FRIDAY'S STOCK PLUNGE WIPES OUT THURSDAY BOUNCE -- SEVERAL GROUPS HAVE COMPLETED DOUBLE TOPS -- AN IMPORTANT BREADTH INDICATOR WEAKENS -- WEEKLY CHART SHOWS S&P 500 UP STALLING NEAR MAJOR RESIS TANCE -- S&P 500 ENDS WEEK BELOW 50-DAY AVERAGE

NO FRIDAY FOLLOW-THROUGH... Heading into Thursday, we had been warning about a downside correction in stocks and commodities (partially owing to a rebound in the oversold dollar). Thursday's stock rally muddied the water a bit. Friday's sharp price drop, however, erased all of the Thursday's price gains and more. That put us back where we were at the start of the week, which was trying to measure the extent of a stock decline. Part of our caution has come from "double top" breakdowns in several stock groups which we've shown before. Four of them shown here are the Bank Index (Chart 1), the Russell Small Cap Index (Chart 2), the Semiconductor Index (Chart 3), and the Dow Transports (Chart 4). We've also warned of a downturn in housing and real estate stocks (Charts 5 and 6). By week's end, most major stock indexes had broken their 50-day moving averages and were bearing down on their early October low. Several of our long-term indicators have warned of an over-extended market in need of a correction. Let's take another look at one of them.

Chart 1

Chart 2

Chart 3

Chart 4

Chart 5

Chart 6

% NYSE STOCKS ABOVE 200 MA IS DROPPING... I recently warned that the % NYSE stocks above their 50-day averages was in overbought territory over 90% and starting to weaken. Arthur Hill showed that indicator plunging to 40% this week in a sure sign of short-term breadth deterioration. The black line in Chart 7 plots the % NYSE stocks trading over their 200-day average which is a better measure of the market's long-term trend. The green line is the NYSE Composite Index. You can see the black line leading the NYSE Index lower from early 2007 to early 2009 and higher since this spring. Readings below 20% are oversold and readings over 80% overbought. The recent reading over 90% was the highest level in five years and warned of an extremely over-extended market. That becomes more dangerous when the black line actually starts dropping. Chart 8 shows that happening. Since mid-September, the NYA200R has fallen to the lowest level in two months (plotted through Thursday). It has also fallen below its 50-day average (blue line) for the first time since March. Arthur Hill has also pointed out signs of deterioration in several other breadth measures. All of which suggests the likely start of a market correction.

Chart 7

Chart 8

S&P 500 STALLS BELOW 1100... It's important to remember where this likely correction is starting from and to keep an eye on long-term weekly charts. I recently showed an earlier version of Chart 9 which plots the S&P 500 stalling just below a two year down trendline just above 1100 and just shy of a fifty percent retracement of its 2007/2009 bear market. I suggested that profit-taking was likely in that area. [The same goes for 10,000 in the Dow and 2200 in the Nasdaq Composite]. The 14-week RSI line (top of chart) is starting to weaken near overbought territory at 70. More ominously, the weekly MACD lines (below chart) are very close to turning negative for the first time since March. None of this bodes well for the market's short-term trend which appears to be weakening.

Chart 9

S&P 500 SUPPORT LEVELS... The biggest correction during the rally from March to October (which occurred during June and July) was 7% (using closing prices). A similar decline would push the S&P 500 down to 1020 which coincides with the early October intra-day low. That also corresponds roughly with a 38% retracement of the July/October rally. That's the first downside target and the first test of underlying support. If the October low is broken (which I believe is likely), a 10% correction would bring the SPX down to the next level of support near its early September low (near 990) which also happens to be a 50% retracement of its July/October advance. The worst (and least likely scenario) would be a 62% retracement to its July peak near 950. If the current pullback is a normal intermediate correction (and nothing more), prices have to remain above that summer high. Any drop below that level would have much more bearish implications. Chart 10 shows the S&P 500 closing below its 50-day moving average for the first time since July. That turns its short-term trend lower. A close below the early October low would turn the intermediate trend down and signal a deeper correction. All of which suggests a more defensive strategy untll the market reaches more substantial chart support and shows signs that the correction has ended.

Chart 10

VIX ACHIEVES BULLISH BREAKOUT... Another warning sign of weakness in stocks is today's impressive upside breakout in the CBOE Volatility (VIX) Index. Chart 11 shows the VIX smashing through its autumn highs. A rising VIX is normally associated with falling stock prices. Today's bullish breakout in the VIX is the most impressive since it peaked in March. Chart 12 puts today's VIX breakout in better perspective. It also shows that the March peak in the VIX coincided with a stock bottom. That's because a falling VIX is bullish for stocks. Unfortunately, a rising VIX isn't.

Chart 11

Chart 12