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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Sara Eisen joined CNBC in December 2013 as a correspondent, focusing on the global consumer. She is co-anchor of the 10AM ET hour of CNBC's "Squawk on the Street" (M-F, 9AM-11AM ET), broadcast from Post 9 at the New York Stock Exchange.

In March 2018, Eisen was named co-anchor of CNBC's "Power Lunch" (M-F, 1PM-3PM ET), which broadcasts from CNBC Global Headquarters in Englewood Cliffs, N.J.

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