I have writ­ten a fair bit over the past few days about the over­bought level of most global stock mar­kets and also how China — a lead­ing mar­ket on the way up — could be the cat­a­lyst for trig­ger­ing a rever­sal of for­tune. It would seem the expected down­ward cor­rec­tion is now squarely under way with the MSCI World Index down by 3.4% and the MSCI Emerg­ing Mar­kets Index 5.2% lower since their respec­tive highs of August 13 and August 3.

A sum­mary of the move­ments of major global stock mar­kets since the recent highs, as well as var­i­ous other mea­sure­ment peri­ods, is given in the table below. Inter­est­ingly, none of the indices in the table have been able to with­stand the down­draught, with the Chi­nese Shang­hai Com­pos­ite Index (-17.3%) and the Russ­ian Trad­ing Sys­tem Index (-10.0) lead­ing the way down — in not dis­sim­i­lar fash­ion to how these indices blazed a trail to record rally returns of 90.7% and 95.4% respectively.

Click here or on the table below for a larger image.

I have dis­cussed val­u­a­tion lev­els and tech­ni­cal sell sig­nals in my recent posts, but another fac­tor that will come into play is sea­son­al­ity turn­ing neg­a­tive. Focus­ing on the S&P 500 Index and the Dow Jones Indus­trial Index, I have done a short analy­sis of the his­tor­i­cal pat­tern of monthly returns for these indices from 1957 to mid-2009. The results are sum­ma­rized in the graph and table below.

Source: Plexus Asset Man­age­ment (based on data from I-Net Bridge)

If one looks at the aver­age return per month and in which months the most mar­ket declines have occurred, it seems as if the months of June, August and Sep­tem­ber are tra­di­tion­ally bad for stock mar­kets. Although June this year played accord­ing to script, with the S&P 500 show­ing a zero return and the Dow Jones declin­ing by 0.6%, July excelled with 7.4%/8.6% gains. Given the over­bought level of mar­kets, it is con­ceiv­able that the “bad” months of August and Sep­tem­ber might con­form to the his­tor­i­cal pat­tern. Sep­tem­ber, specif­i­cally, has over time been the month with the low­est aver­age monthly return.

The much-needed cor­rec­tion of the sum­mer rally could take the form of either a pull­back or a con­sol­i­da­tion (i.e. rang­ing). I sus­pect we may see at least some degree of rever­sion to the 200-day mov­ing aver­ages in a num­ber of instances, but will be watch­ing closely to ascer­tain whether we are deal­ing with a nor­mal short-term cor­rec­tion or a more sig­nif­i­cant move threat­en­ing the pri­mary trend. In the mean­time, sit tight and be cau­tious as mar­kets hope­fully realign with the real­ity on the ground.

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Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.

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