Even as the stock market continues to surge more than 25% from its mid-October low, some investors are expecting a correction.
Fundstrat technical analyst Mark Newton expects more upside in the second half of the year, but he is looking for potential red flags.
These are eight warning signs investors should monitor for a potential stock market sell-off, according to Fundstrat.
Despite the stock market's near-30% rally since its mid-October low, not all investors are convinced that a new bull market has started.
For those investors, Fundstrat technical analyst Mark Newton highlighted the top warning signs to monitor to gauge whether a stock market correction is imminent.
To be clear, Newton is bullish on stocks for the second half of 2023. He increased his technical price target for the S&P 500 to 4,700 from 4,500, and said that most of the warning signs he monitors have yet to flash, suggesting that there could be more upside ahead.
"Seasonality trends remain quite bullish for pre-election years and markets have just [seen] the best two quarters of the entire four-year cycle. However, July normally is also still bullish," Newton said.
But since 1980, the S&P 500 has seen an average intra-year decline of about 14% each year, even when it finishes with annual gains. So there could still be a sell-off on the horizon, and investors should be prepared.
These are the eight warning signs investors should monitor to gauge whether a stock market correction is imminent, according to Fundstrat.
1. Evidence of speculation and complacency
"While a few investor sentiment polls have gotten more optimistic, these are not yet at levels of complacency/speculation that have resulted in prior market downturns," Newton said. Investors can look at CNN's Fear and Greed Index or the AAII weekly investor sentiment survey to measure levels of investor complacency.
2. Defensive strength
"When Utilities, Staples, REITS begin to strengthen sharply on an absolute and relative basis, this normally can precede market corrections," he said.
3. Negative momentum and breadth divergence
"When fewer and fewer stocks are participating in rallies, this has served as a warning – see early 2020, as well as 2021, as examples," Newton said. So far this year, the mega-cap tech stocks have driven a bulk of the gains in the stock market.
4. Seasonality concerns
"US stocks are now leaving the best two quarters of the entire four-year cycle. While Pre-election years as a whole tend to be bullish, the back half of 2023 could show more volatility."
5. DeMark exhaustion
"When TD Combo, TD Sequential 13 countdown signals appear on weekly and/or monthly charts, markets can show potential trend reversals," Newton said, referring to Tom Demark indicators.
They help technical analysts measure the supply and demand of a given security and have been known to highlight important inflection points in price trends. The indicators are commonly utilized by various strategists on Wall Street.
6. Trend deterioration in key market sectors
"If/when these sectors [financials and technology] start to break existing uptrends, markets can face possible headwinds."
7. Overbought market conditions on weekly, monthly basis
"While some investors have remarked that US Equities are overbought, this has mainly only been seen in $QQQ, and not DJIA, nor weekly or monthly charts of Equal-weighted SPX."
8. Intra-market divergence
"Markets are healthiest when indices are moving up in tandem. When this changes and various indices start to lag, that can be problematic and a warning."
