My friend Cullen Roche does a great series of posts called "Three Things I Think I Think." I only wish I would have thought of the title first as it is apropos to today's discussion on three issues that caught my attention today.

1) Bank Loans And Leases

In a recent posting on Business Insider reference was made to a chart by Liz Ann Sonders discussing a recent surge in bank loans and leases as a sign of impending economic recovery. 

"Over the past 15 weeks there has been a sharp acceleration in bank lending, which is now growing at an 8.6% annual rate, and could suggest animal spirits are reviving," she said."

The problem is that the chart is completely out of context.  Is this spurt in activity historically relevant? Have such increases previously led to surges in economic activity or inflation? Or, is this activity just an anomaly that will rectify itself in the months ahead?

While Ms. Sonders certainly presents an interesting point, by taking the data out of context it potentially leads to a misdiagnosis of the issue. The chart below is a long term view of the bank loan and lease data as compared to both the economy and the velocity of money as an indicator of potential inflationary pressures.

What we see is, as would be expected, that businesses respond to changes in the economy on a lagged basis. Business owners, and individuals, do not generally jump out to take on credit until they are sure the economy is recovering and vice-versa.

The recent uptick corresponds with the economic push in the last quarter of 2013. It is very likely, given the recent economic weakness both domestically and internationally, that the recent surge in activity may well be very short lived.

2) Interest Rates Heading Lower

In last week's newsletter, I stated that interest rates were throwing over a major "buy"signal and exposure to fixed income in portfolios should be increased.

However, there is more to the directional movement of interest rates other than just an opportunity to capitalize on fixed income allocations.  Declines in interest rates are also indicative of economic weakness and falling inflationary pressures.

The recent spate of economic weakness may indeed more than just "weather related" as suggested by the recent decline in inflationary pressures. If economic weakness persists there is likely to be a continued "flight to safety" pushing rates back towards 2% in the months ahead. Such a rotation would also be a negative for "risk" assets and would be suggestive of a much deeper decline in equity markets.

3) Is This "THE" Correction?

As I discussed just recently in "No One Rings A Bell At The Top" there is more than enough evidence to warrant caution by market participants.

"The point here is simple. The combined levels of bullish optimism, lack of concern about a possible market correction (don't worry the Fed has the markets back), and rising levels of leverage in markets provide the "ingredients" for a more severe market correction. However,  it is important to understand that these ingredients by themselves are inert. It is because they are inert that they are quickly dismissed under the guise that"this time is different."

Like a thermite reaction, when these relatively inert ingredients are ignited by a catalyst they will burn extremely hot. Unfortunately, there is no way to know exactly what that catalyst will be or when it will occur. The problem for individuals is that they are trapped by the combustion an unable to extract themselves in time."

The question is not whether we will get a rather major correction, it is just a question of when. Therefore, is the recent selloff in the markets the beginning of that anticipated correction? It's possible, however, we will only know for sure in hindsight. However, the fact that the previous leaders, the "momentum" stocks that have been the favorites of high frequency trading, have been severely underperforming the large capitalization S&P 500 Index is certainly a reason for caution.

Such rotations from "risk" to "safety" are typical during market topping processes. However, at the current time the proxy for most investors, the S&P 500, has not currently done anything "wrong" to suggest that a more significant correction is in the process. 

The recent decline has worked off a short term, technical, overbought condition and the market now rests on support at the intermediate term moving average. 

The problem is that we have been here before. Like in January of this year with the "emerging markets" scare that had investors running for the sideline and a lot of chatter about "market bubbles."  It turned out to be a false alarm as the markets bounced off of critical support and rose to new highs as the Federal Reserve promised to not pull away the "punch bowl" too soon.

However, here we are, once again facing the "hoard" like the "Mighty 300." Will the markets hold their ground or give way? A failure here will likely see the markets head rapidly toward 1775 which will be the largest correction that we seen in quite some time. The problem is that such a correction could easily accelerate if the excessive levels start to become unwound as "margin calls" beget a watershed of selling pressure. 

As I stated at the end of March in "Chink In The Market's Armor"

"It is likely that the markets will experience a correction at some point in the near future.  What the data doesn't tell us is whether it will be a "buy the dip" opportunity or something much more significant.   However, given the length of current economic expansion and the extension of the markets above their long term moving averages, the Fed extraction of liquidity potentially increases the risk of a more significant correction than just a dip. 

Whether the current signs of deterioration is just a temporary rotation of "money chasing performance," or a warning sign of something more significant to come, is just too soon to tell.  Regardless, it is important to understand that it is always just a function of"when" a mean reverting event will occur.  Unfortunately for many investors who fail to understand the "risk" they have undertaken within their portfolios, when that time comes it will matter 'a lot.'"