Tags: runaway | nasdaq | reason | caution | charts

Runaway Nasdaq: A Reason for Caution Is in the Charts

Runaway Nasdaq: A Reason for Caution Is in the Charts
(Daniel Kaesler/Dreamstime)

Wednesday, 24 June 2020 12:29 PM

Since hitting intraday lows on March 23, the Nasdaq Composite index has rebounded and pulled ahead of the S&P 500, but a technical market analysis suggests that the tech-laden index may be vulnerable to a deep retreat.

Investors have piled into big technology stocks in the past few weeks, betting companies such as Amazon.com Inc, Alphabet Inc’s Google and Facebook Inc will do well in the post-coronavirus world because their earnings are perceived as being relatively insulated from the effects of the lockdown.

The Nasdaq reached record highs this month and is now up 13% for the year. That’s outpaced the S&P 500, which is down about 3% for the year.

Many investors have been questioning the rebound in U.S. stocks, as a severe economic downturn, record unemployment levels and fears of a second wave of infections have created a disconnect between the real economy and valuations.

Protests over police brutality and racism, and the looming presidential elections further add to this divergence. A technical analysis of both near-term and long-term charts of the Nasdaq Composite suggests caution may be warranted.

BEARISH DIVERGENCE

The long-term, monthly chart of the Nasdaq Composite shows that the relative strength index (RSI), which measures how quickly and by how much the index has moved, is losing steam.

While the RSI is rising, it remains shy of its peaks from 2018, despite the Nasdaq being on track for its highest monthly close ever. This lag, known as a bearish divergence, shows the composite's push to new highs has been getting progressively weaker over time.

Looking back to 2013, the analysis shows that three major declines in the Nasdaq, as well as a number of minor setbacks, were preceded by such monthly momentum divergence.

SHORT-TERM OVERBOUGHT

A pullback is not certain, however. A technical analysis of shorter-term charts, which can help pinpoint when a trend may be turning, paints a murkier picture. Traders use the 50-day moving average as a gauge for the intermediate-term trend, and the Nasdaq is currently above this rising line, indicating that the index could keep moving up in the near term.

An analysis of the RSI on a shorter-term basis is inconclusive. The daily RSI became its most "overbought" since January earlier this month, indicating that the index had moved up too far, too fast, and was primed for a reversal. Indeed, after that happened on June 10, there was a 6% pullback over the next three trading days. But the Nasdaq Composite quickly recovered and has moved to new highs.

The recovery does not mean the threat of a pullback is over. The RSI is rising, too, but more slowly, setting up the possibility that a bearish divergence will develop. That’s what happened in the run up to the high reached in February.

In late December, the Nasdaq hit its most overbought level in nearly three years. The index saw some sharp retreats in the period that followed but kept going for about two more months amid waning momentum, rising as much as 9% before the coronavirus crash.

© 2020 Thomson/Reuters. All rights reserved.


   
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Since hitting intraday lows on March 23, the Nasdaq Composite index has rebounded and pulled ahead of the S&P 500, but a technical market analysis suggests that the tech-laden index may be vulnerable to a deep retreat.
runaway, nasdaq, reason, caution, charts
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2020-29-24
Wednesday, 24 June 2020 12:29 PM
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