After yesterday?s 217 point swoon, the S&P 500 (SPX) has fallen 4.3% from its late May peak. It looks like the ?Sell in May? crowd is having the last laugh after all, of which I was one.

Is this a modest 5% correction in a continuing bull market? Or is it the beginning of a Harry Dent style crash to (SPX) 300 (click here for the interview on Hedge Fund Radio)? Let?s go to the videotape.

This was one of the most overbought stock markets in my career. I have to think back to the top of the dotcom boom in 2000 and the pinnacle of the Tokyo bubble in 1989 to recall similar levels of ebullience. In fact, two weeks ago we were at a real risk of a major melt up if we didn?t encounter some sort of pullback. So the modest selling we have seen so far has been welcome, even by the bulls.

There is still a reasonable chance the final decline will be nothing more than a pit stop on the way to new highs. Institutional weightings in equities are at a lowly 31%, compared to 50% 20 years ago. It seems that everyone in the world is overweight bonds (see yesterday?s piece on ?Welcome to the Sack of Rome?).

In recent weeks, the S&P 500 yield ratio has fallen behind that of the 10 year Treasury bond, at 2.10%, but only just. With a price/earnings multiple of 16, we are bang in the middle of a long time historic range of 10-22. Zero overnight interest rates argue that we should be at the top end of that range. The argument that the ?Buy the Dip? crowd is still lurking under the market is real, just a little further than the recent dips allowed.

So how much lower do we have to go? After the close, I enjoyed an in depth discussion with my old friend, Jim Parker, of Mad Day Trader fame about the possible permutations. The following is an itinerary of what your summer trading might look like, expressed in (SPX) terms:

6.2% - 1,605 was the Wednesday low, the 50 day moving average, and the downside of the most recent upward sloping channel on the chart below. This trifecta of support is many traders? first stop for a bounce.

5.4% - 1,590 is the first major downside Fibonacci level. We could see this as soon as the May nonfarm report payroll is announced on Friday.

6.0% - 1,580 is the old 13-year high. Markets always love to retrace to old breakout levels.

6.5% - 1,570 represents a give back of one third of the November-May 330 point rally.

8.3% - 1,540 is the double bottom off the April low.

11.1% - 1,493 is the 200-day moving average. This is the worst-case scenario. I doubt we?ll get there, unless the fundamentals change, which they always do.

Jim gave me a couple more cogent insights. The average big swing move is 100-110 points. The last 100-point move sprung off of the March nonfarm payroll report, which came out on April 5. Big swings also often start and finish around an options expiration, the next one of those is coming on June 21. So for the short term, 1580-1590 is looking good.

To confuse you even further, contemplate the concept that I refer to as the ?Lead Contract.? There is always a lead contract around, one on which all traders maintain a laser like focus, which leads every other financial product out there. It says ?Jump,? and we ask ?How High?? It is also always changing.

Right now, the Nikkei average (DXJ) is the lead contract. The Japanese yen ETF (FXY) is the close inverse. Every flight from risk during the past two weeks has been preceded by a falling Nikkei and a rising yen.
If you want to get a preview of each day?s US trading, stay up the night before and watch the action in Tokyo, as I often do.

You might even learn a word or two of Japanese, which will come in handy when ordering in the better New York sushi shops.

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