Wall Street’s modest recovery on Friday may have some investors hoping that the worst is over, in terms of event risk related to U.S.-North Korea tensions. However, Thursday’s decline may have done structural damage to the integrity of an uncannily buoyant stock market, the kind of hit that could signal further losses ahead.
The recent downdraft, which resulted in the worst weekly decline for the S&P 500 index SPX, +0.13% and the Nasdaq Composite Index SPX, +0.13% since late March, also pushed the indexes below a key technical line in the sand, one tracked by market technicians to gauge weakening momentum.
Both fell below their 50-day moving averages on Thursday, ending under that level for the first time since July 11. While the equity benchmarks have previously dipped below their short-term trend line a few times in 2017, only to rebound to new highs, this week’s sharp drop may just be the latest indication that bearish trends are occurring beneath the near-record levels of major indexes.
Even with Friday’s move higher, the S&P and Nasdaq remained below the moving average, suggesting the level may have gone from being a so-called support to markets, to a resistance level. Support refers to levels that typically elicits bidding from investors, pushing prices higher, while resistance refers to a point at which traders sell shares, possibly to consolidate gains.
The S&P rose as high as 2,448.04 on Friday—a whisper below the average, which is currently 2,448.27—but was unable to break through. The Nasdaq also moved within 0.1% of its moving average before faltering.
“You change your opinion in increments, and going under the 50-day is a warning, the latest warning,” said Frank Gretz, market analyst and technician for brokerage Wellington Shields & Co. “It isn’t the end of the world, but you need to start somewhere. This isn’t a sign that you need to sell everything, but it is a sign you need to be more careful.”
While the Dow Jones Industrial Average DJIA, +0.07% didn’t breach its own 50-day moving average on Thursday—indeed, it remained more than 1% above it—that may not be the reassuring signal it appears to be. The Dow comprises 30 of the market’s biggest companies, a category that has done exceedingly well this year thanks to the U.S. dollar DXY, -0.34% whose weakness has bolstered the profitability of some its multinational components.
The picture is very different for small companies.
The Russell 2000 RUT, +0.12% is up a mere 1.2% thus far in 2017, well below the 9.2% rise of the S&P 500. The Russell, a compilation of small-cap names, hasn’t closed above its own 50-day average since Aug. 1, and Thursday’s tumble brought it within a whisker of its long-term trend line: the 200-day moving average, viewed as a proxy for longer-term momentum trends.
Gretz said the Russell “has been weak for a while” and noted the small-cap index had fallen beneath its 50-day moving average even on days when the S&P ended at records.
Because small capitalization stocks tend the be the most sensitive to changes in economic prospects or overall investor sentiment, a rise in small caps in tandem with its larger-cap brethren tends to point to a healthy market.
Gertz said the recent deterioration in the Russell 2000 alongside the S&P 500 may add further evidence of this breakdown.
“The market is full of these subtle divergences, and they came home to roost yesterday.”
The largest exchange-traded fund to track the small-cap index, the iShares Russell 2000 ETF IWM, +0.15% has seen outflows of more than $1.7 billion over the past month, according to FactSet data, the most of any ETF on the market. While there is little correlation between flows and future performance, the outflows could be a sign that investors are abandoning smaller stocks at a time when broad gains have been led by a few huge outperformers. The lion’s share of S&P 500’s year-to-date rise, for example, has come on the back of the so-called FAANG stocks, a quintet of internet and technology names.
Of those five, Facebook Inc. FB, +0.41% Apple Inc. AAPL, +1.39% and Netflix Inc. NFLX, +1.34% all remain above their 50-day averages, while Amazon.com Inc. AMZN, +1.16% and Google-parent Alphabet Inc. GOOGL, +0.70% have both fallen and remained below their in recent weeks.
How severe has the divergence between rising stocks and losers gotten?
There were 166 New York Stock Exchange-listed issues hitting 52-week lows on Friday, compared with just 23 hitting new highs. That’s the widest such margin in 18 months, and it comes on a day when the S&P 500 ended higher by 0.1%. The margin was notably wider than on Thursday, the day of the selloff.
On Thursday, 87% of trading volume on the New York Stock was for declining stocks, while 13% was for advancers, a trend that was similar for Nasdaq names, according to data from Frank Cappelleri, an executive director at Instinet.
According to data from StockCharts, only 33.27% of Nasdaq-listed stocks remain above their 50-day moving average, down sharply from a recent peak of 66% on July 25. Fewer than half of Nasdaq stocks—49.6%—are above their 200-day average, compared with 64% on July 25.
For S&P 500 stocks, 44.69% of components are above their 50-day moving average, down from a July 19 peak of 74%. Nearly 69% of S&P components remain above their 200-day moving average, but that’s down from 77% in late July.
For Nasdaq stocks, both the share of stocks trading above their 50-day and the 200-day averages represent the lowest since October. For the S&P, both are the lowest since late May.
Those factors may offer further evidence for bears that more pain may be ahead for Wall Street.