Is a Stock Market Correction Pending?

By Mohit Patel,
Money & Investing Writer

Black Tuesday, the dot-com bubble, and the housing market crash all have one kay factor in common: very few people saw them coming.

In the euphoria amid the economic and financial growth investors and analysts alike often fail to see that warning signs of a market that is about to crash or undergo a correction.

With the stock market at record highs and valuations starting to top out, many investors are starting to believe that the market in 2014 is ready to crash.

Henry Blodget, the co-founder and CEO of Business Insider believes that a correction is bound to happen this year.

He also believes that when it does occur it will happen in a frenzied manner, according to Yahoo Finance.

Mr. Blodget admits, however that he does not know when this this event, which he describes as “a market exodus” is going to happen and that he will not know until after it has happened.

According to Yahoo Finance on factor that Mr. Blodget considers when analyzing the situation is the policies of the Federal Reserve.

Once the Fed begins to reduce its control over interest rates the stock market is likely to react in kind. According to Yahoo Finance, the Federal Reserve has begun winding down open market operations and it has plans to continue to do so into the future.

Another fact that Mr. Blodget has pointed out is corporate profit margins, which he sees as being at record levels.

If this fact changes, even back to historically normal level, the stock market may be adversely affected.

Those two indicators are not the only signs of a stock market correction, however. One of these indicators is the consensus earnings estimate for the Standard and Poor’s 500 stock index.

This is indicator is found by taking the average of a many different analysts’ estimates for what the S&P 500 index’s earnings per share will be for next year.

Despite the fact that the S&P 500’s earnings consensus had decreased by 10 percent since December 2012, the equity index itself has continued to rise, a sign that the market may by overvalued.

Another indicator that shows that the market is overvalued and ready for a correction is the Cyclically Adjusted Price to Earnings multiple (CAPE) also known as the P/E 10 ratio or the Shiller P/E.

The Shiller PE ratio of the S&P 500 index, a metric which was created by Robert Shiller a Nobel Prize winning finance professor from Yale University, takes the current price per share of the index and divides it by the average of the last 10 years’ earnings of the index.

The resulting number can then be compared to past numbers to see if the index is relatively overpriced or underpriced.

At the present time the indicator is at 24.73. This is just under the value of 30 which the ratio reached on Black Tuesday in 1929 prior to the Great Depression.

Although the case for a correction looks strong what investor do about is an entirely different subject altogether.

How long the market will continue to rise is also another point of speculation. Whether investors decide to buy, sell, short, or cover to take advantage of this market, their actions will no doubt be the ultimate factor that determines the future of the stock market as the year 2014 draws to a close.

A version of this article appeared in the Tuesday, Oct. 21st print edition.

Contact Mohit at
mohit.patel@student.shu.edu

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