The investors keep waiting for the imminent market correction that has taken place since the summer of 2013. And yet, the chances for this to happen are growing stronger ever since. Then the question that comes to their mind is: when?
To be sure, the bear market that should characterize such a decline is taking place partially. The well known North American indices have a hard time to go further despite being near their all-time highs. But this event hides a different reality: many average stocks present within these indices have already started to drop significantly thus entering to the bear market phase. And these average stocks will inevitably force the large-caps to follow suite by the time the actual indices start to show some signs of weakness.
This situation is due to the divergence between the rise of the index in question through the price hikes of large-cap stocks and the decline in price of the mid- and small cap stocks. The market breadth, or the number of advancing stocks versus declining stocks had a tendency to fall since last summer and has accentuated its pace since January 2014.
All major indices have either set a new record or were close to it and this event has led the investors to believe that everything was fine, at least on the façade. But the number of stocks that are pulling up the indices has a tendency to drop. The late declines point to a major correction which may last until August before the traditional rally starts. Consequently, I don't say that the investors should liquidate their stock portfolio but they should recognize that the performance of these stocks, despite being in some cases spectacular, is overdue and they should think of placing stop loss levels in order to limit possible losses in case of a severe market downturn. And they should also think of taking their profit in some of their stocks and place the balance into the bonds, just for the sake of being in the safe zone.
Investors are currently blinded by the large-cap stocks that have performed quite well until recently and consequently, they do not see yet the signs of a major correction lying ahead when considering the broad market benchmarks; the performance is masking the price weakness of the majority of the mid- and small-caps. This is mainly due to the shift toward the larger caps, other than large caps.
Up today, the bull market, which has entered to its sixth consecutive year, is characterized by the traditional broad participation of the majority of the rising stocks. And from a historical perspective, one could say that the large-cap outperformance as seen this year is a feature of the market tops. This may not be a sign that the stocks are going to reach the peak or have reached it already but the declining market breadth suggest that a major correction is on its way. Sooner or later, the large-cap stocks will not be in the position of supporting the underlying trend of the late bull market. Thus, a point will soon be reached where the market will reverse its course.
The behaviour of such stock markets have some consequences for the investor. The future prospects are not as good as it used to be and thus, it will become more difficult for the diversified portfolio to perform well. This market favors the intuitive stock pickers and currently the major picks are large caps. One can see this in the portfolio rotation of the institutional investor who shift their positions from risky growth stocks into large and safe companies. The logic is that large stocks drop less than the others when the market declines significantly. Also, such an environment should force the investor to think cautiously about possible buying opportunities during the market pullbacks for a point will be reached when such an approach will not work. A possible avenue of investment could be to switch to some sectors that tend to do better during the mid or later stages of a bull market.
Finally, this situation will last until August 2014 at which point, the market should start its rally lasting until late this year. But. beginning next year's spring, the expected rise in the interest rates will affect adversely the stock markets and one may expect a severe correction that may last a couple of years and then a slow recovery with wild fluctuations, coupled with rising inflation and interest rates environment. The consequences for the economy may be a slower growth and a mild stagflation. As far as the market correction is concerned, a drop by 1/3 of the major indices would not be met as a surprise but will also set the ground for the rise of small-cap stocks while the large- and mid- cap stocks will be trading sideways.
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