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Investor exuberance over massive sums being spent on AI infrastructure is quickly souring.
Following a brief surge, semiconductor stocks are pulling back. Micron Technologies (MU) shed 20% in just four weeks. Intel (INTC) has given back 25% in less than a month.
Semiconductor stocks have collectively lost over $3 trillion in market capitalization and fallen into a bear market from the late June peak.
That’s dragging tech-heavy indexes lower, including the Nasdaq-100 and the Invesco QQQ Trust, Series 1 (QQQ) that tracks it.
Key chart levels on the Nasdaq-100 are giving way, which I warned you about recently.
While we’re seeing a relief rally in technology shares to start the week, that’s bringing the Nasdaq-100’s price back to a make-or-break level that could tip the next big move.
The pullback in semiconductors (and its impact on major indexes) shouldn’t come as a surprise. Surging stock prices since April left prices ripe for a mean-reverting move lower.
At the same time, volatility in the Nasdaq was shooting higher relative to the S&P 500. I had this to say about a month ago:
Volatility measures across the S&P and Nasdaq tracked closely to start the year. But starting in April, Nasdaq volatility started trending higher.
Even though the Nasdaq-100 has rallied to record highs, implied volatility is now trading at the same level as in late March, back when the Nasdaq fell into a correction.
That shows a major disconnect between the price action in the Nasdaq and expected measures of volatility. Remember, volatility tends to increase when stocks are selling off – and vice versa.
At the same time, the Nasdaq’s chart was flashing a warning sign that upside momentum was fading quickly.
Here’s what I noted about the chart:
As the Nasdaq tests the prior high, the Relative Strength Index (RSI) is making a lower high…
The RSI measures underlying price momentum, and the divergence shows that upside momentum is fading. When a stock’s price makes a new high but the RSI doesn’t, it’s a sign that the buying pressure fueling the AI rally is weakening… and the odds of a reversal are growing.
The Nasdaq did pull back as the AI trade came under pressure, while also losing a key chart level along the way.
Now the recent action is setting up another test… and it’s one that AI and chip bulls don’t want to fail.
A jump in volatility and a negative price-momentum divergence on the RSI provided all the right ingredients to see a pullback in the Nasdaq.
Following the loss of a key level, the Nasdaq-100 is now setting up an important test. Here’s the updated chart below:
When the Nasdaq-100 lost the 50-day moving average (MA – blue line), it also broke down from a triangle pattern (shown with the dashed lines).
Here’s where the important test comes into play. Following a loss of a key level, a stock or index will often come back to test that area, whether it’s a moving average or a trendline.
That’s exactly what you’re seeing with the Nasdaq’s price action this week. A rally over the past couple of sessions has brought the Nasdaq-100 right back to the lower trendline of the triangle, which is also close to the 50-day MA (arrow).
That captures the price area around 29,000 to 29,500 on the Nasdaq-100, or $710 to $720 if you’re watching QQQ. Those former support levels now serve as resistance.
Here’s what to watch for next.
My base case scenario is that the Nasdaq will resume its downtrend following the test of resistance. The relief rally will be just enough to fool investors into thinking the worst of the decline is over. But we’ll watch for the downtrend to resume as the Nasdaq rolls over.
On the other side, if the Nasdaq can quickly recapture the 50-day, then it will be a failed breakdown.
The price action around the Nasdaq 29,000 level will set the tone for the AI trade in the weeks ahead, so pay close attention.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
