Too Much Bullishness Has Left Sellers in Control of Stock Market

Amid the darkest stretch for U.S. stocks since 2018, one thing is clear. American investors are paying dearly for the optimism that drove the S&P 500 to record after record at the start of the year.

While big declines often follow big run-ups, this reversal — coming after weeks of euphoric buying — has been almost historically violent. In the 33 trading sessions ending last Wednesday, the S&P 500 fell on successive days only once. Now it’s had four straight down sessions, the first time since at least 1927 that the index fell so fast in the days after hitting a record.

The speed with which sentiment went from one extreme to the other can be seen in how pervasive losses have been. Consider this chart of NYSE breadth:

It shows the number of NYSE-traded stocks that retreated in the past two days has been the highest of the almost 11-year bull market.

The drubbing is affirmation for skeptics who spent January and February ridiculing investors for their complacency. Conspiracy theories abounded over the first seven weeks of 2020. Disbelieving veterans attributed the market’s buoyancy to everything from passive inflows to Federal Reserve repo operations to U.S. deficit spending — the list wasendless.

Now the warnings are bearing out. Take this graph of the Nasdaq 100’s 14-day relative strength index, a gauge of the magnitude and persistence of price movements. At one point, it was the worst four-day stretch on record — worse, even, than during the bursting of the dot-com bubble. When the dust settled, the RSI move was the biggest since October 1989.

“It’s hard to tease out how much is due to extreme bullish sentiment reversing, and how much is due to the realization that a global pandemic could be unfolding,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance. “It’s at least in large part due to the former.”

Another chart, plotting stocks trading at downticks versus upticks, paints a similar picture of desperation. At around 2:30 p.m. New York time Tuesday, almost 1,800 more stocks traded at lower prices on the New York Stock Exchange. That was the most extreme reading since the May 2010 flash crash.

A fourth day of hair-trigger selling has sent the S&P 500 below its 100-day moving average line, a key level of support closely watched by chart jockeys. The indexhad already this week broken below its average price for the past 50 days, leaving the 200-day line as the next potential break, as far as technical analysts are concerned. Should the S&P fall an additional 2.7%, it would breach that level as well.

“Those tech lines should matter — it tells you the psychology is changing,” said Mark McCormick, global head of FX strategy at TD Securities. “When markets are not trading on growth or fundamentals, a turn in sentiment nearly always leads to a drawdown in the things that are overbought and trading at a premium.”

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