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How to Play a Stock-Market Correction


Caution is warranted -- but watch for stocks that are priced to buy.

Stock markets might just have finished a particularly strong quarter -- with the S&P 500 Index gaining 15.2% for its best quarter since 1998, the MSCI World Index rising by 19.7%, and the MSCI Emerging Markets Index adding 33.6% -- but they started to look tired last month. And July is also off to a shaky start.

Volume has been declining on rally days and expanding on declining days -- which can be construed as bearish action. On July 2, Lowry's Buying Power Index closed one point below where the Index was at the March 9 stock market lows -- i.e. Buying Power is now weaker than it was at the early March bottom.

As doubts persist over the strength of the global economic rebound, the S&P 500 Index, MSCI World Index and MSCI Emerging Markets Index have dropped by 5.0%, 5.9%, and 6.3% respectively from their June highs.

Regarding the US markets, an excellent contrary indicator worth keeping an eye on is the CBOE Volatility (VIX) Index. The Index peaked at 52.7% in early March, coinciding with the rally lows, and has since declined by more than half. However, the Index seems to be bouncing off a support line while the Commodity Channel Index (CCI) -- a momentum-type oscillator -- has turned up from an oversold level for the first time since last May. This would indicate the end of the stock-market rally.

Considering the percentage of global stock markets trading above their 50- and 200-day DMAs makes for interesting analysis. Most countries (89%) are trading above the 200-day average -- an indicator of a bullish primary trend.

As far as the secondary trend is concerned, 55% of the countries are still trading above the 50-day average, having corrected from an overbought level of 100% a few weeks ago. One would typically expect this measure to decline to lower levels in order to more fully correct the massive spring rally.
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