Wednesday, May 13, 2009

Correction or Reversal?

On Wednesday, the S&P 500 fell 2.7%. That was the largest decline since April 20, the second loss in excess of 2.0% in three days, and the first three day losing streak since the March low. Moreover, 23 of the 24 industry groups were lower. Overall, Wednesday was a 90% down day (both declining stocks and downside volume represented more than 90% of the total for those common stocks that changed price).

In addition to the above – and as anticipated in Tuesday’s post – near term momentum has now recorded a downside reversal for a large majority of the industry groups and the uptrend line from the March low has been violated. In addition, the point and figure bullish percentage (%BP) indicator for the S&P 500, the S&P mid cap, the S&P small cap, the S&P super composite, and the NASDAQ 100 has violated its 10-dma. This is often regarded as a near to medium term “sell signal.” Any one of these signs of weakness could be taken with a grain of salt when viewed in isolation. But, when taken together, they suggest that the March-May rally is in trouble.

All of those problems are mitigated – at least for now – by the fact that support at 880-879 has not been violated and intermediate momentum still has a bullish bias for 22 of the 24 industry groups (although 15 of the 22 are on the overbought side of neutral). So a case can be made that the weakness of recent days is a correction within the rally from the March low rather than a reversal of that rally.

Our concern is that, even if the market does regain its footing and mount another challenge of 930 and higher, the damage of the past three days may have been enough to meet such a rally with important negative divergences. This condition, plus the corrective Elliott Wave structure of the rally, does not bode well for a sustainable rally from current levels. Moreover, the new near term momentum pressures have the potential to remain in place through May, which suggests that the rally from at least the April 21 “line of demarcation” will be reversed. Lower lows, therefore, will increase the odds that this is a reversal.

For now, nearby support remains at 880-879; a violation of that range would effectively confirm that the rally from the April 21 reaction low had been reversed. While a violation of that range would also make us more alert to the possibility that the post-March rally itself was in trouble, we may need to see a breach of 783 to confirm that larger reversal.

Beyond last week’s 929-930 rally high, next chart resistance is our 944 benchmark. Next Fibonacci resistance is the aforementioned 955-956 area.

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