The tech-heavy Nasdaq is showing signs of 'deterioration' beneath the surface

The Nasdaq composite has begun showing clear signs of weakness, according to a strategist who sees trouble ahead for high-flying growth stocks.

The Nasdaq on Thursday posted its largest single-day drop in over two weeks. Larry McDonald, founder of the Bear Traps Report, said cracks beneath the surface of the tech-heavy index are signaling further downside, particularly after a historically strong year for growth stocks and the broader market. Here's why:

  • The number of stocks hitting 52-week highs in the Nasdaq, as well as on the New York Stock Exchange, has been "deteriorating pretty rapidly," he said.
  • "Fewer stocks are maintaining their highs, and more specifically, fewer and fewer stocks are holding up the market. So the overall breadth has been deteriorating even as the market and the Nasdaq have been making new highs," he said Thursday on CNBC's "Trading Nation." In referring to the index's breadth, McDonald pointed to the number of stocks advancing relative to the number declining.
  • The credit market, particularly in high yield, has seen a "sharp deterioration" relative to the Nasdaq most of this week and last, McDonald said. Specifically, one high-yield exchange-traded fund often seen as a leading market indicator, the HYG, has sharply diverged from the S&P 500 in recent days, perhaps signaling trouble for the market overall.
  • At this juncture, investors ought to think about moving into value, he said. "We've been recommending clients sell the Nasdaq, sell their Nasdaq 100 exposure, and move toward value," McDonald said. "Because value has been underperforming for about 18 months, especially over the last year, and we believe there will be a rotation back to value in 2018," he said.

Bottom line... McDonald says a bevy of technical and fundamental signs are pointing to trouble ahead for the tech-heavy Nasdaq, and he recommends investors begin moving into value names instead.

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Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

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