Falling market tide 'lowering all boats'

Traders work on the floor of the New York Stock Exchange.
Lucas Jackson | Reuters

A sharp selloff in the market last week sent investors scrambling for a place to hide; unfortunately, there wasn't any.

By the close on Friday, the Dow and Nasdaq entered correction territory, down about 10 percent from their 52-week highs. Similarly, the average stock in the Russell 1000 index was down 5 percent for the week, on average.

Meanwhile, ahead of the market open Monday, U.S. stock index futures sold off sharply with the Dow briefly plunging more than 800 points.

The main reason for concern, according to market watchers, is the broad dispersion of the losses.

"This pullback can be described as a 'falling tide lowers all boats,' " wrote Bespoke Investment Group in a note to clients last week.

In the past month, the dropped 5 percent while other major benchmarks such as the Nasdaq 100 and Dow industrials plunged 7.5 percent or more.

The biggest underperformers, according to Bespoke, have been the stocks with the highest valuations, lowest dividend yields, and highest short interest—although the stocks with low valuations and high dividend yields have not been spared either.

"Momentum, by definition, tends to work very well until it breaks," cautioned Bank of America's equity strategist Savita Subramanian last week, noting that going back to 1986, peaks in momentum stocks were followed by bigger losses over the next 12 months.

Well, that momentum seems to have been broken.

Two of the best performing stocks this year, Netflix and Amazon, for example, have seen their shares drop by 20 percent and 15 percent respectively from their recent highs.

Within the S&P 500, about 30 percent of the index components are in bear market territory, depicted by a drop of more than 20 percent. Another 40 percent of the S&P stocks, are in correction territory, down 10 percent from their highs, according to FactSet.

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Among the reasons for the broad decline in equities, market observers point to subdued economic growth, a strong dollar, a collapse in commodity prices and uncertainty over a potential rate hike by the Fed.

"The current outlook for equity markets remains cautious given the skittishness, volatility and headwinds that have swamped markets and investor psychology," said Peter Kenny, chief market strategist at Clearpool.

"The near-term outlook could shift but any attempt at a rally, even from these relatively depressed levels, will likely fail to take shape," he added, describing a lack of a "tradable bottom."

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From a technical perspective, Jim Paulsen, chief investment strategist at Wells Capital Management, points out that the S&P 500 has taken out its support level of 1972, leaving the index vulnerable to a "free fall."

The next stop, according to Paulsen, is the 1862 level, implying another 5.5 percent decline from here.

S&P 500, 1 Year

Source: FactSet

As CNBC Pro pointed out earlier this year, exchanged traded funds such as the iShares 20+ Year Treasury Bond ETF (TLT) and the iShares 7-10 Year Treasury Bond ETF (IEF) perform well when the stock market has a forceful short-term drop.

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