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Stocks in Retreat: Pause to Refresh or End of the Rally?

Aaron Task
Editor in Chief
Fin - Daily Ticker - US

The mood on Wall Street has darkened considerably in recent days as the rolling five-week correction appears to be picking up steam. U.S. stocks fell at the open Monday following a 1%-plus selloff overnight in Asia. In early trading, the Dow was down 0.3% to 12,119.

The markets are clearly responding to a string of disappointing economic data, both here and abroad, as well as lingering concerns about consumer deleveraging, toxic debt on bank balance sheets, political paralysis in Washington and historically high P/E ratios. Last week's dismal jobs number has some on Wall Street contemplating the likelihood of QE3...as well as the limited utility of the extraordinary monetary and fiscal stimulus that have already been pumped into the system.

The good news is major averages entered this week only down about 5% from the cycle highs in early May, a sign of the market's resilience to bad news, including the Japanese tsunami, Europe's debt crisis, and geopolitical unrest in the Middle East and North Africa. Performance anxiety is a powerful motivator on Wall Street and many under-invested fund managers have been willing and eager to "buy the dips" after a giddy 2-year rally that defied expectations.

The other good news, for those long, is how quickly the sentiment has shifted to the negative. Bullish sentiment in the Consensus Index, a gauge of professional investors, has fallen to 56% from 65% three weeks ago. Other the other hand, 56% is still relatively high and other sentiment measures, as well as the VIX, suggest continued complacency among many investors.

The bad news is that many investors remain complacent, which means they're still holding on vs. looking to sell and raise cash.

"We have consistently warned investors for several months of the potential for not only elevated stock market volatility but also the increased likelihood of an economic 'soft patch'," writes Brian Belski, Oppenheimer's chief investment strategist. "However, we believe most investors have ignored these signals given their desire and more importantly their need to perform alongside the broader market. As such, we continue to believe that most institutional investors are not prepared for a prolonged period of market weakness should recent economic trends persist in the coming months."

Being down 5% from the highs means major averages have a long way to fall before hitting technical "correction" territory of down 10% from recent highs. Based on its intraday high of 1370, the S&P won't be in a correction unless and until it hits 1233.

In the interim, traders are bracing for a test of the S&P's April low of 1294.70, with the March lows of 1249 being the next important level of support.

In sum, "strength is to be sold [and] weakness is not to be bought… yet," according to newsletter writer Dennis Gartman.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at altask@yahoo.com