have some cash to invest. For example, I have had the good fortune of closing several new clients over the last two months. The short-term market top at 1,150 on the S&P and this subsequent correction has allowed me to sell some stinkers in their portfolios and hold the cash on the sidelines. If the market declines from here, I will begin to deploy that cash in sectors I believe will lead the markets higher into the spring.

The fundamentals of the economy are improving but that does not mean investors can expect a continual stream of upbeat numbers every week. Recovery, as I have often said, is a process with positive numbers (like this week’s revised fourth quarter GDP growth of 5.9%) followed by disappointment, such as home sales in January which fell 7.2%. In any given week, we will see these kinds of contradictions until the recovery kicks into over drive. Right now we are still changing gears and you should expect some starts and stops during that process.

At the company level, over seventy percent of earnings reports beat estimates but those results were discounted going into earnings season. It will be several weeks before traders begin to focus on first quarter earnings. In the meantime, there are enough unknowns out there (Greece, the Euro, China, the direction of interest rates, etc.) to maintain downside pressure on the averages. It appears that we are in a trading range with the top of that range around 1,112 on the S&P 500 and, so far, the bottom around 1050 with a bias to move lower.

This digestion period, in my opinion, will be good for stocks. It will take some of the froth out of equities, allow investors and traders alike to regroup and square valuations with fundamentals. It will also allow future economic data to catch up to the lofty level of the market.

The short answer is because I can afford to be. Since advising a defensive posture prior to the drop from 1,150 to 1,044, I had the luxury of buying at lower prices as the markets declined. I still have some cash available in case the market suddenly decides it wants to go lower. In truth, I expected the S&P to bottom out somewhere between 1,015-1035. So maybe I was a bit too bearish but better safe then sorry. And I still have some lingering concerns. Hopefully, they will be put to rest once China opens for business after its week-long Lunar New Year.

Over the last few weeks, China has been implementing various actions to slow the growth of its over-heating economy. It has not played well on global markets since many countries are depending on Chinese demand to boast prices of various materials and other commodities. There is also talk that at some point this year, China may allow its currency to strengthen. So I’m going to wait just a bit longer and see what happens in China next week before I give the all clear. In the meantime, regardless of whether there is more or less short-term downside, the next upside target for the S&P 500 is around the 1,200 to 1,235 level. The growth in the economy appears to justify that move up.

“Í think 2010 will be better than many people expect,” said Ron Insana, the CNBC senior analyst and commentator, who spoke at the Berkshire Job Summit on Friday at the Crowne Plaza Hotel in Pittsfield.
Insana, who spent 22 years as a veteran anchor at CNBC, believes that all those who are waiting for the other shoe to drop in the stock market are going to be disappointed.

“We have had our correction,” he contends and also thinks that residential real estate, especially distressed property, such as condos in Florida, are at an once-in-a-lifetime buy right now.

The Federal Reserve’s decision to increase the discount rate by 25 basis points on Thursday evening surprised investors at first but Insana believes, as do many investors (including this writer), that it is a positive sign that the economy is healthy enough to begin taking the punch bowl away from the banks.

“It’s a move to discourage financial institutions from borrowing from the Fed, which is the lender of last resort, and instead borrow from the money markets.”

What investors should take away from this Fed action is that the money markets are back to normal. There is now no further need for a lender of last resort, which is the role that the Fed has provided for the last year.

Sure, the long-term implications are that interest rate will begin to rise but not immediately. At some point, probably at the end of this year, interest rates should rise anyway. It is a natural course of events when the economy begins to recover. Remember too that rates are at historical lows with no where to go but up. That means mortgage rates as well so if you have been toying with the idea of buying a piece of real estate now is the time.

The potential rescue of Greece from itself has been in the headlines of just about every financial journal in the world this week. This off -again, on -again bail-out by the European Community’s wealthier members has roiled the U.S. markets across the board. I believe that ultimately the Greek debt crisis, as well as the problems in the other PIGS nations (Portugal, Italy and Spain), will be resolved, but probably not in the way we Americans would choose to do it.

Europeans, in my experience, are more often behind-the-scenes problem solvers, especially when it comes to the proud and extremely independent –minded members of its community. The EU is not a group of states united under one constitution. It is a community whose common basis is commerce, not politics. Readers should remember that and not expect a U.S.-type bail-out where the banks basically became wards of the state for several months. Greece is not going to stand for any strong-arm tactics by France, Germany or anyone else. You may not agree with that, but I guess that’s why you live here and only vacation once in a while in Greece.

