In the market update for the week ending September 19 we discussed the big IPO, biggest ever, and the euphoria that ensued. We mentioned that history has not been too kind to that sort of glee. Thursday morning on the CNBC show Fast Money, Melissa Lee asked if it was a coincidence that the S&P 500 made an all-time high on the same day that the IPO started trading, with the implication being to wonder whether markets were in for some sort of large decline.

In terms of possibilities versus probabilities, it would be an amazing coincidence for the high for this cycle to actually be on the day of the IPO, but stock market history suggests that things like the biggest IPO ever occur toward the end of the cycle, and the probability that markets are within a few months of the high for the cycle is pretty good.

That IPO is not an isolated warning sign. For months we’ve been talking about the divergence between large caps (outperforming) and small caps. What is interesting is that more and more people are talking about this yet it continues to persist. Actually it’s getting worse.

Market breadth has also deteriorated. Barron’s cited stats in several spots last week about the average stock in various indexes being down even though the index itself is up, a function of market cap weighting where late in the cycle it is the largest stocks that have historically been the last to rollover.

These indicators are consistent with how the bull market ended in 2000 less so than in 2007.

Things that are missing from the bear argument right now include an inverted yield curve and a gross distortion in the sector weightings of the S&P 500.

Whenever the next large decline occurs, I think people will look back at the huge IPO, the divergences that exist and the narrowing leadership and realize in hindsight that a large decline was coming.

The point here is not to make a guess about when to take defensive action but instead to begin to figure out what steps you would take to protect your portfolio, if you would take any steps, and stick to whatever strategy you may have laid out for yourself. My preference is to rely on the 200 day moving average which I have written about hundreds of times.

You may not want to do a whole lot of selling for several reasons including taxes (depending on the account type), transaction costs and the possibility of being wrong. Here, my preference has always been a little bit of selling combined with some exposure to several types of diversifiers (strategies or asset classes that tend to have a low correlation to equities).

It’s always a good time to consider rebalancing trades. Consider the following chart;

Chart from Google Finance

The blue line tracks a stock I follow (the name doesn’t matter for this post) compared to the S&P 500 Index. If you are a long term investor and you use individual stocks you have at least a couple of stocks that have dramatically outperformed the index one way or another over some long period of time.

Obviously this stock has tracked the index with some periods of decent outperformance here and there before blowing up (in a good way) over the last 15 months. The stock you own that has done something similar was bought with some sort of target weight in mind and every once in a while it grows away from that target. Again, if you own individual stocks and hold long term you have some of these, and now might be a good time to reduce those positions. This would also be an easy way to add a defensive tweak without turning the portfolio inside out. Also, this sort of pruning is not a guess about market direction. If you bought this stock with a 4% target weight, it is clearly not 4% anymore. I am unlikely to want to prune a position that has grown to 3.5% from a 3% target but a move as huge as the one on the chart probably is worth pruning.

Yes, this is an elemental concept, but how often do investors stray from the basics? Yeah, pretty often.