How To Prepare For The Coming Market Correction
The Dynamic Wealth Report
April 20, 2010
by Robert Morris, Editor
The market’s 13 month rally had me wondering if the laws of physics no
longer apply. The market has been defying gravity for so long now it
almost seems natural.
I’m sure Isaac Newton would agree.
As of last Thursday’s close, the S&P 500 Index was up an amazing 82%
from the March 2009 low. And, the index topped 1,200 last week for the
first time since the early days of the financial crisis in late 2008.
It’s been a truly historic rally.
What’s been even more amazing is the market’s resiliency. Since
bottoming in March 2009, the market has pulled back between 5% and 8% on
five separate occasions. But, we haven’t seen a full correction of 10%
or more.
However, that may be about to change.
Signs are emerging a long overdue correction is finally at hand.
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On Friday, the S&P 500 suffered its first daily decline in seven trading
sessions… dropping 1.6%. It also closed lower on the week for the first
time in seven weeks.
What prompted the selloff?
The SEC shocked investors by leveling both barrels at Goldman Sachs
(GS). Wall Street’s cops alleged Goldman misrepresented a
mortgage-backed security it sold to investors. And, the usually
bullet-proof Goldman found itself on the business end of an SEC civil
fraud lawsuit.
News of the SEC lawsuit sent a shiver through Wall Street.
Fearful investors not only began piling out of Goldman, they also
started scrambling out of other major bank stocks. Shares of
Bank of
America (BAC), JPMorgan Chase (JPM), and
Morgan Stanley (MS) all fell
sharply on Friday.
Investors are afraid the Goldman suit is just the tip of the iceberg.
They’re worried the SEC is preparing similar lawsuits against other
major Wall Street firms. And, they’re concerned such lawsuits could
undermine the financial sector’s fragile recovery.
If investors begin exiting financial stocks en masse, the selling could
easily carry over to the broader market. A new scandal in the financial
sector is just the kind of event that could spark a full-blown market
correction.
And there are plenty of signs the market is ripe for a correction.
Take consumer confidence for example.
Economists were expecting consumer confidence levels to increase in
April. But, they fell unexpectedly. If investors begin worrying consumer
spending levels might lag, we could see them let some air out of the
market.
Another sign we’re near a market top was recently provided by company
insiders.
Last week the Thomson Financial Insider Transactions ratio showed
insider selling is outpacing buying by a whopping 40:1. When insiders
are selling at this rate, it’s usually a strong sign the market’s headed
for a fall.
And, if these signals aren’t enough, consider the extremely bullish
views of professional financial advisers.
The most recent Consensus Bullish Sentiment Index reading was 76%. Any
reading over 75% for this contrarian indicator means the market is
overbought. The theory is if most financial advisers are bullish, the
market is probably due for a fall.
As you can see, we have some strong signs the market is poised for a
correction. But, don’t fret. The occasional correction is actually a
good thing for an upward trending market.
What should you do to prepare for a correction?
Take a hard look at your stock holdings now. Consider taking profits in
your biggest winners. Especially if they are higher risk stocks like
small-caps, biotechs, technology, and the like. These are often hit the
hardest in a correction.
Of course, if your positions still have good long-term growth potential
and you got in at a good price, you may want to hang on to some of your
shares. I don’t see the market heading back down to the March 2009 lows.
Also, consider exiting any positions that have small gains or outright
losses. If they haven’t performed well in this market, they probably
won’t hold up in a correction. You have to ask yourself if you’re
prepared to suffer even bigger losses.
Perhaps this is a good opportunity to exit these underperformers with
just a small gain or loss?
The point is, now is a good time to raise some cash. A correction will
provide a good second chance to get into top performing stocks at
bargain prices.
The last thing you need to do now is get your shopping list ready.
Identify the stocks you want to own but missed on the way up. Be
prepared to put your cash back to work as soon as the good buying
opportunities appear.
Follow these suggestions and make any market correction work for you.
Don’t let what should be a very good buying opportunity pass you by.
The IPO market is heating up. Seven new issues are scheduled to begin
trading this week. If they all launch, this week will be the busiest of
the year so far for IPOs. The company getting the most buzz on the
Street is DynaVox. They make speech generating devices and software to
help people overcome speech, language, and learning challenges. They’re
looking to raise about $150 million.
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