At the same time, China is also causing waves that are battering the shores of stock markets worldwide, including our own. Whether you like it or not, China, and not the U.S., is the economic locomotive that is pulling the world out of recession. This is the first time the U.S. has relinquished this role since WW II. China’s huge population, coupled with its enormous export prowess, has increased demand for everything from fertilizer to diamond bracelets. Its factories are consuming, on the margin, millions of additional tons of coal, iron ore, copper, oil and other materials. That has pumped up prices of everything including the stock markets.

Recently, however, China’s Central Bank, at the direction of the Chinese Government, has been tightening credit to banks in an effort to head off inflation as well as avert a possible bubble in China’s stock and property markets. Those moves in Beijing are having immediate repercussions in the trading pits of downtown Manhattan, half a world away. In some ways, when China sneezes now, the U.S. catches a cold.
That is another reason that U.S. stocks, bonds, commodities and even interest rates are chopping up and down recently. Traders are making decisions here based on the next predicted move out of the Chinese Central Bank.

I do believe that markets are over-reacting to these foreign events to some extent, but I understand that this is a fairly new development in the U.S. investment community. We, not them, have been the Big Dog in determining where world markets are going. Now that we might have to share that role, it will take some time to adjust.

As for the markets, I believe we still have some downside ahead before the markets are ready to resume their upward movement. I would use any dips to slowly add to positions and not worry too much about what happens in China or Greece. Focus instead on values presented by further declines in the market. My target remains 1,015-1,030 on the S& P 500.

In my column last week “No Pain, No Gain” I made a guesstimate of how low the S&P could go before bottoming out. That range was 1025-1035. I will widen that range a bit this week to 1015-1030. For long-term investors, that range should not matter too much since I believe that once we finish this overdue correction, the S&P 500 could rally back to above 1200 or more. That could give the astute investor another 20% return for 2010.

“But what about Europe, I hear Spain, Greece and Portugal are all bankrupt,” said a worried investor from Great Barrington, MA this week.

He was convinced that these countries’ on-going sovereign debt problems would have severe repercussions in Europe overall and usher in the demise of the European Union. And in a domino-effect, Europe’s problems would drag down our already-weakened U.S. system and before we know it—2008 all over again.
Although I agree that the so-called “PIGS” of Europe –Portugal, Italy, Greece and Spain—are having a difficult time, so are many other countries. They are grappling with a global economy barely out of recession, a history of too much debt and not enough revenue (taxes) to handle their interest payments.

At the same time, their citizens continue to demand policies and follow behaviors that further impoverish their counties. The Greek government, for example, estimates that less than one third of their citizens pay taxes. The point is that rather than bringing down Europe, if push comes to shove, countries like Germany would simply shove a PIG or two out of the EU if necessary, at least temporarily. Yet, investors are nervous and are starting to sell emerging markets across the board fearing that they too may have hidden debt issues.

Remember last Thanksgiving weekend when Dubai, one of the oil-rich United Arab Emirates, had admitted to some issues with $80 billion in debt? Both Asia and Europe experienced sharp sell-offs totaling 4-5%. By the time the U.S. market opened for business that Monday the crisis was largely averted. European leaders will do what is necessary to resolve this crisis of confidence but it sure gives traders and hedge funds a great excuse to knock the markets down and make a lot of money in the process.

You see, my dear reader, I am not the only one who believed 1,150 on the S&P 500 would trigger a correction. Those who did “went short,” meaning they placed bets on the market’s decline. Every percentage point decline in a stock, index, commodity or whatever means profit and a lot of it. So they definitely have a lot at stake in pushing the markets down 10-12%. Think about it. In 13 days a short position has garnered 8%. Not a bad two weeks worth of work if you can get it.

So how do you, the little guy, profit from this? You buy when the blood is running in the streets as a certain Baron once said a century or two ago. If you have been waiting for just that right moment to get back in the market, now’s the time, for those who have been following my advice and have cash put aside for just this buy on the dip opportunity, then get to work. Just don’t try to call the bottom. Buy selectively and bit by bit over time.

“Are you nuts,” demanded one caller, who I advised to start averaging down this week.
“The markets are dropping like a stone. Who says it will stop at your level?”

And that my dear reader is the crux of the matter. I don’t know if it will bottom at 1,015 and I really don’t care. What I am looking at is value. Value is just starting to show its lovely head. The economy is improving, companies are beginning to make real money again, or it appears so from studying fourth quarter earnings results and equity prices are on sale. What’s not to like about that? All it takes is courage to buy.

