Expect 5%-8% Pullback Before This Decline is Over

Wise investors will wait to buy their favorite growth stocks at bargain-basement prices

By Sam Collins, InvestorPlace Chief Technical Analyst 

New York, Feb.26, stock investing .- On Monday, the key stock market indices fell due to a broad range of economic and political events around the globe. In Italy, parliamentary elections produced no clear winner, and interest rates there rose sharply. China’s HSBC manufacturing index fell short of analysts’ estimates. And in this country, there appeared to be little progress in bringing the two major parties together to avoid sequestration at the end of the week.

At the close, the Dow Jones Industrial Average was off 216 points at 13,484, the S&P 500 fell 28 points to 1,488, and the Nasdaq lost 46 points at 3,116. The NYSE traded 819 million shares and the Nasdaq crossed 476 million. Decliners outpaced advancers on the Big Board by over 3-to-1, and on the Nasdaq, decliners were ahead by 4.4-to-1. 

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Monday’s 35% rise in the CBOE Volatility Index (VIX) is one of the biggest one-day jumps for the fear index in recent memory. 

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There is no reason to magnify Monday’s trading bar on the Dow industrials’ chart to show a bearish key reversal day (KRD) as I did for the S&P 500. Not only did the Dow Jones Industrial Average execute a KRD, but the Dow Jones Utility Average did, as well. And the Dow Jones Transportation Average executed a simple reversal, lacking the requirement to open higher than the intraday high of the previous bar.

Conclusion: The stock market has reversed from its recent highs and the chances are strong that the major indices will have a correction of 5%-8%. Please refer to Monday’s Daily Market Outlook forsupport levels on the S&P 500 and to Friday’s for the Nasdaq’s support lines. 

The markets, through a series of negative formations, breadth, volume and internal indicators, have been warning us for over a week that stocks were overpriced. Then, last week, volatility shot up 25% in two days (Wednesday and Thursday) and downside volume increased. On Wednesday, the Dow flashed a KRD, and on Friday, the S&P 500 followed suit. And yet most technicians ignored the reversals with one TV maven even saying that the KRDs are “meaningless.” Perhaps what they meant to say was that KRDs are no sure indicator of a major market top, but this indicator is most accurate in predicting a correction of over 5%. 

Can stocks recoup their losses? The market is being held hostage to the headlines, and so if the Italians get their act together, and if the Americans can settle on a plan to avoid another financial plunge, and if China or North Korea or somebody else doesn’t create havoc for the world, yes the market can turn around. And, Bernanke is speaking today and will, no doubt, attempt to calm the waters.

But, for now, wise investors will not just hope for a turn, but plan and wait to buy some of their favorite growth stocks at bargain-basement prices. ...