Last weekend the S&P was testing support at 2,040 and I called it a critical support test. Over the last five days, the S&P rallied to 2,084 and then fell back to close at 2,046 and right back at critical support once again.

The index failed exactly where it should have failed at the convergence of downtrend and horizontal resistance at 2,085. The return to the support at 2,040 for the fourth time is not a good sign. We have a series of lower highs and lower lows and to complete the scenario the S&P should break below 2,040 to another lower low. Only this time a failure of that support level should lead to significantly lower lows.

The next material support is 2,000, which is also psychological support, followed by 1,975. Below that level, we enter into a congestion range from about 1850-1950 and no clearly defined support point.

The support at 2,040 is so clearly defined that a breakdown should attract a lot of technical selling. There are plenty of bulls holding positions with their fingers crossed that 2,040 holds and a break there should cause them to hit the sell button.

One obstacle to a continued rally is the dollar. Last week the decline in the dollar to a 15-month low reversed and that is negative for the S&P. It is also negative for commodities like oil but the global supply outages and the first major decline in inventories for the summer demand season helped to lift oil prices despite the spike in the dollar. If the dollar rolls over as it did on the last four rebounds this year and then finds a lower low that would be market positive and could overcome the normal selling into the summer doldrums.

The Dow closed at an 8-week low and exactly on critical support just like the S&P. If the Dow drops below the 17,500 mark it may find some weak support at 17,400 but I doubt it will hold. A break of support targets 16,820 but I am going to round it to 16,800. That could be a fairly straightforward decline because there is no material support in its path until that level.

The next stop if the decline continues could be 16,500 and then 16,000 and 15,500. Those levels are easy to spot. The key here is the initial support break. That should poison sentiment and the decline could accelerate quickly.

The Dow Jones Composite Index tracks all the stocks in the Dow Industrials, Dow Transports and Dow Utilities. There are 65 stocks in all and it is thought to be more representative of the broader market than just the Dow industrials. The composite index has already broken the corresponding support at 6,160 and could begin to free fall at any time. The utility stocks have been holding it up as investors hunt for dividend yield in a troubled market.

The Dow Transports have already broken strong support at 7,600 and closed at weak support at 7,500 on Friday. With oil rising and the U.S. economy still weak, the transports are suggesting the Dow will break down and return to the lows. A move under 7,500 could produce some cascade selling on the transports.

The Nasdaq closed on short term support at 4,700 and given the weakness in the big cap techs a breakdown here is almost guaranteed. With Netflix, Apple and all the Apple suppliers crashing, the index is weak. Only the rebound in the biotech sector on Friday saved the Nasdaq from posting a new 8-week low.

The Biotech Index chart may not look like a rebound but it did gain more than 1% on Friday. On Tuesday there was a 3% gain. These rebounds supported the Nasdaq and kept it from setting a new low but it is not likely to last. The $BTK is headed for support at 2,750-2,800 and possibly 2,600 if the candidates continue to bash the drugs companies.

The Russell 2000 was also supported by the biotech rebound but it still declined to near term support at 1,100. The next level is 1,095 and should provide a speed bump in the downward slide. Critical support is 1,065 and the last stop before a drop to 1,000 or even 950.

The Russell 3000, the largest 3,000 stocks in the market, found critical support at 1,200 but the odds are good it is going to fail. The next material level to test is 1,160. This is a broad market index and it represents the actual health of the market rather than a small sector like industrials, financials or tech stocks. This index is threatening to collapse just like the smaller indexes.

The percentage of S&P stocks over their 50-day average declined from 63% the prior week to 51.8% on Friday. The percentage is dropping rapidly because a large number of S&P stocks are in steep decline. Only the big cap discretionary and biotech stocks are keeping this decline from being worse.

The McClellan Oscillator on the NYSE closed at a three month low on Friday. This is an indicator of overbought/oversold and it is nearing the levels we saw during the market correction in January. While we are not there yet we should be able to tell when it is time to reverse from bearish positions when the $NYMO reaches -80 or worse.

The energy sector appears to be stalling out despite the high oil prices. The rebound has run too far too fast and now that we have reached the summer demand season the crummy earnings have weakened the outlook and stocks are no longer rising for more than a couple days a week. The XLE has strong resistance at $70 and we have not yet reached that level. The energy stocks may not be market supportive unless there is another sudden and unexpected spike in crude to more than $50.

The short-term view is bearish. Once we get into June and the summer doldrums take hold the current market weakness could fade and just turn into choppy trading for the summer as we wait on OPEC, the Fed and the political conventions in late July.

Enter passively and exit aggressively!

Jim Brown

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