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Stock Markets Running from Reality?


The latest market correction could be more than a "false alarm."


The predictions of the members of the Barron's mid-year Roundtable discussion over the weekend were in agreement that the March lows of the stock market wouldn't be broken. This reminded me of one of the famous "Investment Rules" of Bob Farrell, legendary former chief stock-market analyst at Merrill Lynch. Rule number-9 stated: "When all the experts and forecasts agree, something else is going to happen."

Meanwhile, many stock markets yesterday registered their worst single-session percentage losses in a month. Commodities also faced heavy profit-taking, but government bonds rallied and the US dollar strengthened against a basket of currencies. "We could be seeing one of those occasional all-change signals in short-term trends," said David Fuller (Fullermoney).

Richard Russell, veteran writer of the daily Dow Theory Letters, commented on Monday:

"I'm of the opinion that this bear market rally is in the process of topping out. When a counte-trend rally tops out within an ongoing primary bear market, the odds are that the stock market will break to new lows during the period ahead. That means that the stock market will break below its March 9 lows in coming weeks. A violation of the March 9 lows would be a shocker to most investors, and it would be a forecast of an even worse economy coming up."

As mentioned on Sunday, the S&P 500 had recently been mapping out a trading range between 925 and 950 as shown in the chart below. Yesterday's close of 924 took the Index below the bottom of the range. As stock markets have started to show exhaustion (also seen from the low volume characterizing the last few days' increases), the odds are that this could be more than a "false alarm."

An analysis of the moving averages of the major US indices shows all the indices still trading above their respective 50-day moving averages, but the Dow Jones Industrial Index has again fallen below the key 200-day line, rejoining the Dow Jones Transport Index. With the exception of the NASDAQ Composite Index, all the indices are below the early January peaks. Importantly, the levels from where the rally commenced on March 9 should hold in order for base formations to remain in force.

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