The bull market run by ASX shares could face its first major hurdle in the next few months, according to a leading broker.
The warning comes as the S&P/ASX 200 Index (ASX: XJO) chalked up a 12% gain since the start of 2021.
Experts are worried that ASX share valuations are looking overstretched and are primed for a painful correction.
Canary in the ASX coalmine
But picking the top of the market is a very difficult exercise, although Macquarie Group Ltd (ASX: MQG) reckons it's uncovered a good metric to watch.
The broker highlighted something called the "OECD diffusion index". The index measures the ratio of countries with accelerating economies versus those with decelerating growth.
Macquarie believes this index is a reliable early warning indicator for equities and reported on it last month.
Correction in shares could be around the corner
"At the time there were slightly more countries with accelerating economies, but now the balance has shifted with the majority decelerating. As a result, a downturn, or 'mid-cycle slowdown' is our base case for 2022," said the broker.
"Based on the average of past cycles where the diffusion index led (it was 1 month late in 2000), the next downturn could start in February 2022."
"If more recent cycles are the guide, the timing could be closer to May 2022, just as seasonality weakens."
How much could ASX shares lose in the downturn?
If Macquarie is right, the downturn could be painful for ASX shares. History has shown that when the index turned negative, the share markets lost an average of 15% in the months after.
"If you exclude 2004/05, which is the only example in the last 8 cycles where there was no material correction due to the commodity boom, the average correction is 20%," added the broker.
But it isn't all bad news. Low bond yields could provide a cushion for the fall and there are some stocks that outperform in a downturn.
ASX shares that can outperform in the sell-off
These tend to be defensive shares, safe haven options, and quality shares that trade at a premium to the market. These include gold, healthcare, technology, telco, utilities, staples, and insurance.
ASX healthcare shares that Macquarie is recommending as a 'buy' include the Ramsay Health Care Limited Fully Paid Ord. Shrs (ASX: RHC), Healius Ltd (ASX: HLS), and Cochlear Limited (ASX: COH).
Other defensive shares on the broker's buy list include the Coles Group Ltd (ASX: COL) and Amcor CDI (ASX: AMC) – just to name a few.
On the flip side, the losers in a market downturn are banks shares, media shares, diversified financials and capital goods.
