Breadth, the number of advancing stocks versus decliners, is one variable that seems to be flashing amber to red. Most market analysts take a faltering breadth ratio as an early warning signal. Then there's momentum. Momentum is positive when existing trends in the markets continue or accelerate. Recently, that has changed.
Take the biotech sector for example. For most of the year this sector was a darling that at its peak was up over 20%. Investors, believing that the area offered enormous growth based on technological innovation, (like stem cells) and new health care initiatives couldn't get enough of these stocks. This week the sector hit a brick wall. Some stocks on Monday and Tuesday were down 10-15% with little warnings.
Other high flyers in the technology space were also clobbered. NASDAQ, which outperformed the Dow and the S&P 500 Indexes for most of the year, also experienced a fairly steep down draft. When momentum stocks and sectors begin to falter, I pay attention.
The initial public offering (IPO) market is also an indicator that bears watching. The calendar for new offerings has been red hot. Companies are falling over themselves to go public with ten new issues this week alone. In the recent past, these IPOs have all opened higher than their initial offering price and then went straight up from there. This week's favorite, a digital entertainment company, was crushed on its first day out of the box; not a good sign.
The phone has been ringing off the hook all week. It appears my last column on the markets triggered some concern. I wrote that the mid-term election cycle could usher in a period of turmoil and possibly a 10% or more decline in the stock market. Given my bullish stance on the stock market for well over a year, my forecast upset several readers.
Let me be clear. I am still bullish on the stock market over the intermediate and long-term. I just see some digestion problems between now and the end of the summer. Any paper losses readers may suffer during that time period will be regained by the end of the year. Occasional pullbacks like the one I am expecting is a necessary and expected condition of investing in the stock market. As I have said before, if you can't stomach these occasional declines, you do not belong in the stock market.
The exact timing on when and how long such a possible sell-off would occur is problematic. Some pundits are arguing it has already begun. I doubt it. We will probably rally again up to the recent highs or even beyond before stalling out again. We may well have another month or so before the markets truly roll over so there is plenty of time to adjust your portfolios in the event you want to take some defensive action.
Bill Schmick is registered as an investment advisor representative and portfolio manager with Berkshire Money Management (BMM), managing over $200 million for investors in the Berkshires.