On Friday, U.S. markets were hit with a rush of profit-taking in reaction to a sharp sell-off in equities in Spain. Spain’s stock market fell 5.8% and its 10-year bond yield topped 7%, causing concern throughoutEuropeand a subsequent sell-off at European bourses.

After four days of gains, the Dow Jones Industrial Average fell 121 points to 12,823, the S&P 500 was off 14 points at 1,363, and the Nasdaq was down 41 points, closing at 2,925. The NYSE traded over 1 billion shares and the Nasdaq crossed 565 million. Decliners were ahead of advancers by 2-to-1 on the Big Board and by over 3-to-1 on the Nasdaq. 

For four days last week, the Dow Jones Industrial Average forged ahead, and on Thursday, it appeared to break the boundary — the bearish resistance line (red dash) — that had restrained it for three months. But there was just one small technical problem: The Dow Jones Transportation Average had failed to break its resistance line and confirm the breakout.

To Dow Theory folks, this is called a “divergence,” or warning that all may not be as bullish as it seems. And there was another subtle sign of trouble: the failure of the industrials to best its June high at 12,944, missing a new high by just 2 points. 

On Friday, the first “small technical problem” escalated when the industrials reversed and plunged back into the three-month trading range, and by doing so, triggered a second failure to confirm a breakout.

Subtle difficulties became obvious failures as more problems surfaced. The industrials’ stochastic turned lower revealing a downtrend of three lower highs and two lower lows in that indicator, while the index’s price line was making three new highs and three higher lows. This is the second “divergence.” 

If these were not enough bearish signals, the transports’ 50-day moving average crossed through its 200-day moving average (a sell signal), and its stochastic issued a sell as well. Finally, Friday’s NYSE volume was the highest of the week.

While the industrials and transports were failing, the more defensive Dow Jones Utility Average broke through a triple-top, which was confirmed by its stochastic’s upward slanting highs and lows. 

Conclusion: Friday’s reversal has confirmed that Thursday’s “breakout” is a failure. The next significant support for the Dow Jones Industrial Average rests at its 50-day moving average (blue line) at 12,615. Below that is the most important support at the junction of its bullish support line and 200-day moving average (red line) at 12,527.

The near-term trend is now down, the intermediate trend is sideways, and the long-term trend is up. Most stocks, with the exception of the more defensive groups like utilities, pharmaceuticals and health care, will likely pull back to their secondary and primary support areas, giving us an opportunity to buy into technology and other favored groups at discounts of 5% to 10% below Thursday’s closing prices.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.