After first showing signs of weakness on May 7 ahead of the publication of the much-leaked results of the US banking sector stress tests, the Dow posted a high at 8587 the following day.  The market then drifted down for a week, reaching 8230 last Friday (May 15).  The Dow then staged a rally and exceeded its May 7 high by just 5 points (close enough to call it a double top), reaching 8592 in the first hour’s trading on May 20, before rejecting this level and selling off to close near its lows for the day.

During the day yesterday (May 21) the Dow dipped below 8230 and created a lower low in the process, suggesting this market correction has further to run.  There may be a bounce back towards 8405 today though, ahead of the holiday weekend.

Just how much further the indices are going to correct is the key question nobody knows the answer to.  If the Dow gave back half of its rally off the 6 March 6470 low then that would equate to a fall of just over 1,000 index points which would severely rattle the bulls and have the bear camp screaming that we are heading back down below the March lows towards 5,000.

Expect the “Sell in May and go away” crowd to also make some more noise soon about the markets topping out.  Objectively we have had a sustained 11-week rally, there is corporate supply of fresh equity emerging (especially in the banking and REIT sectors) and the markets are due a rest after the Q1 results season.

However it is still early enough to protect any gains you have and see how the markets pan out over the coming months (and two daily closes above 8587 would cause a change of view).  However if the Dow does give back half of its recent rally then there are support levels at 7450 (Nov 2008 lows) and 7280 (20 Mar 2009 close and 61.8% retrace), around which it will be worthwhile paying attention to how the market behaves.