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Get ready for August correction, but then grab this bull by horns

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Get ready for August correction, but then grab this bull by horns

Things have come a long way since the dark days of October 2008, when it looked as if the sky was falling in on the masters of the universe and the wider US economy. In short, we have been having a great run but, like all good parties, when the music stops, so does the dancing.

Looking at recent global events, and the ups and downs of the US economy, the current set-up in the equity market is remarkably similar to the summer of 2011, which ushered in an 18% decline.

I do not think any pullback from here will be severe but I believe we are vulnerable to a 10-12% decline in the run up to the autumn, albeit within the constructs of a secular bull market that has years left to run. Take the fortunes of the S&P 500, which is a good portent of things to come. It recently tried to surmount 2,000, and failed.

The last two cyclical bull moves ended in one of two ways: they either failed to better a number such as 2,000 or they made a ‘peekaboo’ look above a similar number. In either event, this feels more like a crescendo, not a new leg-up.

While many of the bulls claimed victory with the renewed resurgence in US equity values, the massive rebalancing of the Russell indices recently could have had a manipulative effect on the equity markets.

How will Wall Street react?

Those rebalances affected more than $5 trillion (£3 trillion) in assets. Accordingly, I am waiting to see what happens in the coming weeks on Wall Street, although many of the players have already deserted New York for an extended holiday.

In a nutshell, I think we are in a secular bull market that has years left to run. The problem is many of the folks in this business have never seen a secular bull market. Their shared experience during the past 15 years has been to buy a stock and, when it rallies by 30%, sell it and look for another stock to do the same thing.

They have not experienced buying high quality, blue chip dividend-paying stocks and holding them through a secular bull market like that of 1982-2000. Manifestly, in such a market, the art of just sitting, without much activity, is one of the secrets of compounding wealth.

There will certainly be pullbacks, so raising cash and repositioning portfolios along the way makes sense, but you should not go into a big cash position.

Even this year, the pattern repeated, with new highs in January and a 6.2% decline in the first week of February. We got an anticipated 5-7% decline in the first three months of the year that the historical odds called for, and now we will see if a trading top will lead to the 10-12% pullback history calls for some time this year.

Blow-offs usually end with a parabolic peak and often with a buying climax, for an example of which look at the ‘selling climax’ of the March 2009 lows and turn the chart upside down.

Similarity to summer 2011

I have revisited the summer of 2011 because I have been getting similar readings for a pick-up in volatility in mid-July 2014, much like the one we saw in June 2011. Moreover, the stock market’s internal energy readings are likewise at levels last seen during the summer of 2011.

History does not necessarily repeat itself but it does sometimes rhyme. Accordingly, I am making a call for the potential of the first decent pullback of the year to begin, perhaps in August, and am recommending culling non-performing stocks from portfolios to raise cash.

If the said decline fails to materialise, we can always recommit the cash to more favourable situations because, longer term, it is looking like the bull run we have been enjoying is set to run and run, albeit with those aforementioned pullbacks in mind.

Jeffrey Saut is head of investment strategy at Raymond James

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