Submitted by George Clausen on Mon, 0503/2012 – 3:001pm

The U.S. stock market moved up again last week after two weeks of decline. That sounds like what’s called a trading range – stocks fluctuate a percentage point up or down, but basically build no trend. Don’t be fooled. We are heading into a correction, defined as a slump of at least 10%.

Why is that, and what can investors do about it?

I am a technical analyst, which means I look for price trends. I assess patterns in trading. The major domestic indexes as measured by SPDR S&P 500 Trust (SPY), SPDR S&P MidCap 400 (MDY) and iShares Russell 2000(IWM) have broken their trend lines, established by their market bottoms in October 2011. In Europe, the indexes gained last week after four straight weeks of decline and Canadian stocks, as measured by the TSX, reversed a seven-week slide.

While the domestic markets have had several strong days during the past week, from a technical standpoint, they are weakening as measured by lower highs. The majority of our indicators, which measure the technical underpinnings of the market, are moving toward a negative bias. Best advice is to: Beware of bears emerging from their lair.

The markets are topping, but understand a topping action can last for weeks or months. It can take a long time for investors to reduce their holdings as the result of the markets becoming increasingly risky. This is not the time to panic and move to cash; however, it is also prudent to keep an eye on the exits.

This rally has been technically driven, not driven on business fundamentals. This inherently weakens the foundation of the rally.

With a market in a potential negative transformation, equities have become a more risky proposition.  A more conservative bond oriented portfolio would offer some limited gains but without the downside exposure of the equity markets.My firm has taken positions in these exchange-traded funds: iShares Barclays Aggregate Bond (AGG), iShares Barclays 1-3 Year Treasury Bond (SHY) and iShares Barclay TIPS Bond (TIP). Since April 1, the TIPS fund (it stands for Treasury inflation-protected securities) is the best performing of these ETFs.

While these are not exciting positions in a normal market environment, they clearly surpass the gains made in any number of money market funds while the equity markets attempt to find their footing.  At this point we are more interested in preserving assets and recent gains than proving our machismo on the trading floor.We are also considering a position in iShares J.P. Morgan USD Emerging Markets Bond Fund Barclay TIPS Bond (EMB). This seeks to correspond generally to the price and yield performance (before fees and expenses) of the JPMorgan EMBI Global Core Index, which purchases emerging market debt.

The markets are going through an overdue correction. Clearly, the markets have come too far, too fast, off the 2011 lows.  The benchmark Standard & Poor’s 500 index is up 12% for the year and almost 30% since last autumn’s low point. After the correction, we expect investors to buy on the dip and the markets to retest recent highs.  Late April and early May are typically strong months for the markets.We remain conservatively invested because after late May, it becomes statistically relevant that gains are much more difficult to achieve.

George Clausen is president of Clausen Capital Management in Charlotte, N.C.