Fears of a software apocalypse could drag the market into another sharp decline.
That’s according to Wall Street forecasters who say they’re eyeing an increased risk of another sharp pullback in US stocks amid the chaos that’s hammered software and the broader tech sector in recent weeks. They say a handful of worrying signals are flashing in the market, pointing to indicators like waning stock momentum and increased options activity.
In a note to clients on Tuesday, Goldman Sachs analysts said they estimate that the risk of another drawdown has increased from 23% to 28%, after accounting for recent volatility and slowing momentum in US equities.
The bank pointed in particular to the drop in equity momentum, a measure of how quickly stocks are rising or falling. Though the S&P 500 is up over the last six months, the index’s momentum has fallen around 4.3% — a key threshold that has historically signaled “larger drawdowns” are on the way, analysts wrote.
When the index’s momentum has dropped more than 4.3%, the index has fallen an average 10% over the following 12 months, the bank said, citing its analysis of stock moves since 1950.
“The unwind over the past 6 months is currently on the cusp of this level,” analysts wrote.
Technical analysts at Piper Sandler also flagged a potential warning sign in its measures of the market’s momentum.
“Our short-term momentum oscillators signal a fatigued market setting up for a pullback within its uptrend. Be vigilant about chasing breakouts and wait for confirmed support before adding to positions,” the firm said in a client note on Wednesday.
Torsten Slok, the chief economist at Apollo, said he also saw the potential for sharp swings in the S&P 500. In a note on Wednesday, he pointed to the fact that more companies in the benchmark index are trading on their own fundamentals rather than moving as a group. More stocks are also moving more than 10% in a single day.
Meanwhile, options trading in the S&P 500 looks “extremely elevated,” suggesting “heavy retail speculation and leverage-like exposure” among investors, he added.
“Larger idiosyncratic moves and outsized options participation leave the market structure more fragile and more vulnerable to an abrupt, outsized move,” Slok said.
