A market correction may be on the cards

BEARISH SIGNS: The broad Standard & Poor's 500 fell 2.6 per cent last week. Unless there is good news from earning reports, analysts said a downturn is likely.


    Apr 15, 2014

    A market correction may be on the cards

    US STOCKS plunged into the red for the year last week, and could fall into correction territory this week - the first time since 2011.

    The broad Standard & Poor's 500 fell 2.6 per cent last week, and is now down almost 5 per cent from its record high on April 2.

    The last time the S&P 500 lost more than 10 per cent from a peak was almost three years ago, when it fell 19 per cent from an April high, amid phobia about the "debt ceiling".

    Last week, strategists at brokerage Goldman Sachs said the current downturn would likely meet the 10 per cent threshold, citing bloated valuations.

    The Nasdaq Composite, weighted towards the more richly valued technology sector, is a hair's breadth from an official correction, down 8.5 per cent from its April high.

    For some time, traders have evoked the 1990s dotcom era when talking about last year's "momentum" stocks, such as electric-car maker Tesla Motors, online travel agency Priceline and biotechnology drug maker Intercept Pharmaceuticals.

    The last time share prices had inflated that fast, the bears warned, it created the stock bubble of 2000.

    Last week, those comparisons seemed apt as losses mounted on the "momentum" stocks. Intercept, whose shares had risen tenfold in the space of a year, has lost roughly 40 per cent of its value in less than a month.

    Momentum, it turned out, can be a curse as well as a blessing.

    "If you think about where this started, it was a sector rotation at the end of the quarter," said Mr Joe Kinahan at TD Ameritrade. "The selling momentum on these stocks built as people took profits and now they're like 'I just want to be out and rotate my money elsewhere'."

    The beneficiaries of the sector rotation are utility and consumer staple stocks. Both these areas had fallen out of favour during the bull run late last year, as investors bet rising interest rates would make the dividend-paying sectors less attractive.

    Recently, however, interest rates have stopped rising. That was partly because of statements from the Federal Reserve, such as in the minutes of the March meeting released last week. In that statement and elsewhere, the central bank has committed itself to keeping rates low even as it retreats from bond buying.

    With the bond market offering little in the way of yields and most stocks "taken out to the wood shed", as Mr Kinahan put it, utilities and other high-dividend stocks have come back into fashion.

    For example, the SPDR S&P Utility sector exchange-traded fund has gained roughly 5 per cent since the middle of last month, in contrast to the SPDR S&P Biotechnology sector exchange-traded fund which has lost about a quarter of its value over the same period.

    Now, the question is: "Are momentum stocks going to continue to maintain their lead, or will that shift over to more defensive and high-quality dividend-paying stocks, and we'll find that out through earnings season," said Mr Oliver Pursche at Gary Goldberg Financial Services.

    Reports last week seemed to confirm the change in leadership. High-flying data-security concern Imperva warned that its growth was slowing, sending its shares down by more than 40 per cent.

    JPMorgan Chase warned that the go-go days of Fed-supported bond trading were "tapering" off, alongside the central bank's market activity. General Motors, one of the strongest consumer stocks in recent months, was beset once more by mechanical and sales worries after a recall scandal.

    This week, a wide range of earnings reports will reveal whether the stock market's shift to a defensive crouch is lasting.

    Bulls argue that the first-quarter reports will positively surprise a market which overestimated the damage a severe winter and tapering have done to corporate growth.

    There are also plenty of bearish indicators on charts: the S&P 500 has broken below levels where buyers had emerged in the past; this time of year is traditionally unkind to stocks; and three years is an unusually long period of time without a 10 per cent correction.

    Unless the earnings reports exceed growth targets this week, the stock market's streak may soon end.