Long-awaited correction confronts Wall Street

By Ellis Mnyandu - Analysis

NEW YORK (Reuters) - Wall Street's spring surge looks to be wilting in the heat, judging by the emergence of bearish chart patterns, anemic trading volumes and rising volatility.

For two months U.S. equities have defied expectations for a correction, but charts show that major averages are finally on the cusp of their first significant pullback since the start of the March rally due to worries about economic growth.

"This is a start of a correction," said John Kosar, market technician and president of Asbury Research in Chicago.

"The market has decided that for now the October 2007 cyclical downtrend is still in play. It doesn't mean we have to go back under the lows, although that is possible."

Analysts do not expect the benchmark S&P 500 to breach its 12-year closing low of 676.53 reached in March, but chart patterns suggest that in the next several weeks the broader market could pull back to at least April levels.

The S&P 500 has shed more than 7 percent from its recent recovery peak of early June, as it jumped nearly 40 percent from the low hit on March 9.

More alarming, according to some chartists, is the index's failure to break through its recent narrow range, leading to the emergence of a "head and shoulders" pattern -- a bearish technical signal.

The "head and shoulders" pattern is formed by an initial price peak followed by a higher second peak, and finally a third peak that falls in line with the first one.

The theory suggests that a break below the so-called "neckline" of the pattern is a bearish signal and the downside price target should be equal to the distance between the head peak and the neckline.

By that measure, the S&P 500 could fall to 827, or about 6 percent from current levels, according to an analysis by market research firm Bespoke Investment Group. On Wednesday the S&P 500 hit an intraday low of 869.32, and is now up about 30 percent from the March 9 low.

Volatility has risen, judging by the Chicago Board Options Exchange Volatility index, or the VIX, Wall Street's favorite gauge of investor anxiety. The VIX hit 33.05 Wednesday, its highest level since late May as options players took out insurance against larger swings in the market.

SPRING CELEBRATION, SUMMER DOLDRUMS

After the market charged hard through March and April, May and June were dominated by sideways trading that kept the market in a narrow range as investors searched for fresh evidence to support optimism about an economic recovery.

Volume and market breadth also started to fray, and as those supportive elements started to give way, the market's strength waned.

"Since mid- to late-June or so, the market has acted pretty poorly, breadth-wise," said Bruce Zaro, chief technical strategist at Delta Global Advisors in Boston, referring to a market gauge that analyzes the number of stocks advancing relative to those falling.