This year's favorite trade on Wall Street could be in trouble, chart analysts warn

Published Mon, Aug 21 20231:42 PM EDTUpdated Mon, Aug 21 20235:39 PM EDT

The tech-heavy Nasdaq-100 has been ripping higher for most of 2023. Now, the technical backdrop for the high-flying benchmark points to a reversal. Indeed, tech has been the trade of the year thus far. Excitement around the future of artificial intelligence and return to growth lifted the tech-heavy index more than 35% this year while also boosting other major indices after a rocky 2022. August has been a different story, however. The Nasdaq-100 is down more than 6% this month. While the pullback is no surprise for some chart analysts on Wall Street — with some noting that technical indicators point to overbought conditions and poor market breadth — many are bracing for a pullback in the high single digits or low teens in the coming weeks. "That's a normal correction, when bull markets get overheated like this," said Dan Wantrobski, technical strategist at Janney Montgomery Scott. "The sell signal probably started to flash warning signs a few weeks ago due to very overbought conditions, very poor breath and participation, and what we're seeing here is mean reversion down to these 200-day moving average areas to reduce those pressures." Moving averages are levels closely watched by market technicians. They track the average closing price over a certain time and are commonly used to gauge an asset's long- and short-term momentum. When a stock, for example, falls below its 200-day moving average, it is seen as a potential sign of more downside pressure. Earlier this month, the index fell below the commonly watched 50-day moving average. As of Monday, the 200-day average stood at around 13,132, while the Nasdaq-100 hovered around the 14,822 level. Wantrobski expects the Nasdaq to keep falling until it gets closer to its 200-day average. Some shorter-term indicators, including the 20-day average, have also rolled over in recent days, with the index well off its 50-day average. "When you have technical conditions lined up in one direction across multiple timeframes, that is your strongest conviction signal that … there's so much pressure in the market," Wantrobski said. Like most market moves, the action won't come in a straight line. Investors can expect some downward days followed by a slight uptrend, and the reverse. "We haven't really had more than one this year, so when you get used to having an uninterrupted uptrend in place, when you do get a 5% pullback, it gets worse," said Roth MKM's JC O'Hara. The chief technical analyst is also monitoring stocks on an individual level and those in the S & P 500 hitting new one-month lows. He's waiting for about 60% of the index to hit that level, and more closes below the 50-day average. "We're not washed out enough," he said. "We need to see more selling pressure before we get the signals that the incremental seller has sold and we're ready to move higher." Fairlead Strategies' Katie Stockton is closely watching a popular trend-following gauge known as the moving average convergence/divergence indicator, or MACD, which recently flipped to a sell signal after reverting to a buy in November. The shift, Stockton said, signals a loss of intermediate-term momentum and that markets have entered a corrective phase that could last several weeks. The next support levels for the Nasdaq, she noted, hover around 5% to 6% lower from levels seen during Friday's trading session. Pressure from yields Technical indicators may help analysts detect where the market is headed, but macroeconomic factors remain the major action drivers influencing sentiment. Some investors have become more optimistic about a pivot in Federal Reserve policy in the near future and the possibility that the central bank can skirt a hard-landing scenario. But rising bond yields have dented some risk appetite in recent weeks as the yield on the 10-year Treasury note hovers near its highest level since 2007 , and higher highs threaten to further pressure risk assets, including rate-dependent technology stocks. "The canary in the coal mine is going to be what happens with yields," O'Hara said. "The pullback can become much deeper if the 10-year yield breaks out to new highs. That's my worry right here."