Overheated Market Gets a Needed Splash of Cold Water

For many investors, a sharp intraday drop in the indexes is good news. The indexes gapped up higher to start the day, following a strong report from Meta Platforms (META) and some semiconductor names. In addition, the Dow Jones was on pace for its 14^th straight day of gains, which last happened in 1987.

It looked like another strong run for the indexes that have been crushing bears and underinvested bulls, but around 1 p,m, ET, the market started to roll over, and the selling accelerated into the close. There was no surprise news to trigger the selling. It was just a market that had overheated and needed to cool off.

While the recent frothy action has been great for fully invested buy-and-hold investors, it has been miserable for traders who have been trying to find prudent entry points and put cash to work. The only way to get into many of the best-performing stocks is to chase very extended charts or buy new highs. Before the reversal today, around 740 stocks were hitting new highs. Breadth turned very ugly and went from positive to around 1,700-6,650 negative. The Russell 2000 small cap fund (IWM) ended up with its lowest close in eight sessions, but the Nasdaq 100/Invesco fund (QQQ) ended up closing near flat.

The obvious question is whether this action is a significant market top. The answer is that it is too early to say. The key will be whether there is follow-through action tomorrow and next week. Typically markets this strong will see dip buying by those that have missed out, which will provide support and prevent an immediate crash. Nothing really changed today other than the fact that overbought conditions became so severe that it triggered some significant profit-taking.

The bulls have done so well for so long that they are entitled to some weakness, but If dip buyers are trapped in a failed bounce more than once, then the character of the action will shift, and it will be easier for the bears to press.

If you have been holding long, then you probably suffered some losses today, but if you have idle cash, then this is good news that will make some new entries easier.