Updated from 1:45 p.m. EDT

Major averages were hovering near break-even midday Thursday, then fell sharply at around 1:30 p.m. after more hawkish comments from Dallas Fed President Richard Fisher.

Fisher -- who had given investors false hope with this "eighth inning" comment last summer -- issued a warning about inflation for a second straight day, saying it shows "little inclination" of declining. Inflation is a "virus" that cannot be allowed to "poison the system," Fisher said, making allusions to the 1970s. The Fed governor added that businesses may be more aggressive at passing through higher energy costs, which adds to inflationary pressures.

In recent action, the Dow Jones Industrial Average was down 0.4% at 10,273.42 vs. its earlier high of 10,369.55. Caterpillar ( CAT) and Hewlett Packard ( HPQ) were among the drags on the Dow. Gainers included Wal-Mart ( WMT), which said same-store sales rose 3.8% in September and expects an increase of 2% to 4% for October, and General Electric ( GE), which raised its earnings guidance.

The S&P 500 was down 0.5% to 1190.48, about 10 points below its intraday high, while the Nasdaq Composite was down 0.5% at 2086.62 vs. an earlier best of 2110.82.

Following several days of heavy selling, Thursday's midday swoon comes as trend watchers are forecasting further pressure over the coming weeks.

As mentioned here Wednesday, Cantor Fitzgerald strategist Marc Pado believes the market had been too complacent in September about the impact of Hurricane Katrina, soaring energy prices, and a Federal Reserve still hell bent on lifting interest rates.

But any complacency started unwinding in the first three sessions of October, with the Dow falling 2.4%, while the S&P 500 lost 2.6% and the Nasdaq fell 2.3%.

The pullback could lead some to believe that a sharp rebound is near, as lower valuations attract fresh buying. But contrarian investors, who believe that buying opportunities arise when negative sentiment has reached a peak, say there is still a ways to go on the downside.

Don Hays, head of Hays Advisory Group, says bullish sentiment is just in the process of deteriorating, and will likely need to erode further to rebuild the so-called "wall of worry," over which bulls can later climb.

"Ladies and Gentlemen, the wall-of-worry is being rebuilt strong and wide," Hays wrote in a morning note.

Hays sees the market approaching a major buying opportunity, presumably as more selling leads to more negative sentiment. But others believe there are negative fundamental trends for the intermediate term.

Worries that soaring energy costs are hurting the economy and profits while pressuring the Fed to hike rates further precipitated the recent downtrend in stocks. But while oil prices have trended lower over the past couple of weeks, that has not helped the stock market. On the contrary, lower oil might even be contributing to the downside given the large weight of energy stocks on the S&P 500.

"The crazy thing about today's market will probably be that as the price of oil drops, one of the biggest contributors to the earnings momentum will also drop, so the indices will look worse even though the underpinnings of the broad market will look better," Hays wrote.

In recent action, crude for November delivery was down $1.49 to $61.30 a barrel after approaching $60 earlier in the session.

The Amex Oil Index was down 1.4%, led lower by the likes of Amerada Hess ( AHC), Occidental Petroleum ( OXY), Chevron ( CVX) and Valero ( VLO).

Another potential negative comes as the third-quarter earnings season gets underway in full next week. Investors are wary that firms may lower their earnings guidance due to rising energy and commodity costs, and/or disruptions related to Hurricanes Katrina and Rita.

Third, technicians are pointing out that damage has been done as the S&P has broken below its 200-day moving average. On Wednesday, the S&P 500 closed below 1200 for the first time since early July.

The index plunging to three-month lows wiped out gains for many investors who took long positions in that interval and didn't get out on time. Some may try to sit it out and hope that the market turns around and restores their gains.

But with investing sentiment turning bearish, those "long positions trapped at higher levels" can actually create resistance on the upside, says Rick Bensignor, chief technical strategist at Morgan Stanley. "It creates overhead supply, as many players will look to get out and sell into a rally that would put them back above water."

Since the heavy selling has been confined to a few days, it is still too early to say the technical damage has been "critical," he says. Back in April, a flurry of selling for a couple of days led to a bottoming-out process, itself followed by a long rally that lasted through August.

"A lot will depend on how long the S&P stays at these below-trend levels," Bensignor says. Fresh buying could be attracted at the lower levels and a snapback to 1225 is still possible.

For now, the S&P can still test lower levels all the way down to 1171 to 1181 and not be "too critical," according to the technician. But if it goes down to 1160, a level not seen since mid-May, "then it will have trapped a lot of people higher," which would make it much harder for the market to make a comeback.

Absent of this deterioration, Bensignor's colleague, Mark Newton, believes that a technical bounce could be seen around Oct. 20.

By then, investors may have received a better idea of the profit outlook from third-quarter earnings reports and more economic data. In addition, many analysts, including Bensignor, believe that the price of crude oil could go all the way down to the mid-$50s, which would also favor a rebound.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback; click here to send him an email.