Hoping for More Upside? Don’t Fear the Pullback
When investors feel indestructible, the market has a way of proving them wrong.
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On Monday, the major stock indices got exactly what they needed: an old-fashioned whooping.
Does that sound like I’m rooting for stocks to fall? That’s not the case. I’m just hoping that some sense of balance can be restored to the markets. Traders have become complacent, due to an ever-climbing market.
Complacency has a long, ugly history in the stock market. The Roaring Twenties are a perfect example.
From 1922 through 1929, stocks climbed at an average annual rate of about 18%. Easy gains led to complacency, which culminated in the crash of 1929. The Dow Jones Industrial Average would lose 89% of its value in less than three years.
Gains in internet-related stocks in 1999 led to complacency, as the tech-laden Nasdaq Composite gained 85.59% that year. This was immediately followed by a stock market crash in 2000, led by over-inflated tech stocks.
Five years later, Time’s infamous "Home $weet Home" magazine cover signaled growing complacency in the housing market, foreshadowing the coming real estate and stock market crashes of 2008.
In all of the above cases, runaway gains lulled investors into a false sense of security. When investors feel indestructible, the market has a way of proving them wrong.
The S&P 500 fell 2.32% on Monday, closing at its lowest level in over a month.
In doing so, a bullish trend line that had been intact since early May (green line) was broken. Note that the S&P 500 stopped falling when it reached its 50-day moving average (blue). The index is still well above its 200-day moving average (red), currently located at 4969.
Earnings will play a role in determining if the index can remain above its 50-MA. This week’s reports from Tesla TSLA and Alphabet GOOGL weren’t well received. Next week is huge, with Microsoft MSFT scheduled to report on July 30, and Apple APPL slated for August 1.
The Nasdaq 100 fell 3.65% on Monday, marking its worst one-day percentage decline since October 2022. The tech-heavy index has lost its 50-day MA (blue).
The Nasdaq 100 has no obvious support nearby, which is exactly what happens when an index makes a straight-line bull move. In order to remain healthy, bull markets need occasional pullbacks. This so-called “backing and filling” creates support levels, which cushion the blow when stocks are losing ground.
Even after Monday’s fierce selloff, the S&P 500 is still up 14.43% year to date. The Nasdaq 100 boasts a 15.04% year to date gain.
If this turns out to be yet another “buy the dip” scenario, stocks will climb to new heights, and there’s nothing wrong with that.
However, in order to create a pullback worthy of the gains stocks have accumulated over the past few years, a deeper decline may be needed. We have a choice: Approach that pullback with fear or understand that it’s part of a process.
At the time of publication, Ponsi was long TSLA.
