Technical analysts are warning that there could be more downside after the fourth quarter got off to a rocky start as recession fears hit stocks.
Stocks opened Wednesday's trading day in the red, accelerating Tuesday's sharp losses, when the Dow fell 344 points and the S&P 500 broke below its 50-day moving average — a key technical indicator. That decline came after manufacturing data hit its lowest level in a decade.
Ned Davis Research chief global investment strategist Tim Hayes remains underweight equities, pointing to a lack of breadth in the comeback in September, as well as slowing equity fund inflows and a failure of the yield curve to steepen. He says this rally is becoming "another round of failure."
"If the outlook was turning bullish for equities, we would see the major benchmarks breaking to record highs with decisive and broad-based confirmation from breadth indicators. ... We would see yield curves steepening," Hayes said in a note to clients on Tuesday. He believes all of these factors are "a reflection of waning confidence in the macro environment globally."
The S&P falling below its 50-day moving average isn't the only technical indicator breaking down, says MKM Chief Market Technician JC O'Hara. He believes "the market is not in the best shape to make new highs from its current position" since "shorter term technical indicators started to show some negative divergences." Specifically, he points to the relative strength index, which he says "started to roll over a week prior."
"We believe more time is needed to allow those indicators to fully reset, and thus are in a better position to make new highs," he said.
Hayes argues that the most recent rally has been uneven, and that could spell trouble ahead. He noted that not only have U.S. indexes failed to regain July highs, but outperformance in large-cap stocks is masking signs of weakness in other areas of the global stock market, specifically, the All World Country Index ETF, which tracks large and mid-cap stocks around the world.
"As the megacaps have been propping up the ACWI and other cap-weighted indices, underlying deterioration has been reflected by the equal-weighted ACWI," he wrote, calling this divergence a sign of "mounting economic pessimism."
Hayes also pointed to the bond market as a sign that the rally's underlying fundamentals may not be supported, saying that if the overall outlook were positive "we would see yield curves steepening again."
Softer inflows to stock ETFs and mutual fund are another sign that the market might be on the verge of turning a corner, Hayes said. In August, investors pulled $46.2 billion from equity ETFs, according to ETF Trends, while $13.5 billion flowed into bond funds. O'Hara reiterated this point, noting that Tuesday stock inflows were light, which was a "negative signal" given that "historically inflows have been present at the start of each month."
But not everyone on the Street shares Hayes' view that stocks could be set for a pullback. Fundstrat Global Advisors' Rob Sluymer said in a note to clients on Tuesday that investors should buy any weakness in "anticipation of further upside through Q4."
Though many traders and analysts remained worried. On a more granular basis, Tribeca Trade Group CEO Christian Fromhertz noted that individual sectors are beginning to show signs of weakness. "On the technicals, you're losing breadth a little bit. You're losing some groups. Health care is the next group to kind of watch that's vulnerable. Sometimes it's OK when you have a couple of groups that are weak … but we're starting to see more groups tilt to the downside," he said.
— CNBC's Yun Li, Fred Imbert and Tom Franck contributed reporting.
