I believe we are in  a period of correction as we will be intermediate term overbought at the end of the day on Monday. In my experience time is more important than price in measuring a correction. Sometimes the market can correct by going sideways for a few weeks while other times the market plunges over those same few weeks. I am planning on remaining cautious until some time passes and/or we get a correction in price.

I don’t expect the market to collapse completely but a correction of 5% from the recent highs would not surprise me nor would some chopiness for a few weeks.We are approaching the turn of the month so its possible the market tries to rally but I don’t believe it will make much progress. If the market manages to score a new high during the turn of the month period I would likely further reduce my moderate net long exposure.

• They are a slow growth company. There are so many companies out there with better growth.
• The stock has gone nowhere in a decade.
• The management team is not the best (to put it lightly)
• Management will squander the money
• A highly paid hedge fund consultant said CA is where good technology goes to die.

When I looked at CA I saw a company that was trading at less than seven times free cash flow (FCF/EV) or a greater than 14% cash yield. If the company is able to consistently generate so much cash despite the fact that they don’t have good management than the underlying business must be really great. Where a stock has traded in the past decade matters little to me. If we were able to simply extrapolate the past into the future we would all be rich. Management had already committed to return 40%-50% of free cash flow to investors so at most they could squander half the money. A 7% cash return was still not bad.

The mistake most made in their analysis of CA is that they completely ignored valuation. There is no price at which they would have liked this stock. I would love it if CA grew like Salesforce.com but the free cash flow yield on Salesforce.com is a fraction of CA’s. Salesforce.com would need to increase their free cash flow many times over before they yielded as much as CA. I prefer a bird in the hand.

I have been holding CA for over a half a year, all the while hearing about what a terrible stock it was. It was not  a pleasant experience but as a value investor and a contrarian I am used to it. After earnings last night CA broke out to a multi year high. CA has solidly outperformed nearly every large cap software stock during the period I have owned it and the market as a whole. Value wins out in the long run and for CA the long run has finally arrived.

As readers know I have been looking for a correction. I would have preferred if the market had actually gone down first before market participants turned cautious. While there are certainly enough signs pointing to the need for a correction it is possible that the market stages one more rally before the correction starts. A rally later this week would occur just in time for the market to become intermediate term overbought. It would also likely vanquish the new found doubts of market participants.

Just because it is more difficult to identify a top than a bottom it does not mean that trying to identify a top is a fruitless endeavor. The more signs of a top that are present, the less favorable the risk/reward is in the market. Unfortunately most prefer to deal in binary outcomes rather than probabilistic outcomes. Most people don’t want to hear that the risk/reward proposition of owning stocks  is declining. They just want to know if the market is going to go up or down.

The way I see it the risk/reward proposition of buying stocks now is low. While I could see the current rally lasting another week, there are enough signs of a top present such that it would not surprise me to see a correction start this week. Tactically, I have been using strength to reduce my net long position and will use further strength to continue doing so.

All this does not mean that there is no more money to be made, only that there will likely be better opportunities. If we did get some sort of a correction, the risk/reward would look a lot better. My best guess is that the market struggles in the days after expiration and a bigger correction should start by late January.