- The stock market is flashing some troubling technical signs, just as some major investors are warning about the market being overvalued.
- The stock market has had a strong run, since late March, but it could be heading into a period of consolidation and choppiness after an important reversal Tuesday and Wednesday's sell off.
- Technical analysts are watching Thursday's action for clues on whether the market is entering a period of correction.
The stock market is flashing warning signs, as some investors are re-evaluating the economy's potential to recover from the coronavirus shutdowns.
Fed Chairman Jerome Powell added to those concerns Wednesday when he said policymakers may need to use additional weapons to pull the economy out of what he described as a downturn without "any modern precedent, significantly worse than any recession since World War II."
Technical analysts, who watch charts, say Thursday could be a turning point for the market, and it risks heading to a period of increased choppiness that could bring a bigger downside move. They point to a key reversal Tuesday, where the S&P 500 went above the prior day's high, reversed and went below the prior day's lows. It was then followed by another sloppy negative day Wednesday.
"A lot of smart investors in the past few weeks have been saying the markets are up on borrowed time," said Scott Redler, partner with T3Live.com. "[Tuesday's] outside reversal gave technical analysts a signal to reverse longs. Does this start a new corrective sequence to the downside? In my opinion, it does. We've mapped out a few levels along the way, and 2,650 is a big level."
He said the technicals and fundamental concerns about the market are becoming aligned. "I think the divergence between reopening and normalization is becoming more of a reality. I also think California saying they won't have schools and universities back in September and putting off businesses reopening for three months shows the economy is not going to have a big bounce in the third and fourth quarter which the market rally in the last few weeks has somewhat priced in," Redler said.
The warnings from technical analysts coincides with some warnings from big investors like legendary hedge fund manager Stanley Druckenmiller and Appaloosa Management founder David Tepper, who both said stocks are overvalued. Druckenmiller told the Economic Club of New York that the "risk-reward for equity is maybe as bad as I've ever seen it in my career."
Tepper told CNBC Wednesday the market is the most overvalued it's been since the tech bubble in 1999.
Ed Keon, chief investment strategist at QMA, said he believes it is a time to be cautious about the market. "The overall back drop at this point is pretty clear. You have terrible economic data. You have data on the virus that is terrible but less terrible than it was, and you have a lot of money and fiscal stimulus," he said. "With the stimulus you at least put in a floor, but I don't think you have much room for upside."
Stock futures were lower again Thursday, after the S&P 500 ended Wednesday with a 1.75% decline, to 2,820.
"The S&P hasn't had a three-day decline for awhile," said Frank Cappelleri, executive director at Instinet. 'It closed on a widely watched area at 2,800. There are signs its leadership has taken a punch. Depending on how they do over the next few days, we'll see if this is part of a bigger decline. We'll especially see how the leaders do with their first real bout of turbulence in the last few weeks."
Cappelleri said it will be important to see if the S&P closes lower for a third day Thursday. "That's going to be important if we see that it tells you number one, momentum is shifting because then we have three downdays in a row. it would just tell you the character changed," he said. "I think people realize the pullbacks have been buyable dips. This is the fifth two-day decline we've had since the March lows. The feeling is if that doesn't change people will be willing to deploy capital again, and if it's faded by the close, then I think momentum will change. We still remember two months ago."
Cappelleri said two ETFs that represent hot parts of the market both hit new all time highs Monday before selling off. The were the First Trust Dow Jones Internet Index Fund ETF and the iShares Nasdaq Biotech ETF IBB.
"I think at the very least you need those areas that were extended to catch their breath," he said.
Redler said key groups, small caps, banks and airlines did not rally in the first four weeks. "In the last two days, they turned lower which gave us a clue the economy is that bad," said Redler.
Redler said the ETF that represents the Russell 2000 was also trading poorly, after the small cap index tried to make headway in the rally. The iShares Russell 2000 ETF IWM broke below the 8-day and 21-day moving averages, signaling a loss of momentum.
"[Tuesday] was a signal to reduce risk. Today, you have downside follow through to the weakness. Now it might be a little but choppy but chances are we see 2,650 before we see 2,950 in the S&P 500," he said. He said there are about 75% odds the highs are in for the year.