By Ellis Mnyandu - Analysis
NEW YORK (Reuters) - The technical picture of the U.S. stock market is deteriorating fast, putting Wall Street on course to test its March lows in the coming days and it could fall even further.
Central to the technical breakdown, chartists say, is the upheaval in the financial sector, where losses stemming from the mortgage crisis are mounting and the profit outlook is becoming bleaker every day, spreading gloom about the economy.
Last month financials were displaced by technology as the broader market's leadership, a development last seen in early 2002.
With financials in a bear market and U.S. inflation concerns rising amid anemic economic growth, technicians said there was very little chance the market would move higher without a recovery in bank stocks.
The damage was evident on Friday when major indexes broke key technical support levels. The Dow Jones industrial average .DJI gave up all its gains seen since the broader market's March 17 low of 1,256 in the S&P 500 .SPX.
"I think we are at a near-term inflection point," said John Kosar, market technician and president of Asbury Research in Chicago. "If there's any more bleeding from here I think that will point to a re-test of the first-quarter lows and maybe a breakdown through those lows in the third quarter."
Technicians are particularly worried about the lag in upside volume seen since mid-May and investor complacency signaled by the 26 percent drop in the Chicago Broad Options Exchange Volatility Index, or VIX .VIX.
Another troubling sign is that New York Stock Exchange shares trading above their 200-day moving average have steadfastly remained under the 50 percent level, a bearish signal.
WALKING ON THIN ICE
Tom Fitzpatrick, market technician at CitiFX Technicals in New York, said the market was "walking on thin ice." He warned in a research note that the indexes could enter a full-blown bear market. During Friday's sell-off it was apparent just how sour the technical picture had turned.
The Standard & Poor's 500 .SPX, which effectively tested its 55-day week moving average four weeks ago, dipped below its 200-day weekly moving average -- a crucial support level -- at 1,318.
The breach put the index's next support at around 1,295, according to Thomson Reuters chart data. After that the sights will be set on the March 17 low of 1,256, a level which if broken could see the index looking for further support at the July 2006 levels around 1,230.
Friday's losses also took the Dow to about 100 points from retesting the low of 11,756 that coincided with the broader market's low of March 17. The Dow's support heading into Friday was around 11,940/30, according to CitiFX.
And with that support base gone, charts put the Dow's next support level firmly at its March 10 low of 11,731. After that charts show 11,634, the January low, as the next crucial support level.
But even with Friday's losses, the Nasdaq showed a somewhat less worrying technical picture. The index is up 8 percent since the market's March low and is above its 200-day weekly moving average. The S&P 500 is now up only 2.5 percent since the March low.
"It's not the declines that bothers me. It's the failed rallies," said Ralph Acampora, a 40-year Wall Street veteran and director of technical studies at the New York Institute of Finance in New York.
"You have to see a broad-based advance, you have to see a shift in leadership, and none of that has been in place since mid-May. We lost it. The only thing that shows any kind of strength are commodity-related plays and that's not the leadership this market needs. We need the consumer, financials, health care and industrials. That's just not there."
At best, the testing of the March lows will subsequently help spur bounce as value investors see the market as likely oversold then, said Acampora. But if the bounce fails, some fear that there the broader could find itself in flirting with the onset of a full-blown bear market.
(Editing by Leslie Adler)
