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Biotechs could be the early warning for stocks

Traders work on the floor of the New York Stock Exchange.
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Traders work on the floor of the New York Stock Exchange.

Traders are watching small caps and the biotech sector Thursday to see whether they continue to melt down, as the harbinger of a deeper selloff in the broader market.

Stocks tanked Wednesday with a variety of catalysts blamed, but one common concern among traders was the steep drop in the biotech sector, which had been soaring just last week.

Other factors include worry about sluggish economic growth after weak durable goods data. Traders also said headlines on Yemen were a factor, as investors worried the reported exit of the president and buildup of Saudi Arabian military equipment on the border could be a prelude to a broader conflict.

There also were concerns about a negative earnings cycle, as estimates point to the first decline in quarterly profits in six years. There are a handful of earnings expected Thursday, including Lululemon Athletica and Winnebago. Thursday's data includes weekly jobless claims at 8:30 a.m. ET.

"It's pretty easy to stack up a list of catalysts, not the least of which is biotechs, which finally broke. They broke but they still haven't tested the 50-day," said Art Hogan, chief market strategist at Wunderlich Securities. The iShares Nasdaq Biotechnology ETF slumped more than 4 percent and is down 7 percent week to date, on track for its worst week since May 2010.

"We've seen that biotechs will lead when it's a momentum correction," said Hogan. "That's what it feels like. Biotechs will take the lead and anything connected to it will break next." He said the S&P also ripped through its 50-day, and in recent selloffs, it's held above the 100-day, which is currently at 2,056.

"Every time it's broken the 50, it's tested the 100-day but those trend lines are strong so that's the good news," Hogan said.

The biotechs led a decline that swept other high fliers, like tech names and small caps in the Russell 2000, lower with them. The Russell was down 2.3 percent, about the same as the Nasdaq. The Dow, down 292 points, lost 1.6 percent to 17,718 and the S&P 500 fell 1.5 percent to 2,061.

Read MoreStocks sell off as bad news turns bad

"The Russell 2000 was holding up pretty well, giving a false sense of security. It had one of its most potent down days of 2015 to catch up with the bios. I think a lot of traders were shellshocked today and are back in wait-and-see mode," said Scott Redler, partner with T3Live.com. "If this is a normal (shallow) correction, the IBB should hold the 50-day, which is at 332, 9 points below where it closed. The bios have not been below the 50-day since October."

The IBB is still up 12.5 percent year to date. "It's the poster boy for stock market speculation," said Peter Boockvar, chief market analyst at The Lindsey Group. "(Biotech) had the most extraordinary run. It went parabolic last week, and I think that was noteworthy and it should not be ignored. You had poor economic data this morning. You've had five months in a row of poor durable goods numbers."

The dollar weakened Wednesday, in a selloff that started after last week's Fed meeting. The central bank downgraded its economic forecasts and also pared back its expectations for interest rate increases, jarring the U.S. currency and sending yields lower. But the more than 7 percent rise in the dollar year to date has already done plenty of damage to corporate earnings, and traders have been bracing for the first decline in S&P profits since 2009.

Read MoreFed's Evans says strong dollar a challenge, but transitory

"The market got a little bit ahead of itself because it was not appreciative of the earnings pressures owing to oil and the dollar," said David Bianco, chief U.S. equity strategist at Deutsche Bank. "I still feel a 5 percent dip was justified based on the decline in earnings." He said the S&P 500 could test 2,000.

According to Thomson Reuters, analysts expect a 3.1 percent decline in S&P 500 net income. Earnings season begins when Alcoa reports on April 8, and talk in the past few days has focused on the anticipated earnings decline that could extend for several quarters.

Read MoreThere's a huge sentiment split building in market

"Maybe it's cold feet as the quarter's wrapping up ... I think in a couple of sectors, there are understandable issues," said Bianco. "The financials—this flattening yield curve is raising questions about values at companies that earn mostly dollars. The pressure is on earnings in first-quarter reports as well as the first two to three quarters of the year."

Even as the Fed is expected to raise rates sometime this year, its latest interest rate forecast has convinced markets it won't move quickly and analysts say lower rates justify a loftier stock market so any selloff should be shallow. While stocks tumbled Thursday, bonds also sold off in an unusual parallel move.

A negative durable goods report normally would have sent yields lower, but they rose Wednesday as stocks responded to a weak report and the subsequent reductions in first-quarter growth forecasts. Expansion in the period is now expected at 1.8 percent, based on the CNBC/Moody's Analytics rapid update of GDP forecasts.

Read MoreGDP forecasts cut again on weak durables

What else to watch

Atlanta Fed President Dennis Lockhart speaks at 9 a.m. ET in Detroit, and the Treasury auctions $29 billion in seven-year notes at 1 p.m.

Earnings are expected from Accenture, ConAgra, Lululemon, Signet Jewelers, Commercial Metals, Scholastic and Winnebago before the bell. Gamestop and Restoration Hardware report after the market close.