Stock markets around the world have rallied to new highs in recent months. However, despite the bullish sentiment, market analysts are now warning that a correction could be looming on the horizon. Here is exactly what they are saying and what it could mean for you as an investor.
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What has been happening to stock markets?
A year after the coronavirus pandemic nearly brought the global economy to a halt, stock markets have recovered spectacularly. In the last few months, we’ve seen many reach new post-pandemic highs. Some have even broken their previous record highs.
Here in the UK, the FTSE 100 recently surged to a 15-month high of 7,100 points.
Across the Atlantic in the United States, two of the main stock market indices, the S&P 500 and the Nasdaq Composite, have both hit new all-time highs.
What has caused the stock market rally?
The stock market rally is due to a number of factors. These include a successful vaccine roll-out and government stimulus.
The biggest factor, however, is a generally positive economic outlook that has boosted investor confidence. In 2021, the UK’s economy is expected to witness its biggest boom since the post-war period.
Although concerns about inflation have dampened market sentiment a little and slowed the momentum in the last two weeks, most markets continue to trade near all-time highs.
That said, analysts are now warning that a correction is coming. And they think it could happen sooner rather than later.
Why do analysts think a stock market correction is on the horizon?
According to a report in The Telegraph, analysts at Swiss investment bank UBS have noted that many investor sentiment indicators, which measure investor confidence, show that a near-term correction in share prices is on the way.
For example, the ‘put-to-call ratio’ for European stocks, which measures how many investors are protecting themselves against a market crash, is at its lowest level since 2017.
Another indicator of a potential incoming correction is the ‘bull-minus-bear ratio’. This is a gauge for how many investors are optimistic about stocks versus those who are pessimistic. According to UBS, the indicator is at its highest level since 2017.
The Telegraph further reports that the Bank of America has noted that confidence among market analysts is at a 13-year high.
According to the bank, bullishness on stocks such as the one that we are currently witnessing is usually a ‘reliable contrarian indicator’ of what will actually happen to prices. In short, investors should embrace a cautious outlook because after the recent rally, a correction is highly likely.
To put things into perspective, the Bank of America forecasts that the American stock market will return slightly more than 6% over the next year. This is a big drop from the bank’s average 12-month forecast of 14% since 2008.
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What does this mean for investors?
A correction should not be a cause for concern for long-term investors. Dips and corrections, after all, are a normal part of the market cycle. It is not a reason to panic and liquidate your investments.
Historically, a stock market correction has almost always been followed by a bullish rally that has wiped out any losses that investors may have suffered during the dip.
If a correction is on the way, market analysts don’t believe it will last long. According to UBS, it’s far too early in the current economic recovery to call an end to the stock market rally.
For savvy investors, a correction may actually be a blessing in disguise. It can give them a chance to buy more stocks and shares for their portfolios at a discount, setting themselves up nicely for an almost certain subsequent stock market rally.
