5 Warning Signs Of A Stock Market Correction


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After running up four months straight, the stock market has fallen into a correction. While profit-taking after such a long run should come as no surprise to ETF investors, there are reasons to be cautious about expecting a quick rally.

Here are five warnings that show how the stock market is very weak and could get weaker:

1. High-volume distribution.

SPDR S&P 500 ETF ( SPY ) shot up to a four-year high of 148.11 on Sept. 14 and then turned tail, closing in the lower half of its intraday range. Since then trading volume on the red days has outweighed volume on the up days. SPY has logged seven distribution days in the past few weeks. This suggests institutions are selling more than buying and buyers' strength is waning.

"The International Monetary Fund caused the market sentiment to dip when it indicated that 'risks for a serious global slowdown are alarmingly high,' in their World Economic Outlook report, which was released in Tokyo on Tuesday ahead of the fund's annual fall meeting," said Mark Martiak. He is senior vice president of Premier Financial Advisors in New York with $300 million in assets under management. "It was its bleakest assessment of global growth prospects since the 2009 recession."

Lee Munson, chief investment officer at Portfolio LLC in Albuquerque, N.M., recommends traveling to China for bargain shopping.

"China, while ugly beyond belief, is selling at a 20% discount to emerging markets," Munson said. "This is a first. If you want value, and think a hard landing has already been priced in, then China and emerging markets should be the place from now until the end of the year."

IShares FTSE China 25 Index ( FXI ),SPDR S&P China ( GXC ) andPowerShares Golden Dragon Halter USX China Portfolio ( PGJ ) offer easy access to the People's Republic.

2. Weak earnings outlook.

Earnings -- the biggest drivers of stock prices -- look ugly. Throngs of companies have issued negative pre-earnings announcements owing to slowing demand overseas as the global economy weakens. The negative-to-positive preannouncement ratio for the third quarter is 4.3, the weakest since the third quarter of 2001, according to Pat O'Hare, chief market analyst at Briefing.com.

Third-quarter corporate earnings are expected to drop 2.9% from the year-ago period, marking the first quarterly decline since 2009, according to Thomson Reuters.

"Q2 was an exercise in accounting. Most of S&P 500 missed on revenue and hit on earnings. Accountants earned their keep in Q2," said Andrew Norman, an analyst at BullandBearMash.com in Plano, Texas. His firm specializes in analyzing the S&P 500, Dow and Nasdaq 100 indexes.

"The only thing that will save revenues in Q3 will be channel stuffing. That's where the sales people call their distributors and play 'let's make a deal.'"

"There is too much unsold product to stuff in an already stuffed channel," Norman added. "The auto industry has been stuffing going back to 2010. Channel stuffing is a process, not an event. The issue arises when channels overflow."

A major Dow industrial component,Alcoa ( AA ), kicked off earnings season Tuesday night on a sour note. Owing to poor demand and low aluminum prices, the aluminum maker lost $143 million, or 13 cents a share, vs. a profit of $172 million, or 15 cents a share, in the year-ago period.

Fellow Dow member,Chevron (CVX) said third-quarter earnings, due out Nov. 2, would be "substantially lower" than the prior quarter.

Engine makerCummins (CMI) lowered its 2012 outlook for a second time this year.

3. As goes Apple...

Apple (AAPL) has fallen below its key 50-day moving average and is trading 10% below its 52-week high. It corrected 19% from April to May this year. It fell 15% peak to trough between October and November last year. So it could sink considerably more while staging a normal correction.

The tech giant accounts for nearly 20% ofPowerShares QQQ (QQQ) and 4.4% of SPY. As a major holding in those indexes, Apple could take both indexes down with it.

"The tide may be turning for the stock, at least in the short term," said Vahan Janjigian, chief investment officer at Greenwich Wealth Management in Greenwich, Conn. "But the Apple story is not over. The company makes great products and it will continue to do so."

Janjigian added: "However, I believe there has been too much enthusiasm for these products. Whether it is a new iPhone, a smaller iPad, or Apple TV, the stock runs up in anticipation and in reaction to these products."

"It's normal for investors to take profits on the stock as analysts cut their sales outlook for iPhone 5 sales because of supply problems," said Alan Zafran, partner at Luminous Capital in Menlo Park, Calif. He also cited Normura's report of possible slower growth in 2014 but the stock trades at cheap valuations.

"One can hardly call Apple shares expensive, currently trading at 12.5 times forward earnings, whereas shares ofGoogle (GOOG), for instance, trade at 15.3 times forward earnings," said Zafran. "Meanwhile, you have a product wildly in demand, iPhone 5, two other products along the way, iPad mini and iTV, and potential significant growth in China in 2013."

4. The smart money is short.

The so-called "smart money," or commercial traders in S&P 500, S&P 400 and Nasdaq 100 index futures, are overwhelmingly short the market, or betting it will go down, according to the latest Commitment of Traders reports . Meanwhile, the so-called "dumb money," or noncommercial traders such as retail investors and speculators, is overwhelmingly long. More-knowledgeable commercial traders are more likely to be right than retail traders, who are generally wrong. Of course, that's not always the case.

5. History suggests caution.

October may be the new September. The market didn't sell off in September, so it's due for a correction. Historically, the market dreads September, which has been the worst-performing month of the year for the Dow and S&P 500 since 1950, according to The Stock Trader's Almanac . It's been the worst month for the Nasdaq since 1971 and for the Russell 1000 and Russell 2000 since 1979.

"Performance does improve modestly in election years, but it is still negative nearly across the board," the Almanac stated in a client note in August. "Only the small caps of the Russell 2000 have been able to escape negative territory and post a modest 0.4% average gain in the last eight election-year Septembers."

"Measured on a long-term basis, the stock market typically rallies from it's midyear correction, bottoming out in September or October, and then rallies again into year end," said Brian Schreiner of Schreiner Capital Management of Exton, Pa. "But given all the variables investors are contending with right now, there are a whole range of outcomes with relatively high probabilities in play."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing ETFs
Referenced Stocks: AA , FXI , GXC , PGJ , SPY

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