>MARKET ANALYSIS COMMENT (MERRILL LYNCH)

A spring haircut but only a trim

■ Market in a confirmed correction - should be limited to 10%
The market remains in a base- building process, now going into its eighth month. In the process, the S&P 500 has rallied nearly 40% from the March 6 low (666) and is currently down 5.5% off the May 8 high of 930. It still appears to us the S&P 500 is forming a right shoulder of a head and shoulders bottom (see chart in report). To anticipate a directional change in the market we have overlaid a 40- day moving average and 150-day moving average, and the 40-day is just approaching the 150-day. A sustainable cross of the 40-day above the 150-day would be a positive sign that this correction should remain limited. Additionally, cash levels remain elevated, and AMG inflows into domestic equities are not excessive, and levels are supportive of additional recovery highs.

■ Short levels remain elevated in mega caps and financials
Short levels did fall in late-April by 5% for the first time since December, but levels remain elevated in mega cap stocks and financials. We have adjusted for hedging (selling short) against recent financial equity offerings and short levels are still elevated.

■ Commodities spring back to life
Energy, grains and soft commodities are positioned to continue their rally. Crude oil is in a confirmed rally and natural gas is just breaking to the upside from a Vbottom. A rally is under way in sugar, soybeans and coffee - and wheat and corn could be next. The correction in the US dollar confirms the commodity rally.

■ Levels to watch:
First support on the S&P 500 is 845-825 and this range is within a 10% correction. First support on the DJIA is 7900-7750. Should this be a more sizable correction the second level of support on the S&P is 815-780 and on the DJIA 7435-7260. Our upside targets remain intact with S&P at 1055-1065.

To see full report: MARKET ANALYSIS COMMENT