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S&P 500, Russell 2000 and Nasdaq are at risk of pulling back, charts suggest

avatar by Editor
January 1, 2020
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S&P 500, Russell 2000 and Nasdaq are at risk of pulling back, charts suggest

New highs, new risks?

The stock market’s surge to fresh records hasn’t come without concern for Matt Maley, chief market strategist at Miller Tabak. In fact, he sees risks percolating that could pause the rip-roaring run, he told CNBC’s “Trading Nation” on Friday.

“We’ve got good news with the Russell 2000, the S&P [500] and the Nasdaq breaking key resistance levels, so, that’s positive. But all three of them are also getting quite overbought, so, it leads me to believe that we … may need to take a breather here early in the new year,” he warned.

Starting with the small-cap-heavy Russell, Maley pointed to the main indicator driving his worry: the relative strength index, or RSI, which tracks a stock’s momentum trends to determine whether it’s overbought or oversold.

“This [index] … hasn’t broken to a new high yet, but it has broken out of an 11-month sideways range,” he said. “Whenever you break out of a multimonth sideways range, especially [one] that long, it’s usually very bullish. But if you look at its RSI chart, not only is it overbought on a short-term basis, but its weekly RSI chart is overbought, as well, and that shows that on an intermediate-term basis, it’s getting to levels where it has been followed by pullbacks in the past … and, in some cases, fairly deep pullbacks.”

Same goes for the S&P 500, Maley said. While the index has repeatedly reached new all-time intraday highs — 34 this year, to be exact, including Friday — its weekly RSI chart is also starting to get a bit stretched, he said.

“Its weekly RSI chart [is] getting quite extended, and again, at levels where it has been followed by, at least, corrections of 5% or more over the last two years,” the strategist said.

Last but far from least was the chart of the Nasdaq Composite index, which reached the 9,000 record milestone in Thursday’s session.

“It’s had an unbelievably great breakout, well above its November highs, but it’s the most overbought of the bunch,” Maley said. “Again, it gives me concerns that over the near term, once we get into the new year and past this kind of year-end euphoria, you may see a little bit of a pullback.”

Still, as concerning as this seemed, Maley didn’t want to sound the sell alarm just yet.

“That’s not saying, ‘Oh my gosh, you’ve got to sell, the market’s going to zero, it’s going to flip over,’” he said. “But people with new money who’d like to put new money to work might want to keep a little bit of dry powder and, as they add a little bit into the new year, look for those dips of 5% or maybe even more to add to their favorite names.”

Steve Chiavarone, a vice president, portfolio manager and equity strategist at Federated Investors, echoed that sentiment.

“Of course we’re going to have a pullback,” the money manager said in the same “Trading Nation” interview. “Markets aren’t going to go up in a straight line. I think the issue, though, is that we didn’t have an over-bullish sentiment coming into this run, and so everyone wants to get into this market.”

In Chiavarone’s experience, “if everyone’s waiting for a 5% pullback,” the likelier outcome will probably be a 2% or 3% drop, which means investors should take advantage of down days, he said.

“We think you have to be aggressive on buying any dips as they come because we think the fundamental setup is good,” he said. “We’ve got a 3,500 target for [the S&P] next year based on the idea that economic growth, corporate earnings and manufacturing have bottomed and are rebounding and rates are staying low, and we think that’s bullish.”

As such, Chiavarone had one catch-up play he recommended buying.

“If you’re looking to add somewhere, yeah, you probably don’t want to go out and buy growth right now,” he said. “But when you look at that Russell 2000, small caps, as well as they’ve done, they’ve underperformed the S&P by 6% this year. So, we think that there’s opportunities in small caps, value and even some internationally, particularly emerging markets, that aren’t as expensive. And if you want to do some buying, those look like pretty good places.”

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