Danger: Further Breakdown Ahead

The S&P 500 fell again yesterday, its sixth decline in a row, and the worst losing streak in over two years. But volume on the NYSE totaled just 1 billion shares, and decliners exceeded advancers by a mere 3-to-1 — hardly selling climax extremes. Now investors are asking, “How low is low?”

With the path of least resistance down for both the near and intermediate term, we turn again to the S&P 500’s daily chart. The most significant support is still at the 1,250–1,260 double black line. Adding significance to this zone is the uptrending 200-day moving average (solid red line), which intersects at 1,252 and the low of March at 1,249. Also note that the Relative Strength Index (RSI)red line at the bottom of the chart is approaching the lower channel of a pattern that began in November, and this should provide support. But will it?

Focusing on individual sectors shows that the decline is very broad. Note that the Semiconductor HOLDRs (AMEX: SMH) chart shares many similarities with the stocks of the S&P 500. Yesterday began a test of the April low at $33.50 with the next support at the March low. Note, too, the similarity of the downward channel of its RSI with that of the S&P 500.

And even completely unrelated industries are following similar patterns. The Market Vectors Gold Miners ETF (NYSE: GDX) chart shows a major support band is currently being tested. Yesterday’s close at $53.43 fell at the lower range of that band. A close under $52.50 could put more pressure on this group and confirm the validity of a double-top and a possible sell-off to the mid-$40s.

Conclusion: Stocks are deeply oversold, and there is a strong possibility of a relief rally. However, the intermediate direction of the market has turned bearish. Moreover, the broad-based nature of the decline is reminiscent of a buildup of negative sentiment that could overwhelm buyers as margin calls force further liquidations. The stock market is in danger of breaking down. Defensive action is warranted and rallies should be used as opportunities to lighten up on equities. Traders should revert to the short-selling strategies.

There is a strong possibility of a relief rally, but stocks are likely to continue their decline