Expect Long-Awaited Correction in Q2: Investors
This bull market that seemingly won't quit is headed toward a correction this quarter, many investors said, citing recent history, the lack of retail investor participation and the upcoming earnings season.
"The second quarter has proven to be the period when the market finally provides the correction that many investors had begun to anticipate during the latter stages of the first quarter," said Brian Belski, chief investment strategist at BMO Capital Market, in a quarter-end note. "It is an appropriate time for investors to become tactically more defensive within portfolios."
The average second-quarter performance for this three-year-old bull market has been a 5 percent decline, Belski noted. That is in sharp contrast to average gains of 7 percent in the first and fourth quarters. On average, the third quarter has seen little change.
Anyone can see this pattern by looking at the S&P 500 chart going back to March 2009, when its bull market began. April or May have been tops leading to 5 percent to 10 percent selloffs each year. The S&P 500 hit a new closing high Thursday, the quarter's last business day.
"I have been gradually lightening positions since February expiration and so I am underinvested here and getting more so," wrote Phil Pearlman, executive editor of StockTwits and an avid trader, citing similar historical evidence. "I risk missing a bull that never corrects. I'm good with that and for now I'm just waiting."
Meanwhile, the retail investor is failing to lend buying support to this rally. Cash allocations for individual investors is at a 16-month high of 23 percent, according to a recent survey by the American Association of Individual Investors.
"While some AAII members are more optimistic about the short-term outlook for stocks, others fret that stocks are overbought and are due for a pullback," said Charles Rotblut, editor of the AAII Journal, in a report about the survey.
Earnings season kicks off next week with Alcoa's first-quarter report, and early indications are that profit reports and outlooks may not justify this run in stocks. Negative warnings from S&P 500 companies are outpacing positive guidance by more than 4 to 1, a ratio we haven't seen since 2001, according to Thomson Reuters.
Take investors who jumped on the FedEx bandwagon this year, for example. The economic bellwether was up more than 9 percent heading into mid-March, then cratered after the company reported guidance well below Wall Street estimates.
(Read More: FedEx Earnings Fall Short on International Weakness)
"We have encountered many of our clients straying from their disciplines with increasing frequency during the past several weeks in hopes of improving performance," wrote BMO's Belski. "This is quite troublesome, in our view, considering the seasonal trends that transpired between 2010 and 2012."
Some investors believe this market will, for the most part, stay the course, as it's already proved this year that it can handle a fiscal crisis and a European crisis.
"Corrections of 5 percent or more have historically averaged about five times per year, and we have not had one since last November," wrote Savita Subramanian, Bank of America Merrill Lynch equity and quant strategist. "But with widespread expectations for a pullback, and many looking to buy on the dip, any near-term pullback we get could be shallow and short-lived."