Last week we wrote that extremely optimistic crowd sentiment was becoming a growing headwind for stocks, increasing the chance of a correction. In light of our optimism on corporate earnings in 2010, we view the S&P 500's 3.9% decline last week as only a pullback in the context of its primary uptrend. While our first level of technical support at 1120 was violated, we expect technical support between 1100 and 1080 to hold. However, a more severe correction to the 200-day moving average around 1007 is possible and would be consistent with pullbacks in strong rallies, like stocks had from July through January. Finding support above 1080 and crowd sentiment resetting back to neutral or even extreme pessimism are important conditions for us to maintain our near-term bullish view toward risk assets. We are watching the dollar and credit spreads for signs of a trend change; if the dollar and credit spread trends clearly turn upward, we will reassess our tactical view. (see "What Could Go Wrong," The Weekly View, 1/11/10).

David Fuller's view The term "normal correction" can cover a multitude of sins, or perhaps I should say opportunities if we are looking for technically overbought selling opportunities in a downtrend or technically oversold buying opportunities in a uptrend, as we can see from this weekly chart of the S&P 500 Index covering the last ten years.

The crunch question for investors today is: Are we seeing another mean reversion correction relative to the 200-day moving average within an ongoing uptrend, or is the market forming another top as we saw during 2007 and early 2008?

With China roiling stock markets by curbing lending and President Obama standing in combative mood on his version of Dubya's aircraft carrier and inviting the banks to bring it on, we could be forgiven for thinking that the bear is returning. Anything is possible in markets but we doubt it.

Nevertheless, the uptrends since mid-July for many leading indices have been hit since mid-January by failed upside breaks from trading ranges, downward dynamics and breaks in the progressions of rising lows. Moreover, the best performers remain well above potential support near their trend mean represented by the MAs. Lesser performers are still in the ranging corrective phases which have limited upward scope since September and October.

Why might this be no more than another correction rather than the beginning of a new bear trend? Unless the modest global economic recovery is about to slide back into another slump, which I doubt, I do not see the catalysts for another stock market collapse. Instead, and despite the current uncertainty, I think this could still be an economic sweet spot for stock markets characterised by modest global GDP growth, reasonably accommodative monetary policy and generally low inflationary pressures. Yes, there has been some overheating in emerging Asia, especially China where the PRC's monetary authorities have moved early and incrementally to contain this problem, as I have said before. In North America and Europe central banks are talking about ending quantitative easing but that is not the same as a monetary squeeze. Historically, the US stock market has usually continued to rise during the early stages of a cycle of higher short-term interest rates from the Fed, and this has yet to commence.

If there is a parallel with the last bull phase from 2003 to well into 2007, I suggest that it is with 2004, which you can see on the S&P's weekly chart above. If the outlook is worse, perhaps we have more ranging, in line with the slower rate of economic recovery. Meanwhile, all corrections are unnerving for those who hold medium to longer-term positions. However, we should ask ourselves, is there another speculative mania or other credit bubble out there, about to burst, as we last saw in 2000 and 2008? If not, the odds favour another correction, which becomes a buying opportunity in its latter stages, rather than a major peak. Fortunately, there are many more medium-term corrections within cyclical bull phases than peaks which mark their end. (See also Eoin's technical review of several Asian stock markets below.)

On another subject, The Weekly View mentions that food inflation in China has accelerated rapidly (see second paragraph). I am not aware of this as we do not see it in the prices of pork, soybeans or rough rice. Rapidly inflating food prices were a problem for China in 2007 and 2008, but today? I would welcome any thoughts on this from subscribers in Shanghai or Beijing.

Rod Smyth and Co's report also contains an interesting graphic on sentiment towards the US dollar's prospects. I hope they will show us when this next turns back downwards and beneath the "Excessive Optimism" line.