Wall St's rout seen as onset of correction

NEW YORK (Reuters) - The sharp slide in U.S. stocks this week portends more trouble for Wall Street in the days ahead as investors worry if the recent rally is sustainable.

With major indexes breaching key technical support levels on Wednesday, market technicians said Wall Street was likely to see the onset of a long-anticipated correction following a 70 percent run-up in the benchmark S&P 500 from March 2009.

"This is the beginning of a correction. It's been brewing for months," said John Kosar, market technician and president of Asbury Research in Chicago. "There's more risk on the downside than opportunity on the upside here until we get a correction."

Besides grappling with a deteriorating technical picture, Wall Street is also starting the new year with an even less reassuring fundamental picture as the Obama administration pushes to limit banks' risk-taking.

Additionally, there are concerns that China, the world's third-largest economy, risks derailing the nascent global economic recovery by tightening lending too soon to prevent its economy from overheating.

Disappointing 2010 corporate outlooks have added to the negative tone, eclipsing far rosier fourth-quarter earnings thus far.

According to Kosar, the latest downdraft could potentially drive the S&P 500 to 1,100-1,084, a level which should potentially spur new buying. But if the buying failed to materialize, the index could then head down 10 percent or more from the recent high.

"The market is overextended by almost every metric that we look at, which makes it vulnerable to some kind of a pullback, and more than one that will last two days," added Kosar.

Sector leadership has also become an issue as both financials and technology shares falter after underpinning the recent rally. As is traditionally the case, investors tend to get off the fastest horses first when the going gets tough.

Bellwether International Business Machines Corp is a case in point. Despite beating analysts' profit forecasts, IBM shares were pummeled.

Intel Corp's upbeat 2010 gross margin forecast of last week provided little comfort, and investors sent the chipmaker's stock down.

So without leadership, analysts see the stock market more vulnerable, particularly with the pace of earnings announcements set to go into high gear in the coming weeks and the risk of disappointments set to rise.

"I have been picking up negative divergences for the last month and half in breadth, in volume, leadership and rotation," said John Schlitz, chief market technician at Instinet in New York. "The stocks that took us to new highs last week were the garbage stocks when all the other stuff was starting to fade."

The developments that underscored the precariousness of the stock market's technical picture on Wednesday included a surge back above 20 in the CBOE Volatility index, Wall Street's gauge of sentiment.

Just last week the VIX had traded as lows as 16.86 -- a 19-month low -- spurring some concern that bullish sentiment may have gone to one extreme.

But even more alarming, the Dow Jones industrial average finished Wednesday below its 50-day moving average for the first time since October when the stock market made an abortive attempt to correct.

To be sure, nearly every apparent correction since July has proven to be short-lived, with buyers quickly coming in to bid beaten-down shares higher. This time, though, could it be any different? Bulls will certainly hope so.

"Everybody wants to know if this is the start of the long overdue 10 percent correction. What I am saying is I don't have enough evidence to say that yet. Right now we've broken out of a very minor two-week top," said Schlitz at Instinet.

Both the Dow and the S&P 500 have lost 3 percent since Wednesday, backing off from their 15-month closing highs of the day before.

(Editing by Kenneth Barry)