Why a Bull Market Correction Might Be Near

— -- Many investors are on the edge of their seats these days, awaiting earnings reports that tend to spell out the near-term future of their holdings.

Earnings reports for the first quarter have been mixed, but many forecasts call for general earnings contraction among the S&P 500 (the 500 largest public companies in the US) for the first time since 2009. S&P Capital IQ, for example, has predicted S&P first-quarter earnings will decline more than 3 percent. As this big-company category has defined so much of this long bull market, such forecasts have created concern among many investors who have grown accustomed to long-ascendant earnings.

The recent past may hold more clues than forecasts. The market’s overall behavior has changed this year--a lot of waffling with almost no direction. According to Bespoke Investment Group, the second half of the first quarter had 28 consecutive trading days where the S&P 500 didn’t post back-to-back gains. (Since World War II, that has only happened twice, in 1970 and 1994.) It’s been a zig-zagging market recently, and this may turn out to be the most pronounced theme of 2015.

As earnings reports trickle in over the coming weeks, other factors are weighing on the minds of investors. Chief among these is the way that, despite a recent uptick in oil, the depressed energy sector is driving everything else down with it. And based on the lackluster guidance statements issued by corporations to manage investors’ expectations, there’s every reason to expect an overall dip in earnings. Increasing this likelihood is the tendency for large companies anticipating poor earnings to do corporate housecleaning – such as selling under-performing business units – to get all of the bad news out of the way when investors are expecting less. That way, they won’t sully sunnier quarters down the road.

All of this leads to thinking about the C-word. That’s right: a correction -- the increasing likelihood of a bull market dip of at least 10 percent.

Many people believe a correction may be around the corner because the Fed may take action that raises interest rates. A correction may soon be upon us, but if history is any guide, these people are mistaken about causation. Data from Bloomberg shows that, between 1993 and 1995, when interest rates rose from 3 to 6 percent, the S&P 500 gained 50 percent. This index also gained 50 percent between late 2003 and 2007, when rates went from 1 to 5.25 percent.

Of course, in the market, misperception can affect reality, as demonstrated by a recent dip attributed to rate-increase fears. But an interest rate increase is now baked into share prices and investor perceptions. What matters more is the market’s performance after actual increases and history tells a different story.

But, as we used to say in the 1970s, just because you’re paranoid doesn’t mean that everyone isn't out to get you. Contrary to the fears of interest-rate Chicken Littles, a correction in the near-term seems likely not because of any rate increases, but primarily because of expected weaknesses in earnings and the reality that the market is way overdue for one.

To some extent, saying that a correction is coming is like saying it’s going to rain. It’s going to happen, the only question is when. And we’re not talking about rain in the Mojave Desert. In the context of market history, the incidence of this corrective rain falling in the market is more like a wetter climate. Data from American Funds shows that between 1900 and 2013, the market declined 10 percent or more for an average period of 115 days about once every year. This has happened twice during the current bull market—beginning in July, 2010 and October, 2011. Some of these declines turned out to be much more than corrections, as they were far greater than 10 percent and lasted much longer.

Once there’s a significant decline, there’s naturally no telling whether it is indeed a correction – whether the market will bounce back – or whether it’s the beginning of a prolonged downturn, otherwise known as a bear market. If the market soon enters an apparent correction, it may turn out to be something far more severe.

Yet the current market possesses none of the characteristics historically typical of the end of a long-term bull market, including fundamental weaknesses in large companies—the kind of serious weaknesses that one poor earnings report doesn't indicate. By this gauge, a near-term correction would likely be nothing more than, as Coca-Cola used to say, a pause that refreshes.

Moreover, the entire U.S. market is well-positioned globally for a resumption of the raging bull, if it corrects anytime soon. Though markets in Europe and elsewhere may have improved a bit this year, their long-term performance and fundamentals have been too weak to support the case for continued growth. This leaves the U.S. as the world’s investment growth engine – one that’s singularly attractive to foreign investors, auguring continued inflows from abroad in domestic markets. Because of this, it seems likely that the substantial decline will be a corrective interruption before the bull market resumes.

All of this suggests some potential strategies for individual investors:

* Although it has worked only once in the last five years, in 2011, there’s an old market saying that may be wise to heed: Sell in May and go away. If you’ve got good gains on some stocks, this may be the way to go – this May, anyway.

* If you don’t have the cash on the sidelines, consider selling interest-sensitive items such as electric utilities, REITs or bond funds. These will probably provide little income in up markets anyway -- maybe 4 percent -- so dumping them carries less downside. You could also raise cash selling high-beta speculative stocks, since they would likely pull back more than the general market.

* After things dip enough, buy stocks once they become cheaper. Of course, you’d be taking the risk that stocks may keep falling – finding the bottom has been likened to catching falling knives – but a true correction is usually a mere interruption in a bull market, signaling a buying opportunity. In case of a dip, look at insurance companies and banks that would benefit from rising interest rates, as well as computer and biotech stocks that are oversold.

If earnings come in low as expected, keep these moves in mind. But remember: Even with a poor earnings quarter, there’s still no better place to invest than in U.S. markets. And the world’s money has to go somewhere.

Any opinions expressed are solely those of the author and not of ABC News.

Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.