If you've only been looking at the Dow Jones Industrials or the S&P 500 lately, then everything looks just fine in the stock market. Yesterday's big plunge aside, major market benchmarks have been hitting new record highs, extending their recovery beyond the doubling that they've seen since the 2009 lows. Even considering yesterday's drop of around 1%, it's far too premature to start calling for a correction.
But if you look beyond the headline benchmarks and do some digging, you'll find several signs that the overall stock market isn't quite as healthy as the Dow and S&P might lead you to believe. Take a look at three of those signs:
1. Small-cap stocks aren't keeping up with large caps.
Even as investors around the world seem to be flocking to U.S. stocks, small-cap indexes have been noticeably absent from the list of benchmarks setting new record highs. After hitting a record in mid-March, the Russell 2000 has failed to get back to that level and now stands nearly 4% below its all-time high.
What makes that lagging performance particularly troubling is that small-cap stocks helped lead the markets higher throughout the past four years. At its peak, the Russell 2000 was up more than 175% from its March 2009 lows, which is quite a bit stronger than the 135% move up for the S&P 500 over the same span. It may be simply that large caps are finally catching up to their smaller counterparts, but the move also suggests that conservative investors are getting more defensive and taking more volatile stocks off the table.
2. Emerging-market stocks have corrected much more dramatically than U.S. stocks.
The international stock markets give a much uglier picture of the global economy than U.S. markets, and in particular, emerging-market stocks have seen relatively terrible performance compared to the domestic multinationals that get so much of their business from emerging markets. The broad-based Vanguard Emerging Markets ETF has fallen steadily throughout 2013 and now trades fully 7.5% below where it closed on the first trading day of the year.
In particular, Chinese stocks have held back the global markets. The closed-end China Fund is down 10% from its early February levels as fears escalate about the emerging giant's ability to keep its economy growing in the face of an overheating real estate market and inflationary pressures. Even stocks once considered stalwarts in China have plunged, with Internet search leader Baidu once again testing new 52-week lows even as it follows Google's lead in developing digital eyeglasses. Even as economic data in the U.S. has improved, macroeconomic trends internationally look far less favorable, and until they turn, international stocks won't do as well as their domestic counterparts.
3. Formerly hot sectors have taken big hits.
In every bull market, certain industries lead the way higher. When those industries start to turn around, it can be a sign that the overall market will follow suit.
For instance, over the past couple of weeks, many homebuilders have seen their stocks fall substantially. In particular, Hovnanian and Beazer Homes have reacted negatively even to news last week that home prices had risen by more than 8% year over year. Occasional pessimistic data points, such as new-home sales falling more than expected last month and consumer confidence figures declining, have been enough to make investors question whether there are further gains to be had from stocks that have already soared. You can find similar stories in other hot sectors, such as financials and airline stocks.
Wait and see
After four years of steady and dramatic rises, the stock market is arguably overdue for a correction. But even these signs of a potential end to the bull market don't mean that such a correction is imminent. What they do tell you, though, is that it's time to make sure your portfolio is ready to handle whatever comes next -- including a substantial downturn that could potentially be right around the corner.
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