A Pullback Would Be Healthy

 | Apr 14, 2014 | 11:30 AM EDT
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The 3.1% decline in the Nasdaq and the 2.5% drop in the S&P 500 market indices last week was a breath of fresh air. For the past couple of years the market has only known one direction: up. You don't want stock prices only going up (I mean we do, but let's be realistic).

An unchecked rise in equity prices will create little support on the way down. And since investor psyche is important to the equity market, it is better to have an orderly and healthy pullback than a wild race to the top followed by a crash on the way down.

That's why, despite last week's decline, the attitude toward the equity market has not changed. I would argue that over the next several weeks or months, the market will be better off if we experience a continued cleansing. If the market fell by another 10% over the next eight to 12 weeks, I think investors would be better served.

A lot of capital still remains on the sidelines that is ready to be put to work. I believe we would see that capital go to work very quickly under the scenario of a declining market.

Unlike 2007 or 2008, the economic picture continues to improve. So a drop in stock prices now would likely be viewed as a buying opportunity vs. a race to the exits. Housing is stabilized in most parts of the country and unemployment rate is finally breaking below 7%. And interest rates still remain low, making equities a very attractive asset class to most people today.

The recent selloff has allowed Potash (POT) to yield more than 4%, which is a juicy yield for one of the largest fertilizers outfits in the world. Citigroup's (C) recent selloff and its current valuation of 10x earnings is a significant discount to both the overall market and its peers. More selling just makes the upside potential even better.

It's notable that the biggest decliners so far in 2014 have been the high-flying tech performers. The fact that they are declining is a healthy sign that complete irrationality has not fully set in. Investors are cashing in the chips of highly over-valued issues rather than chasing them up for a little more alpha.

My view is that for the remainder of the year, Mr. Market will grow to favor names such as Cisco (CSCO) over names such as Twitter (TWTR) and Netflix (NFLX). After years of very lucrative gains, investors are now focused on capital preservation. Transitioning the money made into high quality value names that can deliver 8% to 12% total returns in this market is a very attractive proposition.

If further pullbacks are in the future, expect some smart investors to come back into the mix to take advantage of the better prices.

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