Nearly 20 years ago I was getting my first introduction to the financial markets by handling the logistics for options trading seminars. The man teaching the seminars–one of my investment mentors–was Kenneth Trester. During the class, one of the observations he taught was that investments tended to advance laboriously–like someone climbing a steep mountain. Corrections, on the other hand, tended to be quick and dramatic, kind of like jumping off a cliff.

Over the past 20 years market behavior has changed substantially and one of the changes is how markets react after a correction. While downturns frequently remain swift and steep, today the recovery is often jut as fast. The market’s most recent correction is a good example. Take a look at the chart below. The black line is the Nasdaq. The gold line is iShares S&P Latin America 40 Index Fund (ILF) and the blue line is Merrill Lynch Oil Sv HOLDRS Dep Receipt (OIH).  The latter two funds represent two of the year’s top-performing industry sectors.

Notice that for all three of these positions, the correction that began after mid-July bottomed about four weeks later. About a month after that low point, the three positions had gained back all that they lost. Since then all have continued to move ahead and set new highs for the year.

My personal opinion is that the most recent correction was an overreaction to market conditions. That might help explain why the impact of that downturn has so quickly bee negated. We saw a similarly fast recovery, however, after the market’s downturn in the summer of 2006. In a historical context, these kinds of rebounds are unusual. As my mentor pointed out, two or three decades ago market recoveries tended to take two or three times as long as the preceding downturn.

So far in 2007 we saw a nice advance from early March unto mid-July. The rally that began in mid-August has had a much steeper slope by comparison. Going forward, I anticipate that the market will not be able to maintain that degree of advancement. We are likely to see some more sideways consolidation over the next few sessions before the market resumes a less pronounced rally for the remainder of the year.

Of course, this is just an educated guess based on the long-term trend continuing. Economic and market fundamental appear to be strong enough to sustain the advance.

Have a beautiful fall weekend.
F.S.

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