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Courtesy of Gluskin Sheff:

The equity market is technically oversold right now and is due for a near-term bounce, but that would be a rally that I would fade if we see it.  There has been too much of a rupture to ignore with the S&P 500, Dow and Nasdaq all closing below their 200-day moving averages (fist time in almost a year for the Nasdaq). There were only 11 new highs yesterday and 212 new lows, so this ratio is still quite bleak.  Decliners/advancers were also 11-to-1 on the major exchanges. This is what I mean by rupture.

On average, corrections that take place after such a massive move up from a depressed low is 20%, which would mean that we could expect to see the S&P 500 still test the 970 level; with a prospect of a second-order Fibonacci retracement implying a move below 950.  Remember that before the last big leg up in the market last summer, the S&P 500 was hovering around the 920 level, which is my target to begin getting interested again.

A 10% correction, even in a bull market, is pretty normal, and historically has occurred about every 12 months — and tends to occur more in the second year of a rebound, or bull market, than in year-one.  So the European debt crisis is certainly the catalyst for this renewed round of risk aversion, but is not out of line with market patterns over the past century.

Two critical data points to watch for — the May 6 flash-crash intraday low of 1,065 on the S&P 500, followed by the 1,044.5 low on February 5.  If these don’t hold, and the bulls need these levels to hold, then another leg down to or through the 950-970 levels is likely.

To turn bullish, we would need to see Libor-OIS spreads begin to narrow again, corporate spreads tighten, and stability in the euro.  That would be important signals from the other asset classes.  Technically, it would be encouraging to see two big up-days in the stock market with large volume — we need a follow-through with huge participation.  It would also help if market sentiments swung towards the bearish camp — believe it or not, the most recent Investors Intelligence survey has the bulls at 43.8% and the bears at 24.7%.  At the lows, we would expect these numbers to be reversed.

The fly-in-the-ointment is that unlike 1987 or 1998, this is not just a financial crisis but one that is occurring with the global economy in a post-bubble fragile state — if it is a recovery, it is a nascent recovery.  And, already we see that the U.S. leading economic indicator fell in April, which is unusual at this early stage of the cycle, and jobless claims heading back above 470k, if sustained, is worrisome because in the past this has coincided with job losses fully 75% of the time.  By the time the jobless recoveries were over and done with in 2003 and 1993, claims had already moved down to 400k in the former and 350k in the latter.  And, practically every house price measure in the U.S.A. is rolling over right now.  The lesson of 2002 is that market priced for perfection does not even need a classic double-dip to falter — a simple growth relapse will do the trick.

Good stuff as usual.

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