Will there be a correction in the stock market in 2014? It’s a question I hear from more and more readers at stockideas.org. And rather than stick our heads in the sand and ignore the possibility of a stock market correction in 2014, let’s dig a little deeper.
In this blog post we’ll look more seriously at the possibility of a correction in the stock market in 2014. You’ll get an overview of the progress year to date, and where the cracks are forming in the major stock market indices. Sound good?
No Signs of a 2014 Stock Market Correction on the Surface:
When you look at the S&P-500 ,as well as the Dow Jones Industrial Average in 2014 it doesn’t look there is a stock market correction underway. The Dow is actually within striking distance of all time highs. Just take a look for yourself:
Year to date, the S&P-500 and Dow Jones have been more or less flat. So at a glance, it doesn’t appear that we’re seeing a stock market correction in 2014 (yet). But let’s take a closer look at what’s going on under the surface…
Small Cap Stock Index Correction in 2014:
The small cap Russell 2000 index is another part of the stock market that is a little bit higher risk than the relatively safe mega-cap stocks making up the Dow Jones. Additionally, the small cap stock index led the way higher last year. So if there is some faltering in the small caps, this might indicate a possible stock market correction in 2014.
As you can see, the small caps have broken their previous uptrend. And now the small cap stocks are making a series of higher lows and higher highs. Is this a correction?
Well either way…
This pullback is a significant divergence from the more mainstream S&P-500 and Dow Jones. While this does not portend an imminent stock market crash, it does raise a little cause for concern. So if yore curious you can read more about what’s happened in the past when the risk index has led the market lower.
But there’s another part of the stock market that also appears to be correcting in 2014.
Technology Stock Market Index Correction in 2014:
Technology is an amazing thing. But sometimes, investors hyped up expectations get ahead of the facts. And in the case of biotechnology, social media and internet security stocks (among others) we started to see some crazy valuations heading into 2014. When you compare these sky-high valuations with the record levels of margin debt, it appears the stock market could pullback or correct in 2014, right?
But don’t take my word for it. If you take a look at the chart below you’ll see that just like the Russell 2000, the Nasdaq has broken it’s prior uptrend and now looks to be starting to trend lower (or at least consolidating sideways).
While traders and investors might contend the Nasdaq and Russell will play catch-up to the major indices, there are a couple of red flags. First of all…
The earlier Nasdaq leaders like FB, YELP, AMZN, WFM, FEYE, and many many others have taken huge losses after their almost never-ending run-up. And it’s worth nothing that many of these companies had seemingly good earnings only to sell-off. So could these stocks continue to lead on the way down?
Another consideration is:
Despite the big sell-offs in marquis tech stocks, a lot of these stocks are still quite over-valued based on traditional metrics. It seems like even after this pullback a lot of growth is still priced-in to these former stock market leaders. Since they were irrational on the way up they can also be irrational on the way down.
Further, most of last year’s gains came from multiple expansions, stock buybacks and reducing expenses. Revenue growth hasn’t been amazing across the board. So it’s hard to predict the stability of these lower-quality earnings drivers, especially with FED slowing the pace of QE.
For these reasons I think it pays to err on the side of caution when considering a stock market correction in 2014. It’s hard to resist the potential reward, but you shouldn’t ignore the risk of a stock market correction either.
One glimmer of hope for bulls will be the old technology stock rotation. I previously outlined the best tech investments in 2014, and they continue to be the stodgier old names like ORCL, MSFT and AAPL (rather than the social media darlings of 2014). If these older names can hold onto the baton their might be some strength to the bullish sector rotation argument.
For now though, I remain skeptical.
Will the Stock Market Correction Spread in 2014?
The main issue going forward is going to be whether or not the stock market correction in biotech and internet stocks will spread to the larger parts of the market. Keep an eye on the biggest components of the Dow Jones Industrials to try and get a hint. I’m also watching for a higher USD as a sign the correction could thread through the rest of the stock market in 2014.
Finally, even if you don’t think the stock market will see a correction in 2014, it doesn’t hurt to think about what you would do if it did. Don’t stick your head in the sand. Make a plan, just in case.
And By The Way: If you’re looking for more information on how to prepare yourself for the stock market in 2014 I encourage you to sign for my email updates below. You’ll get the best tips and tools each week to help you improve your approach to the stock market. You’ll also get a free copy of my ebook to help show you I built a system to help with my investment and stock trading decisions.