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The Globe and Mail

National Bank: Stocks poised for 'meaningful correction,' gold will rally

A man is reflected on an electronic monitor displaying share prices outside a brokerage in Tokyo July 9, 2012. Japan's Nikkei share average fell back below the psychologically important 9,000 level on Monday morning as worries about faltering global growth were reinforced by sluggish U.S. jobs figures and disappointing data from China and Japan.

Issei Kato/REUTERS

Globe editors have posted this research report with permission of National Bank Financial. This should not be construed as an endorsement of the report's recommendations. For more on The Globe's disclaimers please read here. The following is excerpted from the report:

The major themes and trends that carried markets in 2013 will likely extend into early 2014. A two-tier market that is especially evident in Canada is a major theme that played out in 2013. Most sectors and stocks outside of the resource area did well while resource-related issues underperformed. This theme will again dominate market action in 2014 perhaps in a different way. Two-tier markets ultimately converge and as this theme matures, the probabilities increase that a convergence materializes sometime in 2014. ....

Historically, a strong year such as 2013 is generally followed by a year of constructive action where markets are being supported by upside momentum. To gain a broader perspective of what could potentially happen to markets in 2014, we have to look at a longer time frame than one year of history. If we look at what happens to markets after a down year followed by two strong up years as in the current case, the probability of a continuing strong performance trend is questionable. The accompanying table from Investor's Business Daily highlights the seven instances of this performance pattern going back to 1920. According to this record of one up, one flat and five down years out of seven, 2014 does not appear to be a promising year.

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Extending this analysis to what the market does after a four- to five-year bull market with returns well in excess of 100% indicates that there is increased risk of a significant correction. Examples of such periods were 1932 to 1937, 1982 to 1987, 1995 to 2000 and 2002 to 2007 which were followed by meaningful corrections. This bull market is approaching its fifth anniversary with market averages in the United States up well in excess of 100% since 2009. The probabilities favour a negative surprise in 2014 that will be contrary to consensus and act as a catalyst for a correction that is due.

A correction in the S&P will have a negative impact on the upper tier of the Canadian market. The relative outperformance of the commodities sectors will provide somewhat of an initial cushion against the negative impact of a downturn.

Read the full report here.

Read other research reports here.

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