Stock Market Slump Welcome After Fomo Rally, Bulls Say

The rapid ascent of U.S. stocks, characterized by a sustained and vigorous rally, encountered a significant setback on Wednesday, marking the most substantial decline in major indexes in several months. For those bullish investors seeking a respite to rejuvenate an overstretched market, this pullback was a welcome development. On the contrary, bears argued that the retreat hinted at the market rally being constructed on unstable foundations.

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The Dow Jones Industrial Average (DJIA) experienced a notable drop of 475.92 points, equivalent to a 1.3% decrease on Wednesday. This represented its most substantial one-day percentage decline since October 3, snapping a streak of five consecutive record-setting finishes. The S&P 500 (SPX), which had surged to within 1% of its January 3, 2022, record close, retreated by 1.5%, closing just below 4,700 and marking its most significant percentage decline since September 26. Likewise, the Nasdaq Composite (COMP) witnessed a 1.5% drop, the largest since October 26.

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Before Wednesday's setback, both the Dow and Nasdaq had experienced a nine-day rally. This accelerated move, starting from the October lows, had propelled major indexes into significantly overbought territory according to technical indicators, as highlighted by analysts.

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Despite this pullback, all three major indexes showed a robust rebound early on Thursday. Market economist Ed Yardeni of Yardeni Research concurred with the prevailing sentiment that the market was overbought and due for a correction, maintaining a year-end target of 4,600. Yardeni, however, remains optimistic in the long term, anticipating the S&P 500 to reach 6,000 within two years.

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Bullish sentiment had reached extreme levels, as indicated by investor surveys. Nevertheless, technicians emphasized that heavy bullish sentiment is a less reliable signal for market tops compared to heavy bearish sentiment as an indicator of bottoms.

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In a Thursday morning note titled "Embrace Weakness," technical analyst Jeff de Graaf, chairman of Renaissance Macro Research, suggested that a setback in an uptrend with momentum is a buying opportunity. He pointed out that any weakness, likely not exceeding 3-5%, is considered buyable for those with a six-month horizon.

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However, bears anticipate further weakness. Michael Kramer, founder of Mott Capital, expressed concern that the entire rally had been built on an unstable foundation, likening it to a pile of loose sand. He projected the potential for the S&P 500 to retreat to 4,100 over the next several weeks.

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The expiration of options contracts on the Cboe Volatility Index (VIX) on Wednesday was identified as a contributing factor to the selloff. Options activity had suppressed the VIX, commonly known as Wall Street's fear gauge. Kramer also referenced Elliott Wave analysis, a form of technical analysis indicating market waves, which pointed to a potential peak.

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While cautious not to make an overly pessimistic call, Kramer acknowledged better alignment in the current scenario, considering the count that works, the rising VIX, and the S&P 500's inability to get more overbought than in recent days. He concluded, "So again, if this is some top, it would make sense."