For some investors, it is hard to imagine for some investors that a week that was practically full of good earnings announcements, many far better than expected, could be greeted by wave after wave of selling. Even Apple’s fabulous earnings and roll-out of their new Ipad failed to stem the tide of selling that the tech-heavy NASDAQ encountered. The confirmation of Ben Bernanke to a second term as Chairman of the Federal Reserve was met with a resounding “who cares,” although just days before traders warned that a failure to appoint him would be a disaster for the market.

Friday’s fourth quarter GDP number surged 5.7% far higher than economists forecasted, and still the markets faltered. President Obama unveiled a set of new initiatives to grow the economy, reduce unemployment and help small businesses. No one paid attention, except possibly me. Instead, investors chose to dwell on the problems surrounding some of the countries in Europe, especially Greece, whose sovereign debt is shaky at best and Japan, whose deficit rivals only the U.S. in magnitude. It is clear that investor psychology and sentiment have changed from “half-full to half-empty”. That should provide an opportunity for contrarian investors such as myself.

Last week, I advised caution and identified 1090 as a level on the S&P 500 index that had to hold or else. It broke that level and so far we’ve dropped to 1071. That works out to be a 6.3 % decline so from the top. I think the downside risk on this dip is S&P 1025-1035 or a total 10% correction. However, I’m not waiting around for that low because although I might be right, the markets could easily drop a few more points from here and then stage a sharp recovery.

“Never worry about catching the bottom or the top,” said one of my mentors back when I had hair and could still travel all night and work all day.

I try hard to follow that advice, so over the next week I would be putting some cash to work in the technology and commodity areas. Both have sold off far more than the S&P and yet, in my opinion, their future growth prospects are above average. Another area that looks quite attractive to me now is emerging markets. These markets started to correct about a month before the U.S. and have fallen far more; China, India, Brazil, even Russia, look tempting to me as does the rest of South East Asia and Latin America. I feel strongly that emerging markets should have a place in every investor’s portfolio.

It is also interesting to note that the tired old theme that most asset allocators try to sell you is not holding up in this correction. Their claim that a portfolio of bonds, stocks, commodities etc. will provide the best returns “over time” and a buy and hold strategy works best, held no water in 2008-2009 and it is leaking once again today in this correction. Cash and Treasury bonds are about it right now if you want to protect your principal (plus inverse securities), but how many advisors have done anything but blink at their computer screen and hide under their desk in the last week? Maybe that is unfair. I’m sure there are some advisors out there somewhere who have acted upon their own initiative to protect your portfolio.

Over the last few months, I have been warning readers that 1,150 on the S&P 500 Index would be an area where the markets would falter, at least over the short term, before resuming an upward trend toward 1,200. It appears that correction is now in progress.

“How low will the markets go?” asked a worried investor from Sheffield, who e-mailed me this week.

Since short-term forecasting is at best an art, I am guessing that we drop to 1,090 on the S&P before staging a comeback. To put that into perspective, Friday the index actually hit 1,090 intraday so I’m not talking about a lot more downside from here. That would put this dip at -5%, an average correction among several dips we’ve had since March, 2009.  That 1,090 level must hold. However, if it breaks that, we can expect a more serious decline in the vicinity of 7-10%. Our deepest pullback to date was about -7%.

I’ve already outlined the major reason for this decline. Investors bid up markets in anticipation of good fourth quarters earnings.  In a typical “sell on the news” maneuver, now that earnings results have come in as expected, investors are cashing in.

 However, Thursday, when President Obama launched another broadside against the financial community, the downside action in the markets gained momentum. The President threatened to prohibit proprietary trading by banks as well as limit their size.  It is easy to understand why the markets swooned. Most of this nine month rally has been led by the banking sector. The same banks that took our tax payer money (TARP funds, for example) but instead of lending it to us (which was the government’s intention); they speculated in the bond, stock, currency and commodity markets and they raked in huge gains.

 As a result, the lion’s share of bank’s profits emerging from the financial crisis has been generated by their proprietary trading departments. We’re talking about billions of dollars in profits.  It’s the reason, in case you were wondering, how the likes of Goldman Sachs could pay on average almost $500,000 in bonuses per employee.  The removal of this profit center leaves the large banks with a big hole in earnings. How can they fill that gap? God forbid that they have to go back to lending us money for things like cars, trucks, homes and education! Where’s the profit in that?

President Obama, in announcing these measures, is endeavoring to tap the outrage most of us feel toward the financial sector. That anger appears to be growing, fueled by the aforementioned bonuses that are now being doled out by the banks. It may also be why the confirmation of Federal Reserve Chairman Ben Bernanke to a second term is in trouble.

