US Indices in Correction: Rebound or Further Down

The Nasdaq and DJIA both entered correction territory, with the tech-heavy index under particular strain beyond the potential repercussions of the war in the Middle East.

The Market-Moving Developments

• Major US indices entered a correction after five weeks of losses, with the Nasdaq the worst performer.
• While uncertainty around the war has pressured equities, the Nasdaq is particularly vulnerable given concerns around private credit exposure to software companies.
• The rotation from tech to industrials has effectively ended amid concerns about higher inflation.
• Rising rates could worsen credit issues affecting tech stocks as well as weigh on high-valuation software stocks, putting particular pressure on the Nasdaq.

Tech Stocks Weighed By AI, Credit Exposure

US indices have recorded five consecutive weeks of losses across the board, with both the DJIA and Nasdaq falling more than 10% from their peaks, officially entering correction. Given the market disruption from the war in the Middle East and heightened expectations for Fed hawkishness, the surprise isn't so much that US equities are in correction territory as that it took so long to happen. The easiest explanation for the drop is simply that traders fear rising costs, which would slow business and consumer activity and hurt the return on investment from equities. But US stocks, in particular, have managed to avoid the losses of their Asian and European peers, as energy costs are not expected to rise as much. Offsetting losses from exposure to the Middle East, US oil companies are projected to reap profits from higher global energy prices and increased sales. However, that narrative could be starting to crack as the war enters its second month and more infrastructure is affected. Iranian airstrikes damaged two major aluminium plants in the Middle East as the war escalated over the weekend, potentially raising the cost of industrial metals alongside already rising fertiliser and chemical prices.

While this narrative can explain declines in global equities, it doesn't explain why the tech-heavy Nasdaq is the worst-performing major US index. The war might get most of the attention and overshadow other underlying issues, but that doesn't mean those problems have gone away. Traders were already worried about the situation for software providers as AI makes coding much easier, and concerns about private credit exposure to software firms have only grown as headlines have focused on Iran. Many tech and edge companies rely on private credit instead of traditional financing, given the high risk of their ventures. The concern is that a loss of creditworthiness among software companies disrupted by AI could trigger a cascading effect across the financial system. Even if it doesn't lead to a full-blown financial crisis, private equity is restricting its investments in software firms, making it harder for those companies to fund themselves. This is a particular problem for high-valuation companies that need to grow to satisfy investor expectations.

Upwards, Downwards, or Rotation?

Traders who were concerned about software companies being disrupted by AI in January and February were rotating into more defensive stocks, such as those in the DJIA. But this play has evaporated, as industrial firms are now likely to be adversely affected by higher inflation, effectively ending the rotation trade. Amid the uncertainty, investors have instead opted out of equities, with the Nasdaq the most vulnerable to rising yields as the war persists. While markets jump or fade on hopes of a ceasefire or other end to the conflict, the trend for the Nasdaq, in particular, might be downward until the uncertainty around future rate hikes and the private credit situation is resolved.

Nasdaq Double Top Neckline Breakdown

Following the peak at 26250  and subsequent move under the 24k support, the Nasdaq has confirmed a bearish breakout after trading for at least three sessions below support. Notably, the breakdown point appears to be the neckline support of a double top pattern, which often extends the height of the pattern that currently spans 2550 points. If the text-heavy US index fails to reclaim 23k and the 23500 swing support, the odds of sliding towards 21750 will increase, especially if 22660 gives way to bears. On the upside, bulls must reclaim the neckline support to make a respectable attempt to reverse the recent bearish course of the Nasdaq.

Source: SpreadEx | US Tech 100, Daily Chart