Concerns of a Shaky Foundation
However, bearish investors argue that this pullback may indicate that the market rally was built on unstable grounds.
The Dow Jones Industrial Average (DJIA) plummeted by 475.92 points or 1.3% on Wednesday, marking its most substantial one-day percentage drop since October 3. Similarly, the S&P 500 (SPX), which had reached a record close on January 3, 2022, came down by 1.5% to close just below 4,700.
The Nasdaq Composite (COMP) also experienced a 1.5% drop, the highest since October 26.
Analysts highlight that the rally had pushed major indexes into significantly overbought territory according to technical indicators.
“We agree, which is why we haven’t raised our longstanding year-end target of 4,600,” said market economist Ed Yardeni of Yardeni Research.
Interpreting Sentiment Signals
While heavy bullish sentiment may not always signify market tops reliably, technicians argue that heavy bearish sentiment often acts as a signal for bottoms.
Looking at future returns for S&P 500 futures (ES00) compared to the Consensus Inc. measure of sentiment, experts note that the bar “is higher to be bearish” based on sentiment metrics.
“We’re in the camp that any weakness, unlikely to be more than 3-5%, is buyable for those with a [six-month] horizon,” wrote de Graaf, highlighting their optimism despite the anticipated minor market correction.
Caution and Potential for Further Decline
Founder of Mott Capital, Michael Kramer, cautioned that the entire rally appeared to be built on uncertain foundations, suggesting a potential retreat for the S&P 500 to approximately 4,100 over the next few weeks.
He also emphasized that options activity had contributed to suppressing the VIX, Wall Street’s fear gauge, and that Elliott Wave analysis pointed to a market peak.
However, Kramer acknowledged the challenge of predicting a precise downside target and noted that previous intraday reversals during the rally failed to indicate a definitive top.
Nonetheless, he believed that the current alignment of factors—such as a viable count, rising VIX, and overbought S&P 500—suggested that if this was indeed a market top, it would make logical sense.