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3 Reasons a Correction Is Coming: Merrill Strategist

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With the markets up nearly 27% in 2013, investors are wondering what might bring an end, or at least a lull, to the party.

MacNeil Curry, head of global technical strategy at Bank of America Merrill Lynch (BAC), says to expect a negative turn in the second or third quarter of 2014.

Equity markets likely will be affected by three factors, Curry said in an interview on Yahoo Finance/CNBC early Wednesday.

1. The Treasury Environment

Since mid-2012, we’ve been in a rising interest rate environment, he points out. That bear trend remains in effect, and Treasury yields could spike next year into a new range of 3.17%-3.33%.

When there’s a breakout into a new range, investors concentrate on the change.

“When all of the corrections [in the S&P 500] transpired over the course of the past year, it’s been because of the Treasury market,” Curry said. “When Treasury yields have started to push higher aggressively, and as fixed income volatility has risen, that has spooked investors in the equity space and led to a correction in the U.S. equity market.”

“We think the bogeyman is still lurking in the background,” he added, noting that the Treasury market remains “an ongoing source of concern and vulnerability to U.S. equities.

2. ‘Old Age’

The current bull market has been running for more than four years. “I don’t mean that … a correction is imminent, but the advance is maturing,” Curry explained.

“If you look at new 52-week highs, that [number] has slowly been declining,” he said. “If you look at the percent of stocks in the New York Stock Exchange trading above their 200-day [moving average], that is starting to decline.”

These shifts mean that in early 2014, “the probability of a correction is going to increase,” the strategist notes.

3. Seasonality

Historically, the second and third quarters tend to be negative for stocks, despite the exception of 2013. “This went out the window in 2013,” he said, “when we really just had hiccups of 5% [declines.]”

Investors shouldn’t count on that happening again, especially given the historic returns of the year as it falls within the presidential cycle.

“But 2014 could be a bit different … the presidential cycle and the annual season pattern should line up,” probably in the second or third quarters, Curry said.

While he won’t put an exact number of how big the coming correction will be, “I suspect we will see a move of 10%-20%,” he said.

The market hasn’t seen a 20% correction since 2011. When the last major shift in interest rates occurred, in 2004, the markets had a six-month trading range of about 10%, he adds.

“With the interest rate environment being negative,” Curry concluded, “it’s safe to say at some point we will have 10%-20% correction.”

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