Bending, but Not Broken

On Tuesday the S&P 500 suffered its third straight loss – and its biggest in over two weeks – with a decline of 2.2%. Interestingly, the index was higher in the morning, so the resulting “outside day” implies some downside follow through. Moreover, Tuesday was a 9:1 day as both breadth and volume ratios were negative by more than 9:1.

Further weakness in the days ahead would not be surprising. In addition to the outside day, first support (1015-1001) was violated, as was the primary uptrend line from the mid August low from the perspective of the hourly charts on both an arithmetic scale and on a point and figure basis. Moreover, Tuesday’s decline carried the index through a 61.8% retracement of the post-August rally. This combination of Fibonacci and trend violations suggests that the index is positioned to fully test the mid August low at 979. If that test is not successful, then more serious trouble will likely lie ahead.

In Monday’s post we said that a decline through 980-970 would make us nervous because such a decline would violate both the mid August reaction low and the uptrend line from the benchmark March low. To that we would add that a test of the mid August low would also be an approximate 38.2% retrace of the rally from July’s low. Thus, a breach of the 980-970 range would imply further weakness to at least the 954-934 range, which encompasses a 50%-61.8% retracement of the July-August rally. The July low itself at 869 is still viewed as tactical support.

NYSE Bullish Percentage (top) and S&P 500

That said, we have consistently maintained that the rally from the March low is a bear market rally. So when the trend line from that low comes under pressure (especially if that pressure is derived from a five-wave decline), the potential exists for a return to the March low. However, we don’t think that recent weakness is the beginning of a full retrace to 666. The 22-week and nine-month cycles are still nominally bullish, sentiment shows a decent degree of skepticism, and a number of intermediate indicators do not have the negative divergences that often accompany a top. Thus, our inclination is to treat any additional weakness as a correction within, but not a reversal of, the post-March bear market rally pattern.

For quite a while we used 1007-1048 as an area of important chart and Fibonacci resistance. We subsequently adjusted first resistance to 1037-1058, with 1070-1081, and 1117-1127 viewed as second and third resistance, respectively. Those remain important levels, but we are putting them on the back of the stove. In the days ahead, we will use 1015-1040 as our front burner focal point.