To market veterans, talk of a stock-market “bottom” after a mere 3% pullback might sound odd, but that’s the sort of world investors live in right now, says one chart watcher.
While stocks have climbed in 2021, hitting new highs as recently as last week, fewer and fewer individual stocks have participated in the move, said technical analyst Andrew Adams in a Wednesday note for Saut Strategy. That narrowing breadth is what’s now sending a bottoming signal, though indexes haven’t suffered steep falls.
Stocks got smacked hard on Monday, accelerating a selloff that began late last week and left the S&P 500
down 2.9% from its July 12 record close. The Dow Jones Industrial Average
on Monday suffered its biggest one-day drop since October. The S&P 500, Dow and Nasdaq Composite
subsequently bounced back Tuesday and Wednesday, taking back all the lost ground.
In One Chart: Why the S&P 500 could be poised for a 5% drop — or even more this summer
While the moves on Monday were dramatic, the scope of the selloff wasn’t what would normally prompt talk of a washout, given that steeper pullbacks of at least 5% are relatively common.
But a look beneath the hood shows that market breadth has been narrowing since February, Adams said.
Several individual stocks have fallen 10%, 20%, or much more from their previous recovery highs, he said. As a result, it hasn’t taken much damage to the S&P 500 or Nasdaq averages to get to the point, in terms of breadth, that have signaled past market bottoms.
“It feels strange talking about a ‘bottom’ after only a 3% dip in the S&P 500, but, again, this is a weird market right now,” he said.
Adams explained that in a “legitimate” market pullback, fewer than 30% of stocks on the New York Stock Exchange and Nasdaq exchanges remain above their 50-day moving averages. Readings below that threshold represent a “washed out” market, that’s likely getting close to being oversold and attractive to traders eager to buy the dip, he said.
Having fewer than 30% of stocks above the 50-day average doesn’t guarantee the market is bottoming, but it’s generally a sign that investors can have more confidence and begin to add back some risk, he said.
It’s a similar story for the S&P 500, with pullbacks testing the index’s own 50-day moving average proving common over the past year. Indeed, this week’s rebound came as the S&P 500 held support at the 50-day average, though only 25% of NYSE and Nasdaq stocks were above their individual 50-day averages, Adams noted.
So is everything hunky dory for the bulls? Not so fast.
Given how “weak and rotative the general market has been recently, it’s still hard for me to advise buying just anything on such a slight dip in the S&P,” he said, adding that the S&P 500 and Nasdaq still face long-term resistance near their recent highs.
Until the market overcomes those areas, the risk-versus-reward outlook for the indexes remains fairly poor, he said.
That doesn’t necessarily mean there still won’t be opportunities for buying, as this remains more of a “market of stocks” than a “stock market,” Adams said, “I think we have to continue to be selective and try our best to stay on top of these rotations.”