Why This Market Washout Will Spark a Year-End Rally

Why This Market Washout Will Spark a Year-End Rally

Over the past few weeks, interpreting the market has been more difficult than normal. From a macro perspective, the picture has gotten bleaker, with higher interest rates and soaring energy prices. Conversely, a flurry of new innovations and AI spending have buoyed the overall market. However, this week, the AI piece of the market’s Jenga tower was removed after Chinese company announced progress in its memory technology and neocloud debt fears spooked investors. However, despite the market’s ugly price action the pullback may be the flush that bulls need to stage a year-end rally. Below are 5 reasons to be bullish into year-end:

Market Breadth Improves

Lately, the biggest concern for Wall Street investors has been weakening market breadth (participation). For instance, while the Nasdaq recently notched few highs, those highs were driven by robust performance in a handful of mega cap tech stocks like Meta Platforms (META). However, after a blood red open on Thursday morning, markets showed healthier market breadth into the close. With one hour left in the trading session, there were 74.43% advancers on the NYSE and 59.41% on the Nasdaq 100 Index.

Nasdaq 100 Fills Gap

When a stock or market index move in overnight trading, they often leave a blank space on a chart, better-known as a gap. These gaps act as psychological magnets where selling pressure exhausts and buyers’ step in once they are filled. For instance, the early September rally began after Nasdaq 100 Index (QQQ) filled its August gap. Is QQQ ready to provide some deja vu?

Meanwhile, several AI-related stocks such as Advanced Micro Devices (AMD), Micron (MU), and Nebius Group (NBIS) printed “hammer” candles off support levels. A hammer candle occurs when a stock has a wide intraday range that closes near the high of the day. Hammers signal seller exhaustion and often provide the washout that bulls need.

Semiconductor Washout Signals Bounce Potential

Amid hotter U.S. inflation, AI debt concerns, and the pressure on memory stocks, the iShares Semiconductor ETF (SOXX) has fallen for 8 consecutive sessions, marking its longest losing streak since 2010. The good news for investors is that in the past six instances where the SOXX declined for 8 straight sessions, it gained ground 2 days later 100% of the time.

Sentiment Signals Extreme Fear

The CNN Fear/Greed Index has remained in the “fear” zone since early September. Similar instances have acted as reliable market bottom indicators.

Q4 Seasonality Tailwinds

Historically, October is the strongest month of the mid-term election seasonality cycle. On average, the Nasdaq delivers more than 3% returns. While the market has been weak thus far in October, investors must recognize that the October strength often begins in the back half of the month.

Bottom Line

While macro headwinds and AI volatility have unsettled investors, the recent price action reflects a classic market washout rather than a trend reversal. With extreme fear, technical gaps filled, and strong seasonality on the horizon, the stage is set for bulls to regain control.

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This article originally published on Zacks Investment Research (zacks.com).

Zacks Investment Research