"All things considered, I think the environment remains constructive for equities notwithstanding what we saw in some of those stocks like Facebook and Netflix," MacNeil Curry, global head of technical strategy at Bank of America Merrill Lynch, said, referring to the selloff in momentum names. "If you look at where the breadth and leadership is coming from, the trend is still healthy."
The best performing sectors Tuesday were materials and consumer staples, both up 1.4 percent, followed by utilities, up 1.3 percent. Tech was the worst performer, down 0.2 percent.
Momentum names fell Tuesday after a sharp decline in Netflix, which had shot higher in afterhours trading Monday on strong earnings, and extended those gains on Tuesday morning before selling off sharply. Traders said the decline in Netflix sparked a sell off in momentum names. Investor Carl Icahn later disclosed that he had sold about half his stake in Netflix, or 3 million shares. Icahn had bought the stock at an average $58 over a year ago.
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In an unusual commentary Monday afternoon Netflix CEO Reed Hastings warned investors of euphoria around the stock, which had tripled this year alone. That warning echoed through the market Tuesday, as stocks like Amazon, Apple, LinkedIn, Pandora and Google were all hit, along with Chinese internet stocks like Baidu and Sina. Some of the names recovered but others like Facebook and LinkedIn were still much lower on the day.
Icahn filed on the stock sale with the SEC after Tuesday's close; he also tweeted about it:
Spacey starred in "House of Cards," a proclaimed Netflix original series, which helped launch new interest in the company.
But the event rattled traders, since dozens of stocks reacted to the decline in Netflix and the selling was heavily correlated.
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"It was like a shot across the bow. When you have one of the favorite names of 2013 selling off on good news, it sends fear into other names," said Scott Redler of T3Live.com. "A lot of things that sold off out of fear kind of regrouped, and that isolated Netflix as an event."
Redler said the selling in momentum names triggered more selling as traders' stops were hit and those short in some names were forced to cover. "At first the market got pretty fearful when you saw that flash move, but the fact the S&P held above yesterday's high was technically bullish," he said. "But traders were definitely hearing footsteps of a flash crash."
Redler said the $80 swing in Netflix leaves a bad taste for traders, and they probably will not trust the stock for a long time. "It's safe to say the highs of the year are in for Netflix," he said. Not all stocks recovered from the selloff, including Facebook and LinkedIn.
BofA-ML's Curry said the selloff of momentum-related stocks is not a sign of trouble for the market. "Anytime you have a pickup in correlation, it tends to be worrisome, especially in down moves. It tends to suggest people are panicking a little bit. Given the fact it's just one sector, it's a concern but I don't think it's enough to say this uptrend is in trouble yet," he said.
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Other factors suggest a positive outlook for stocks for now. "More importantly, if you look at the environment for volatility across asset classes we're seeing volatility come down pretty decently, but not to levels where we've seen complacency transpire. If you look at Treasury volatility, that's come down pretty hard," he said.
Lower rates proved a positive for stocks Tuesday, as the yield on the 10-year Treasury retreated to 2.51 percent late in the day. Curry said the MOVE index, or the Merrill Lynch option volatility estimate index – a yield curve weighted index in implied volatility in Treasury options – fell to 63, from its peak of 117 in July. The May lows were 48. "When that goes down it allows people to move into carry trades and high beta trades and things like that. You have that and the fact you have strong seasonal leadership from equities," he said.
Lower volatility in Treasurys is a plus for stocks, since it means narrower moves in rates. It was the quick sharp moves higher in yields that stung stocks, when the Fed began discussing tapering its bond-buying program in the spring and summer.
Curry said the move to record highs by the Dow Transports is also worth watching, since it will be bullish for the market if the Dow Industrials confirm the move by also reaching new highs. Curry said Dow theory, an old time market measure, has become more relevant now that the transports reflect the shipment of so many goods that are bought on the internet.
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Other companies reporting earnings before the bell Wednesday include Bristol-Myers Squibb, Airgas, American Electric Power, US Airways, Norfolk Southern, Federal-Mogul, General Dynamics, Owens Corning, Tupperware, Wyndham Worldwide, Dr. Pepper Snapple, Encana, Northrop Grumman, Eli Lilly, Lorillard, Motorola Solutions, Thermo Fisher, Wellpoint, WR Grace and GlaxoSmithKline. After the bell reports are due from AT&T, F5 Networks, Cheesecake Factory, Fortune Brands, Lam Research, Morningstar, Ethan Allen, ETrade, Citrix, Crown Castle, AvalonBay, Akamai, Trip Advisor, O'Reilly Automotive, Raymond James, Symantec, Angie's List, Varian Medical, Whiting Petroleum,
Import prices are due at 8:30 a.m. ET and the FHFA home price index at 9 a.m. Mortgage applications will be reported at 7:15 a.m.
—By CNBC's Patti Domm. Follow here on Twitter @pattidomm.