(Bloomberg) — The Nasdaq Composite Index tumbled into an ominous “death cross” technical formation Friday for the first time since April 2020, when the pandemic battered the global economy and U.S. equity markets swooned.
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Following Friday’s 1.2% decline, the index has now shed 16% since touching a record high on Nov. 19. The pattern, which is used by some investors to assess longer-term trends, has at times presaged further weakness. It appears when an index’s short-term 50-day moving average crosses below its longer-term 200-day moving average.
The formation occurred in June 2000 when the dot-com bubble burst and again in January 2008 ahead of the global financial crisis.
“When you hear ‘death cross’ your antenna goes up,” Jay Woods, chief market strategist at DriveWealth Institutional, said in a phone interview. “It doesn’t always mean doom and gloom is coming. It just means we’ll likely be in a more extended downtrend.”
With inflation surging, the Federal Reserve is preparing for its sharpest monetary policy tightening in decades in an attempt to bring down prices. This has sparked wild swings among the rate-sensitive tech, Internet and growth stocks that fill the Nasdaq Composite, since their elevated valuations become targets as borrowing costs rise.
To be sure, a death cross has historically been a lagging indicator, meaning that by the time it appears, the move has already occurred in stocks. For instance, the Nasdaq entered a death cross in April 2020 but the index actually bottomed in March of that year, Woods explained.
“This could actually be a buying opportunity for longer-term investors since stock prices are getting cheaper,” Woods added.
Since 1971, there have been 31 death crosses for the Nasdaq Composite, according to data compiled by Potomac Fund Management. The index rose over the next 21 days 71% of the time, and it was higher six months later 77% of the time.
“A signal like the death cross has preceded major drawdowns in the past, but there hasn’t always been a major market decline following one,” said Dan Russo, portfolio manager at Potomac Fund Management. “Market breadth is still a concern for investors right now, but as long as we stay above the January lows, it will likely be choppy consolidation. If we fall below those lows though, I think it’s a good idea to manage your risk.”
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