U.S. stocks were clearly in danger of a technical pullback after a breakneck rally off the October lows, but Wall Street’s sudden Wednesday downdraft has traders and analysts weighing whether more pain may be in store.
“Perusing hundreds of charts, some Technology stocks are extremely extended. In addition, many of 2023’s laggards are also very extended after huge recoveries. That doesn’t leave too many attractive charts, at least in the near term,” said technical analyst Mark Arbeter, president of Arbeter Investments, in a Thursday note.
“So, this was either a one-day wonder or the start of a decent pullback,” he said.
The Dow Jones Industrial Average DJIA dropped 475.92 points, or 1.3%, on Wednesday for its biggest one-day percentage drop since Oct. 3, ending a streak of five straight record finishes. The S&P 500 SPX, which had rallied to less than 1% away from its Jan. 3, 2022, record close, dropped back 1.5% to close just below 4,700 for its biggest percentage decline since Sept. 26; the Nasdaq Composite’s COMP 1.5% drop was the largest since Oct. 26.
Stocks on Thursday took back some of the previous session’s lost ground, with all three major indexes on track for a higher close.
See: Why stock-market bulls say ’embrace weakness’ after biggest stumble in 3 months
Arbeter said trendline support for the S&P 500 lies at 4,675, while the rising 21-day exponential moving average is at 4,621. He views 4,600 as important chart support since it marked the start of the last upside breakout.
Both the Dow and Nasdaq had rallied for nine straight days before Wednesday’s setback. The rally, which had accelerated a move off the October lows, had left major indexes significantly overbought based on technical indicators, analysts said, but not everything had pointed lower.
“Yes, price momentum and market breadth were extremely overbought, but the major indexes had yet to trace out any daily bearish momentum divergences, while breadth has remained strong,” Arbeter said.
Breadth refers to the number of stocks participating in a move. Momentum divergence refers to a shift in the relationship between the movement of an asset’s price and a momentum indicator, such as the relative strength index.
Arbeter said the percentage of S&P 500 stocks above their 50-day moving average had spiked to 91%, while the percentage of stocks in the Nasdaq-100 NDX -tracking Invesco Trust QQQ Series ETF QQQ hit 95% on Dec. 19.
Based on data going back to the end of 2001, such “breadth thrusts” usually occur in the early or middle stages of a bull market, Arbeter noted, though there was a “really bad signal” that happened in October 2007. Another negative signal came in January 2018, leading to an immediate pullback that was followed by a solid rebound, though another thrust preceded the market’s late-2018 meltdown.
“In the near-term, we would not be surprised by a pullback, but based on price and breadth, the bull looks like it has further to go,” he said.
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