The U.S. Senate vote was supposed to take place on Friday but it was postponed to next week in an effort to garner more “yes” votes. Bernanke and the Fed have been criticized not only for being asleep at the switch as this financial crisis unfolded, but in ensuring that through government bail-out money, the banking sector would come back bigger and better than ever. The return of huge bonuses, say the chairman’s detractors, is the most visible indication of that collusion.

I suspect the rejection of Bernanke for a second term would not be taken lightly by the markets. It is one reason why I am advising a bit more caution than usual in this coming week and why holding that 1,090 level on the S&P will be crucial.  Be careful out there.

Normally the market’s “off-season”, which is what I call the period between earnings announcements, is a time where stocks either correct or consolidate. But during this last off season (beginning at the end of third quarter earnings), stocks actually moved higher by about 5%. Investors bid the markets up, expecting good earnings to be announced for the fourth quarter. But the last two times this happened, the market fell as earnings were announced and it appears that is happening once again.

Remember that the market is a forward looking mechanism that discounts the future whenever possible. Now that earnings are coming through, investors are selling. Take Intel and JP Morgan, for example, both companies beat estimates (unlike Alcoa, which missed) and both stocks sold off almost immediately after the announcement.

Coincidentally, the S&P 500 hit my medium-term target of 1,150 on Thursday most likely propelled to that level by the same discounting mechanism. Over the last few months, I’ve been preparing readers that once we hit that level some selling would be a real possibility. That’s not to say the stock market is in for a big correction. I don’t see that. Given my contrarian nature, I believe it’s an ideal time to put more money to work, if you can.

This week I interviewed my friend, John Roque, technical strategist and managing director at WJB Capital Group, for our radio show “Investing with Bill Schmick” on Vox channels throughout the Berkshires. You remember him. He was one of the few players on Wall Street who called the 2008 decline in the markets and I passed his comments on to my readers as early as December, 2007. More recently, he also advised readers to buy gold under $1,000/ounce.

“I think the S&P 500 can reach 1,200 this year,” John says.

Some of the sectors he likes are healthcare, industrials, technology, basic materials, energy and consumer discretionary. He also likes commodities in general, although he thinks that gold is due for a period of consolidation. Silver, on the other hand, looks even more promising.

“I’m not saying that you should sell gold, just practice a little patience. Silver has industrial uses as well as jewelry so demand should improve. My price target on silver is $30 an ounce.”

As for the markets, this coming week will be another “buy on the dip” opportunity for readers. If you have been following my columns, you should have cash on hand to take advantage of this drop. As a guesstimate, the S&P could fall back to the 1090-1100 range but don’t hold me to that. Short term calls are always the most difficult to make. It may turn out that next week’s earnings announcements will be so far ahead of investor’s expectations that the decline will be nipped in the bud. Let’s hope so.

So far so good for the first week of 2010 but no, I’m not going to extrapolate one week’s gains and predict the year will be straight up, especially right now when we are just ten points away from my 1,150 target for the S&P 500. Around that level, I’ve been expecting a pullback. Any pullback, no matter how minor, is painful. That doesn’t mean you should bail out of the market. I suspect the downside (if it occurs) won’t be anything more than another buy-on-the-dips correction like we experienced several times last year.

In my New Year’s column, I wrote that the markets will continue to move higher over the next few months but not at the torrid pace we enjoyed last year. I also think that the bulls are far more discriminating than they were in 2008 when everything was down 36% to 50%. It is what I call a stock picker’s market.
Unfortunately, most investors (and financial advisers/brokers) don’t have a clue how to play that game. Retail investors tend to chase the hot stocks and sectors only to be left holding the bag as the insiders move on to the next target.

The advice from most financial professionals is even worse. Decked out in thousand dollar, three piece suits, they usher you into their conference rooms of polished mahogany. Solemnly, they advise you to buy a “market portfolio” with an allocation of bonds that most often depends on your age, risk tolerance or some other mumbo jumbo that pretty much guarantees mediocrity in a market like this.

So what do you do? For starters, be a lot more careful in where you commit new money. I’ve noticed some players cashing in on some of their big winners of last year and putting some of that cash in laggards. Laggards are those stocks and sectors which have not done as well as the market. I’ve learned, in talking to several of the most successful mutual fund managers, like Don Yacktman (Yacktman Funds) and Bruce Berkowitz (the Fairholme Fund) that both have large holdings in health care stocks going into 2010. This is a sector that has underperformed the market thanks to the cloud of uncertainty generated by pending health care legislation. You might want to pay attention to what these value fund managers are buying.

