BROKEN SUPPORTS TURN FIRST RESISTANCE -- NY COMPOSITE HITS FIBONACCI RETRACEMENT -- NON-CONFIRMATION PRECEDED DOW THEORY SELL SIGNAL -- S&P 500 CORRECTS AFTER THE 5TH OF THE 5TH -- BEARISH SCENARIO SHOWS S&P 500 ENTERING 3 OF III

BROKEN SUPPORTS TURN FIRST RESISTANCE... Link for todays video. Fridays employment report provided a little good news on the labor market, but stocks still struggled with sharp losses in early trading on Friday. The major index ETFs are quite oversold, but showing no signs of support or firmness that could give way to an oversold bounce. Some of the weaker index ETFs are entering retracement zones that may provide support for an oversold bounce. Chart 1 shows the S&P MidCap 400 SPDR (MDY) breaking support with a 15 percent decline the last two weeks. The ETF is entering the 50-61.80% retracement zone. Should such a bounce materialize, broken support the 167 are would turn into the first resistance zone. The indicator window shows the MDY:SPY ratio breaking down as well. Mid-caps have been and remain relatively weak.

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Chart 1

NY COMPOSITE HITS FIBONACCI RETRACEMENT... I first featured the NY Composite with its Head-and-Shoulders pattern on Wednesday, July 27th. Even though I laid out the potential downside targets, I did not think they would be reached so quickly. Chart 2 shows the index breaking support and reaching the 61.80% retracement mark on Thursday. There is also support here from the October-November lows. Oversold conditions are also present as RSI(14) moved below 30 to become oversold for the first time since May 2010. The pieces are in place for an oversold bounce, but selling pressure refuses to let up. Should an oversold bounce take hold in the next week or two, I would mark first resistance at broken support around 7900. This area also marks a 50% retracement of the current decline.

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Chart 2

NON-CONFIRMATION PRECEDED DOW THEORY SELL SIGNAL... Based on the writings of Charles Dow, the Dow Theory uses the Dow Industrials and Dow Transports to generate buy and sell signals for the broader market. Dow chose these two Averages because of their relationship to the economy. Industrial companies are at the heart of the economy because they produce goods for consumption and industry. Transports are the backbone of the economy because they move goods for consumption and industry. The more goods produced, the more movement needed. Dow theorized that these two Averages can be used to determine the underlying trend for stocks. The big trend is up when both forge higher highs. The big trend is down when both forge lower lows. A non-confirmation is present when only one forges a higher high or lower low.

Chart 3 shows the Dow Industrials within a clear uptrend from late August to early May. This uptrend started to falter when the Average failed to exceed its prior high and formed a lower high in July. A clear trend reversal occurred this week as the Average broke below its June low.

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Chart 3

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Chart 4

Chart 4 shows the Dow Transports with an uptrend from August until early July. Notice the difference? The Dow Transports exceeded its May high to forge a higher high in July. The Dow Industrials failed to confirm this new high in the Dow Transports. A non-confirmation is simply a warning sign. The Dow Theory sell signal did not materialize until both Averages broke below their June lows. How long will this sell signal remain in effect? Until there is a Dow Theory buy signal with higher highs in both Averages. There is no timeframe for these signals. They are simply in force until proven otherwise.

S&P 500 CORRECTS AFTER THE FIFTH OF THE FIFTH... The last posted Elliott Wave count (June 13th) argued that the S&P 500 was in the infamous fifth (5) of the fifth (V) and that an abc correction was unfolding. While this scenario is still possible, the depth of the most recent decline could signal the start of a bigger decline, which would be a 5 wave impulsive sequence. First, lets review the chart posted on June 13th. Chart 5 shows the S&P 500 as a 5-day EMA to smooth out the fluctuations, which makes it easier for wave counts. There is a five wave advance (I to V) from March 2009 until May 2011 (26 months). The fifth wave (V) subdivides into 5 waves (1 to 5). Also notice that the fifth wave (V) is the shortest in percentage terms. After a 33.35% advance from the July 2010 low, a correction is certainly in order. In Elliott terms, corrections usually take place in three waves as zigzags or flats. This means an ABC decline from current levels would be corrective. A five wave decline from the May high would suggest that a new, and bearish, impulse sequence has started.

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Chart 5

BEARISH SCENARIO SHOWS S&P 500 ENTERING 3 OF III... There is also an alternative count that is very bearish. In Elliott Wave theory, wave 3 of III is the most dynamic of all waves. Moreover, there is even a case to be made that the S&P 500 is currently embarking on wave 3 of III down. Chart 6 shows the S&P 500 making a low in March 2009 that constitutes wave I down. Wave II up just completed as a huge ABC correction. Corrections usually form three waves and ABC zigzags subdivide into a 5-3-5 sequence. Waves A and C are impulsive because they are in the direction of the wave to one higher degree, which is wave II. Wave B is the corrective wave and it subdivides into three waves.

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Chart 6

With this ABC correction complete, a new five wave sequence would now be expected (1 to 5). Note that this sequence is also part of the bigger wave III. Wave 1 bottomed in late June. Wave 2 peaked in July. Wave 3 is currently underway. This means we are in wave 3 of III. Should this count materialize, wave III is projected below the March 2009 low. In short, it would be Armageddon. While I personally do not subscribe to this count, I readily admit that the current trend is down and the weight of the evidence is bearish. After the 1200 area, the next big support zone resides around 1050 from the 2010 lows. I will stick with Dow Theory and adhere to the current downtrend until it is proven otherwise.