SHIFT CHANGE COMING?

SHOULD WE EXPECT CORRECTIONS AFTER A LONG STOCK MARKET RALLY? WATCH FOR SOME KEY SIGNS.

WRITER: THOMAS H. RUGGIE, CHFC, CFP

The stock market has been rising steadily higher, reaching a number of record highs since November 2012. So what happens next? Will we as investors see the markets continue on their course, or can we expect a bump in the road, a dip, a correction, a pullback, or the start of a bear market?

If you are looking to buy or sell stocks, it is helpful to know if prices are trending up or down, since many stocks seem to follow the market. It is easy to see the recent prevailing trend of the stock market has been positive.

So what are some signs that change is coming?

Going down?

Before we look for those signs of an upcoming dip — or worse — in the markets, it is helpful to look at what those downturns have looked like historically.

According to a study performed by Ned Davis Research (see graph), there have been 294 times the Standard and Poor’s Index has corrected five percent or more. Of those, there have been 94 times the market corrected 10 percent or more. However, there have only been 25 times the market has fallen 20 percent or more — a situation known as a bear market.

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V1EeGBfBrt: Siahpush, Mohammad et al. “Financial Stress, Smoking Cessation and Relapse: Results From a Prospective Study of an Australian National Sample”; Addiction. onlinelibrary.wiley.com/doi/10.1111/j.1360-0443.2005.01292.x/abstract: de Bloom, Jessi ca et al.

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Therefore, looking at this data, we can see that about once a year, we can expect a 10 percent or greater correction. However, only about 26 percent of the time does this dip turn into a bear market.

According to the research, markets will “breathe or exhale”. And while pullbacks are no fun to sit through, most don’t result in a serious bear market correction.

Bullish or bearish?

It is important to have an idea what the general trend of the market seems to be and what the market is telling us about future trends.

Reading the market from one day to the next may not be helpful, but you can watch the general direction of the market and with some study, spot the warning signs that a change may be coming.

Positive trends: Are stocks trading in a positive trend that is showing higher prices? If you begin to see down days too frequently in a market that had been moving up, it may be a sign that it is about to reverse course or stall. Markets are generally thought to be healthy when more than 50 percent of stocks in any given index (such as Standard & Poor’s 500) are trading in a positive trend. When more than 50 percent are showing lower prices, this can be a sign a correction is coming.

Bullish percents: Another sign that market conditions are deteriorating is the underlying supply and demand for that stock. Stocks are on either a “buy” or “sell” signal; they are on “offense” or “defense”. While the charting of this is technical, broadly speaking, when there are more buyers than sellers, the market is trending up. When there are more sellers than buyers, the market is trending down.

Relative strength: As the name implies, this measures how one stock is doing compared to another. For example, how is Apple measuring up against Google? Relative strength calculates which investments are the strongest performers compared to the overall market and recommends those investments for purchase. When those stocks begin a downward path, this may be a sign a correction is on the horizon.

In addition, watch what mutual funds and institutional investors are doing. Volume buyers and sellers move the market. When they move in a direction, that is where the market goes. You can see it in the price and volume numbers. A market that shows sharp price movements in either direction without corresponding volume increases should be watched carefully.

If a change is coming, what next?

The truth is, regardless of the amount of research we do, there is no way for anyone to be certain which direction the market is going to move next. In fact, we commonly state the market does its best to fool the largest number of people. Our belief is a pullback (or a dip) is a perfectly natural function of the market and could happen at any time. We do not see anything currently in-place that could lead to more of a longer-term setback or a prolonged situation leading to a bear market. However, many things can trigger a quick change to this view.

Most of the time, it is not helpful for long-term investors — as opposed to traders — to watch stock market trends on a daily basis. In fact, little happening in the market today will tell you what will be happening in the market three or five years from now.

As a rule, it is probably wise to avoid big changes in your long-term investment strategy based only on market timing. Having a strategy in place that allows you to set your investment goals, contribute toward them, take advantage of opportunities for growth when they occur, and also monitors your progress will let you breathe easier when inevitable downturns occur.

THOMAS H.

CFP is the founder of Ruggie Wealth Management. With more than $425 million in assets under management, he has been ranked among the nation’s 50 Fastest Growing RIA Firms , the Top 100 Wealth Managers, Top 100 Independent Advisors, Top 40 Most Influential Advisors, and again, as one of Barron’s Top 1,000 Advisors. truggie@ ruggiewealth.com