If you are heavy in bonds—hedge. The bears won’t be hibernating in this area in 2010. For some readers, selling your bond holdings is not an option.

“I live on the income,” explained one reader who called from Cairo, N.Y, “and I personally find it a more comfortable place to be than stocks.”

Consider protecting (hedging) your investments, especially in U.S. Treasury bonds. I’ve written at length on inverse securities, especially exchange traded funds, which investors can purchase to protect your investments from market declines. It would be a prudent thing to do in the bond market, in my opinion, to develop a defensive strategy before interest rates begin to rise.

Rising interest rates, given today’s historically low levels, is not a question of “if” but simply “when” rates begin to rise. As rates rise, bond prices decline and bond holders suffer. If you need help in devising a strategy to protect yourself in a rising rate environment, you know how to contact me. Otherwise, take some action now.

Over in the commodity corner, oil is fast approaching my $90/BBL. target, thanks to timber- shivering weather around the country. But gold and silver continue to zig as the dollar zags. I advised taking some profits in precious metals above 1,200/ounce in gold (and $19.89/ounce in silver). I don’t think the correction in that market is quite over, despite the recent bounce. Normally, gold and silver will spend several months in a trading range before moving higher again. My target, once the bull run resumes, is north of $1,300/ounce for gold.

Agricultural commodities, stocks and ETFs however, are a place I feel comfortable accumulating on any dips. The supply and demand picture for food hasn’t changed just because we experienced a financial crisis last year. People have to eat and today there are a lot more people worldwide who can afford three squares a day. That’s going to mean that demand for agricultural products will continue to rise as will the price of just about anything food-related. So eat up and profit.

We did hit new yearly highs, however minor they may be. The paltry volume left most investors wary of making too much of these gains at least until the coming week. The buzz from traders is if the ‘players’ return from the holidays and bid the markets higher, well then the move up over this last week or so will be confirmed and next stop should be S&P 500 level 1,150, and after that 1,200.

The S&P broke 1,120 with no problem, which was a good sign. It went on to reach 1,130 before profit-taking set in this week. On a short-term basis (meaning over the next two or three weeks) we may see the index hit 1,150 and then pull back before moving higher. As such, it could simply be a continuation of the recent past where investors buy on the dip throughout the first half of 2010. Even today there are many investors who are still waiting for a big correction and a chance to get in the market at a more reasonable level. So the most inconvenient thing the markets could do for the most number of people is to continue to move higher. Technical data appears to support that view.

On the economic front, the major uncertainty that most investors face is what will happen when the government stimulus ends. Will the private sector pick up the slack? If they don’t, will it bring on a double dip recession?

I think those worries make great television debates but have little to do with the facts. The facts are that less than a quarter of the government’s $787 billion stimulus package has been spent. The reason is both simple and cynical. There are political elections in 2010. The party in power has been waiting to spend that money where it will do the most good (i.e. on electing or re-electing the most democrats possible through pork barrel spending). Welcome to Introduction to Washington Politics 101. If the shoe were on the other foot, a Republican administration would take the same tactic. Bottom line; expect more, not less, government stimulus in 2010.

That spending should keep the economy chugging along at a steady but modest rate of growth. In turn that should help propel the markets higher at least into May. At that point we might get hit with a bigger correction that lasts through the summer months. What could cause such a drop in the averages? Higher interest rates, valuations that get out of hand on the upside, fear of inflation, any number of things could give the markets an excuse to sell off.

On the inflation front, I don’t really think we have much to worry about yet. This recovery has been anemic and nothing I see points to anything more than a slow growth recovery this year. That is not the stuff of rampant inflation. You can pump all the money you want into the system, but if it is not being used, the velocity of money stays low. Only when that money begins to change hands (turn over), for instance in making loans or buying houses, autos, televisions and building new factories does velocity increase and inflation begins to take hold. We have nothing like that yet and won’t, in my opinion, for a good part of 2010, if not longer.

I would also like to point out that this has not been a very good decade for the stock market. If you had practiced a buy and hold strategy, you would have lost money over the last ten years, which is why we should bid adieu with some relief to both the strategy and the decade. Historically, there have actually been three decades in the 20th Century where stocks have suffered losses over ten years, ending in 1939, 1974 and 1982.

The good news, in all three instances, was that the following ten years were volatile but great for stocks if you had a buy and sell philosophy. We expect that in this century the same pattern will hold true. So 2010 should be the beginning of something quite positive for all of us. That should make for a Happy New Year.