Is The Stock Market Heading For A Correction:  What Happens Next?

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Investors were grabbing stocks with both hands.

They were encouraged by strong growth outlooks for the US economy and corporate earnings.  And forecasts of 15% to 20% growth for the S&P 500 had investors salivating over big potential profits.

As a result, the market climbed higher and higher through January and most of February.

Then in late February, popular unrest in the Middle East and North Africa turned into full blown revolutions.  Television screens broadcast images showing millions of average citizens in Egypt demanding an end to President Mubarak's 30-year dictatorship.

But it wasn't long before peaceful protests turned into bloody riots.

The whole world watched with baited breath... most expected the Egyptian police would crush protesters beneath the heels of their boots.

As you might expect, investors did not take the new geopolitical uncertainty well.  They started dumping stocks as if the end of the world loomed on the horizon.

It's no surprise US markets started correcting.

But then the Egyptian revolution ended almost as quickly as it began. Mubarak agreed to step down and turn control over the much loved and respected Egyptian military.

However, just when it seemed we were out of the woods, another disaster struck.  This time it took the form of a devastating earthquake in northern Japan.  What's worse, the quake spawned a massive tsunami that literally washed away villages and towns up and down the Japanese coast.

It's believed 20,000 Japanese lost their lives and 500,000 more lost their homes.  And if that wasn't bad enough, we soon learned the quake had sparked yet another crisis.  A nuclear facility had been damaged by the quake and several reactors were melting down.

Of course, this combination of terrible news sent the markets tumbling further.

But here's the amazing thing...

The decline didn't go very far or last very long.

All of the major market indices hit bottom and reversed on March 16th. From peak to trough, the S&P 500 dropped just 7%.  Since then, they've been climbing steadily higher.  The market is nothing if not resilient.

Most pros refer to this as the market climbing a wall of worry.

Whatever it is, it's been great for investors.

But now, the markets are nearing another inflection point.  They're bumping up against the highs reached in February 2011 before the correction began.

Take a look at a chart of the S&P 500 for instance...


The big question on everyone's mind now is will the market breakthrough resistance at the pre-correction high?  Or, will the market put in a double top and correct again?

Only time will tell of course... but one piece of news this week has me concerned we're on the verge of another correction.

I'm talking about the Investors' Intelligence survey.

Since 1963, this weekly survey of stock-market newsletter writers has been one of the most widely followed indicators of investor sentiment.  The survey is conducted by Investors' Intelligence and asks newsletter writers if they are bullish or bearish on the market in the near-term.

The results of the survey were published this past Wednesday.  And if history is any guide, the results don't bode well for the market in the short run.

According to the survey, a bunch of bears have thrown in the towel and are now bullish.  Of those surveyed, the percentage of bears dropped from 23.1% a week ago to 15.7%.  That's a whopping 32% drop in bearish sentiment.

In fact, it's the biggest change in sentiment since 2003.

On the other hand, bullish sentiment rose to 57%.

The remaining 27% believe the market is primed for a short-term pullback... but they are still generally bullish long-term.

At first blush, this may sound like positive news for the market.  More market experts are bullish after all.

But here's the problem...

This indicator is most often used in a contrarian way.  In other words, high bullish sentiment and low bearish sentiment often occur at short-term market peaks.

For example, at the market lows of last August, bullish sentiment was just 29.4%.  Looking back, that was clearly a great time to buy stocks.  In contrast, at the market peak of October 2007, the bulls weighed in at a hefty 62%.  We all wish we had locked in our profits then.

So what does this mean for investors going forward?

You may want to take some profits off the table in case the market enters a new corrective phase.  Or at least, tighten up your stops to protect your profits.

In addition, start compiling a list of stocks to buy or add to during a correction.  Given the strong economic outlook and corporate earnings growth projections, any correction is likely to be shallow and of short duration.  There's a good chance positions entered during a correction will be nice winners later in the year.

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