Another Shoe to Drop?

Tuesday was a good day. After Monday’s sharp decline, the S&P recovered with a 2.1% rally, which was its best performance in over two weeks. Twenty of the 24 industry groups within the S&P were higher.

On Monday is was Bank of America’s earnings that put pressure on the group; on Tuesday it was Treasury Secretary Geithner saying that banks had “options.” There always has to be a “reason,” or else nobody would buy newspapers. (Oops, nobody is buying papers!)

The bottom line from our perspective is that the post-March rally was probably overdue for a correction (a six week winning streak is not common). Moreover, the rally pattern was clearly corrective, suggesting that a reaction could be sharp. So, in the end, we are hard pressed to believe that the correction will only be a two-day wonder. Probabilities suggest that lower reaction lows are likely. The pullback of the past two days is a 23.6% retrace of the late March-April rally – but we typically expect a minimum 38.2% retracement. Near term momentum, which has been weak since late March, has the potential to remain under pressure into the early days of May. The 10-day CBOE put/call ratio is still more overbought than not. Finally the decline from the highs has an impulsive (trending) look to it, while Tuesday’s recovery has an initial corrective (counter-trend) look.

All of this suggests that the correction from Friday’s high has more life left in it. Thus, while today’s (Tuesday) rally may experience some follow-though, probabilities suggest it will be followed by renewed weakness to lower reaction lows.

Our Elliott Wave opinion is unchanged. We still believe that the April-May rally was the first leg of a larger rally pattern. Thus, the decline of recent days should prove to be an interruption to the larger, unfinished bear market rally pattern.

Nearby chart and Fibonacci support is in the 796-771 range. However, from a P&F perspective, important intervening chart and trend support exists at 828-825. First resistance is 851-857, then 861 and above.