Even this long-time bull is worried about cracks in the tech stock rally. Here's how Tom Lee expects the market to shake out.

By Jamie Chisholm

Critical information for the U.S. trading day

The Dow Jones Industrial Average has just notched a ninth consecutive day of gains, its longest winning streak since 2017.

But significantly the latest advance occurred in a session that also saw the Nasdaq Composite record a 2% drop, its biggest loss in four months.

Is this the broadening of the market action that will allow for the bull run to continue in a more sustainable fashion? Or does the crack in technology stocks portend the start of a meaningful correction for the S&P 500 , which is still up 18.1% so far this year.

Well, worryingly for investors even Tom Lee, the seemingly perennially positive head of research at Fundstrat, is wary at the moment, describing some profit taking as "healthy."

The latest tremors, which have seen weakness in the high profile mega-cap tech names, alongside gains for defensives like utilities, healthcare and staples, and some negative signals from technical indicators, means the chorus of those calling for significant pullback is building, Lee says in a new note published late Thursday.

"So it bears watching whether a correction of 5% could be underway. That would be roughly 200-225 points of downside [for the S&P 500] and would be painful for investors," he says.

But this is Tom Lee, so the caution comes with a fat caveat: any dip is likely to be shallow. Here's why.

First, concerns about the market being overextended are overstated. Some traders are worried that an S&P 500 that was more than 12% above its 200-day moving average was overbought. But as the chart below shows, 8 of the last 12 instances when the market was that much above the trend line it still managed to move more than 20% above. It's just the sign of a strong market, Lee insists.

Next, institutional investors are already expressing skepticism. The latest Bank of America fund manager survey shows that cohort has equities as their most underweight asset class.

And a recent JPMorgan survey shows that only 17% of institutions plan to increase exposure to stocks in coming days and weeks, down from 85% in January 2022. Such negativity can prove to be a handy contrarian indicator.

Furthermore, the record bearish positioning in S&P 500 futures has started to unwind, a trend that four out of the last five times signaled "large positive moves" in equities, says Lee.

Finally, Lee reckons that there are some important events coming in the next few weeks that may lead to lower interest rates and thus support stocks. For example, the Federal Reserve's policy decision on July 26 could signal the last rate hike of the cycle. The June PCE deflator data two days later should mirror the benign June CPI report, while the July CPI report on Aug. 10 may display similar disinflationary pressures.

"So the next 2-3 weeks have positive fundamental catalysts, that we believe could positively surprise markets. Thus, the correction path has a somewhat narrow window. Meaning, the weakness could reverse by July 26th," Lee concludes.

Markets

U.S. stock-index futures are higher as benchmark Treasury yields are little changed. The dollar is a bit firmer, while oil prices rose and gold fell.

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The buzz

Second-quarter earnings season rumbles on. Among the companies presenting numbers on Friday are American Express (AXP), Comerica (CMA), Regions Financial (RF) and AutoNation (AN).

CSX Corp. (CSX) shares fell nearly 4% in premarket trading Friday after the railroad operator reported second-quarter sales that missed expectations, dragged by lower fuel and coal prices and weaker shipping volumes.

Shares of Sirius XM Holdings(SIRI) were down more than 8%. The stock jumped 42% on Thursday on an apparent combination of short covering, an unwinding of a spread trade involving Liberty SiriusXM, and possible buying related to a rebalancing of the Nasdaq 100 index.

Inflation in Japan rose to 3.3% in June. That's the first time it's topped the U.S. measure since 2015. However, the yen and Japanese government bond yields are sliding after reports that the Bank of Japan still won't consider tweaking its ultra-loose monetary policy after next week's meeting.

Spain goes to the polls for a snap general election this weekend.

There are no U.S. economic data of note due Friday.

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The chart

Shares of Carvana, the auto retailer, had a rough session Thursday, shedding 16.2%. That can happen when a stock has risen about 1,000 for the year to date. The charts below from Vanda Research illustrate what many in the market think is an important factor contributing to the remarkable rally: "Individual traders are likely responsible for the recent short squeeze given the surge in interest aligns with a step reduction in short positions," says Vanda.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

Ticker  Security name 
TSLA    Tesla 
INFY    Infosys ADR 
NVDA    Nvidia 
MULN    Mullen Automotive 
AAPL    Apple 
AMC     AMC Entertainment 
CVNA    Carvana 
NIO     NIO 
AMZN    Amazon.com 
NFLX    Netflix 

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-Jamie Chisholm

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07-21-23 0636ET

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