A 20-30% correction is possible

We are in the final stages of the first leg of a great bull market, maybe one of the greatest ever. The characteristics of the final stage is an expansion of the multiple, a contraction of earnings and shift in monetary policy. Another very important, yet overlooked, variable is the relationship between the equity market and the "changing of the president" cycle. As it turns out, when we see a shift in the Oval Office the stock market becomes very volatile and finds the catalyst for corrections. Market historians will remember 2008, 2000, 1992, 1988 even 1980 as bad years for the equity markets. This is not a coincidence; Capital markets do not like uncertainty and a changing of the guard presents the ultimate uncertainly for capital.

But what of the other characteristics of the final stages of this bull run? We were looking for an expansion of the multiple which, had the dollar maintained its value, could have taken the S&P 500 up towards the 2300 level. Earnings, which as Larry Kudlow says, "are the mother's milk of stocks," have seen a contraction because of the strong dollar. The strength of the U.S. dollar took roughly $15 to $20 out of the estimated S&P 500 earnings for 2015. With equities going sideways throughout 2015 and the dollar causing a contraction in earnings, we ended up witnessing an expansion of the multiple in a stealth manner.

Most every multinational has cited the strength of the dollar as a headwind for forecasting future global sales. With a Fed now decoupled from the rest of the global central banks, look for further moves up in the dollar and continued pressure on earnings forecasts for the S&P 500. The reality is that the Federal Reserve, with its move off of the zero interest-rate policy, has put a floor under the U.S. dollar against other global major currencies. Whether it be the European Central Bank, the Bank of Japan, the Bank of England or even China, the rest of the world is still searching for the panacea of central bank easing while our Fed has taken a bold, new course towards normalization.

Finally, there is the subject of Sovereign Wealth Funds and the effect they will have on global capital markets. As I have written in the past, trillions of dollars from SWF's have been invested from countries who find crude to be their main source of national revenue. These funds are from Russia, Saudi Arabia, Norway, United Arab Emirates, Kuwait, Kazakhstan, Canada, etc. But the energy revolution is upon us. Fracking technology now allows for horizontal drilling with preexisting wells which do not require new capital investment for greater production. The Saudis are helping OPEC implode. The Russians keep pumping at full throttle. And let's not forget Iran is ready to unleash their crude supply on the world. As the price of crude stays low for the foreseeable future, the pressure on oil producing nations will mount. Countries will struggle to meet internal budgets and the need to repatriate the capital from SWF's will be inevitable.

So what does this all mean for investors and traders? First, you can't fight the Fed. Janet Yellen has made this HER FED and we are not going back to ZIRP, barring a Black Swan event. Second, earnings are contracting with no end in sight for the near future. Multinationals, as strong as they might be, are fighting the global phenomenon of king dollar. Third, crude prices will keep pressure on stocks as SWF selling hits hard in the first or second quarter of 2016. And last but not least, this market is tired and has hit the "changing of the prez" cycle. This could be the perfect storm for the bears and take the market down 20 to 30 percent in 2016. For the last few years my mantra has been to buy dips, now the time has come to sell into strength. It's the time to play defense!

The market always gives you warning signals. It's best to heed those warnings and adjust accordingly. Remember, no market goes up or down in a straight line. A 20 or 30 percent correction in stock prices after the run of the last few years would be very healthy. Unfortunately, we are talking about 500 or 600 S&P points, which would scare everyone! There will be talk of 2008 and the doom and gloomers will come out of the woodwork. It's at that point when we will find the base for the next leg up in this great bull. The lower input costs and strong dollar which will act as a catalyst for the correction will turn into tailwinds setting the foundation for the next move up in stocks. Until then, buckle your seatbelts.