June 24, 2020 / 3:33 PM / 15 days ago

COLUMN-Runaway Nasdaq: A reason for caution is in the charts

 (Terence Gabriel is a Reuters market analyst. The views
expressed are his own)
    By Terence Gabriel
    NEW YORK, June 24 (Reuters) - Since hitting intraday lows on
March 23, the Nasdaq Composite index has rebounded and
pulled ahead of the S&P 500, but a technical market
analysis suggests that the tech-laden index may be vulnerable to
a deep retreat. 
    Investors have piled into big technology stocks in the past
few weeks, betting companies such as Amazon.com Inc,
Alphabet Inc’s Google and Facebook Inc will do
well in the post-coronavirus world because their earnings are
perceived as being relatively insulated from the effects of the
lockdown. 
    The Nasdaq reached record highs this month and is now up 13%
for the year. That’s outpaced the S&P 500, which is down about
3% for the year.
    Many investors have been questioning the rebound in U.S.
stocks, as a severe economic downturn, record unemployment
levels and fears of a second wave of infections have created a
disconnect between the real economy and valuations. Protests
over police brutality and racism, and the looming presidential
elections further add to this divergence.
    A technical analysis of both near-term and long-term charts
of the Nasdaq Composite suggests caution may be warranted.
    
    BEARISH DIVERGENCE 
    The long-term, monthly chart of the Nasdaq Composite shows
that the relative strength index (RSI), which measures how
quickly and by how much the index has moved, is losing steam. 
    While the RSI is rising, it remains shy of its peaks from
2018, despite the Nasdaq being on track for its highest monthly
close ever. 
    This lag, known as a bearish divergence, shows the
composite's push to new highs has been getting progressively
weaker over time. 
    Looking back to 2013, the analysis shows that three major
declines in the Nasdaq, as well as a number of minor setbacks,
were preceded by such monthly momentum divergence.
 
 
    SHORT-TERM OVERBOUGHT   
    A pullback is not certain, however. A technical analysis of
shorter-term charts, which can help pinpoint when a trend may be
turning, paints a murkier picture.
    Traders use the 50-day moving average as a gauge for the
intermediate-term trend, and the Nasdaq is currently above this
rising line, indicating that the index could keep moving up in
the near term.
    An analysis of the RSI on a shorter-term basis is
inconclusive. The daily RSI became its most "overbought" since
January earlier this month, indicating that the index had moved
up too far, too fast, and was primed for a reversal.
    Indeed, after that happened on June 10, there was a 6%
pullback over the next three trading days. But the Nasdaq
Composite quickly recovered and has moved to new highs. 
    The recovery does not mean the threat of a pullback is over.
The RSI is rising, too, but more slowly, setting up the
possibility that a bearish divergence will develop.  
    That’s what happened in the run up to the high reached in
February. In late December, the Nasdaq hit its most overbought
level in nearly three years. 
    The index saw some sharp retreats in the period that
followed but kept going for about two more months amid waning
momentum, rising as much as 9% before the coronavirus crash.
   
 
 
 
    
 (Editing by Alden Bentley, Paritosh Bansal and Steve Orlofsky)
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