Stocks Frothy; NASDAQ Composite Early Warning

After roughly a 5 percent drop over 4 trading days, through April 7th, the Nasdaq Composite index rebounded, with the entire market, gaining 133 point in two trading sessions, or about 3.3 percent through yesterday’s close.  The 5 percent fall appears to be a precursor to what could be the most significant market correction/crash since the 2008/9 financial crisis drove stocks to lows not seen since the mid-1990s.  While some market commentators are calling for an advance to the 1,950 level for the S&P 500 before a correction (which is only about 4.5 percent from current levels), most expect some kind of significant correction to occur before the end of 2014.

While it is always possible that the market could continue its upward trajectory without a major correction, it is extremely rare for stocks to experience a bull market lasting more than 5 years and not have a large correction or crash during the 6th year.  Since World War II there have been 3 such bull markets and in two of the three stocks did experience major corrections (the crash of 1987 (-30% for the S&P 500) and the crash of 2008/9 (-57% from the peak of 1,565 to the low of 666)).

Investors are well aware of the risks – they are prominently displayed in headlines in every financial news service.  One has to wonder whether investors simply do not believe there will be a correction, or if they think they are smart enough to sell just before it happens.

Cash is king, in my opinion, in this type of market condition.  Bonds are in a major bubble, real estate has rebounded dramatically and rates are expected to rise, and stocks are very expensive (I would go so far as to say they are in a bubble as well).  Cash is the most flexible asset class, protecting investors from downside risk while offering the opportunity to take action if there is a correction, to buy quality stocks that are pulled down with the overall market.  This is my strategy.

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