U.S. stocks are facing the possibility of a technical pullback following a rapid rally since October. Wednesday’s sudden downturn has prompted traders and analysts to consider the likelihood of further declines.
Technical analyst Mark Arbeter, president of Arbeter Investments, expressed his observations in a note on Thursday, stating, “After examining hundreds of charts, it is evident that some Technology stocks have become extremely overextended. Additionally, many of the laggards from 2023 have also experienced significant recoveries. This leaves very few attractive charts, at least in the near term. Therefore, this could either be a one-day anomaly or the beginning of a notable pullback.”
The Dow Jones Industrial Average (DJIA) experienced its largest one-day percentage drop since October 3, closing down 475.92 points or 1.3% on Wednesday. This was the first decline in five consecutive record finishes. The S&P 500 (SPX), which had risen to within 1% of its January 3, 2022, record close, also decreased by 1.5%, falling just below 4,700. This decline marks its most substantial percentage drop since September 26. Similarly, the Nasdaq Composite (COMP) dropped by 1.5%, its largest decline since October 26.
On Thursday, stock prices recovered some of the lost ground from the previous session, with all three major indexes expected to close higher.
Arbeter identifies trendline support for the S&P 500 at 4,675, while the rising 21-day exponential moving average sits at 4,621. He considers 4,600 as significant chart support because it signaled the beginning of the last upward breakout.
Bullish Momentum Continues, but Potential Pullback Expected
Both the Dow and Nasdaq have been on a consistent rally for nine consecutive days, showcasing impressive momentum. This upward movement has been particularly significant as it rebounds from the October lows.
According to analysts, technical indicators seem to suggest that major indexes have become overbought. However, there are still some positive signs pointing in the opposite direction.
While price momentum and market breadth have become extremely overbought, daily bearish momentum divergences have yet to materialize in the major indexes. Additionally, the strength of the breadth, referring to the number of stocks participating in the rally, suggests a promising scenario.
In terms of statistics, the percentage of S&P 500 stocks above their 50-day moving average has skyrocketed to a notable 91%. Similarly, the Nasdaq-100 NDX tracking Invesco Trust QQQ Series ETF QQQ has seen an impressive 95% surge as of December 19th.
Historical data dating back to the end of 2001 reveals that these “breadth thrusts” usually occur during the early or middle stages of a bull market. However, it is important to note that there have been instances of negative signals in the past. One such example occurred in October 2007, which turned out to be a “really bad signal.” Another negative signal surfaced in January 2018, leading to an immediate pullback but followed by a solid rebound. However, it’s worth mentioning that another thrust preceded the late-2018 market meltdown.
In the short term, it would not be surprising to witness a pullback. Nevertheless, considering the overall price and breadth indicators, there seems to be further room for the bull market to continue its upward trajectory.