Three signs of a coming equity market correction

Published on, Source: Reuters, April 15, 2010.

Signs are appearing, at least to those who like to study financial market runes, that equities could be in for a short-term fall.

Nothing is certain, of course, what with past performance being no guarantee of future returns as the standard disclaimer reads, but three different historical trends are suggesting equities could soon turn.

It all has to do with eight days in March, an aversion to cash and, contradictorily, falling equity market volatility.

First, the eight days … 

… At some point—perhaps now, if BofA Merrill is right—cash levels will normalise, cutting off riskier assets from some of their fuel.

The third sign of a correction is less numeric and more psychological.

State Street Global Advisors, an investor with USD 1.9 trillion in assets under management, says it is seeing growing interest from institutional investor clients in low-volatility equity strategies, essentially protection against stock market falls.

The best time to enter such strategies, State Street says, is when volatility has bottomed out and equities themselves have risen sharply from a low, as now.

The CBI Volatility Index is below last year’s low and 71% below last year’s high. The MSCI all-country world stock index, meanwhile, has risen some 83% from what many believe was its cycle low a little over a year ago.

Cyclical bull:

None of this is to say that such a correction will spread into the longer term.

BofA Merrill’s Schoewitz said its study of corrections following cash reserves hitting 3.5 percent “is a very short-term signal”.

Furthermore, Morgan Stanley notes that while days of hitting 50%-plus gains has led to a correction in the short term, on 96% of occasions it has been followed by 10% rise in equities over a 12-month period.

The firm believes that equity markets are currently in a cyclical bull market that should continue into next year

But for the short term, signs are there. (full text).

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