Following a prolonged rally of the market, illustrated by an overabundance of bullish investors (often without hedges) and stocks breaking through moving averages, a correction or bearish market is guaranteed to ensue.
The difference between a market correction and a bearish cycle is often defined by the extent of the decrease in prices; although some argue such vague definitions are used by financial media to scare average investors out of stocks, before the correction is over.
The official benchmark for a bear market is a 20 percent fall in price, whereas any less is a market correction for overpriced stocks riding on a bullish wave, numerous ‘buys on margin’ and ambitious investor sentiment. The current market condition following the decline in late February 2015 resembles a market correction, illustrated by an intermediate downward trend on both the NSE All Share Index and the NSE 20 Index of 8.37% & 13.72%, respectively (Figures 2 and 3, on 11/06/15).
Typical signs that a bullish market is getting ‘long in the tooth’ include; prices previously having broken through key technical levels (Figure 4) and rallies currently have less energy, lower highs.
In addition, the market would exhibit a divergence in breadth, as the number of advancing equities (A) decrease versus the number of declining ones (D); particularly in the small-cap market, despite the market still rising (Figure 1). This is also a great indicator of availability of liquidity in the market, in which liquidity – or lack of it- can tell how severe the market drop will be.
We anticipate the market to enter a strong correction (vis-à-vis), shoring up to 15-20%, in the short medium term due to lack of liquidity. Liquidity has reached record lows, due to increased repo and TAD offers by the CBK, increased cost of capital(CBR – 10%), tax remittances, and subsided diaspora remittances; only further exacerbated by high demand for the 2-Year 2014 bond, first and second issue to be auctioned next week (15th-19th June).
More ad hoc signals include a high P/E ratios coupled with low dividend yields and the bull/bear ratio, where investors sentiment is so optimistic there are no bullish investors to turn; indicating the market is going to top-off.
Two things an investor can do are;
Take note, however, that each correction/bear market is different. Thus we remain with the question, how to invest when a ‘new normal’ (bullish market) turns to the ‘true normal’, a market correction.