These are the 8 warning signs that investors should watch out for to know if a stock market correction is imminent

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  • Even as the stock market continues to gain more than 25% from its mid-October low, some investors are anticipating a correction.

  • Fundstrat technical analyst Mark Newton expects more upside in the second half of the year, but is on the lookout for any potential red flags.

  • According to Fundstrat, these are eight warning signs investors should watch for a possible sell-off in stock markets.

Despite the stock market's nearly 30 percent rally since its mid-October low, not all investors are convinced a new bull market has begun.

For these investors, Fundstrat technical analyst Mark Newton has highlighted the key warning signs to watch to gauge if a stock market correction is imminent.

To be clear, Newton is bullish on stocks going into the second half of 2023. He raised his technical price target for the S&P 500 to 4,700 from 4,500 and said most of the warning signs he observed had yet to materialize, suggesting that it could be more upside down.

“Seasonality trends remain quite optimistic for the years leading up to the election, and markets just did [seen] the best two quarters of the entire four-year cycle. However, July is usually still bullish,” Newton said.

But every year since 1980, the S&P 500 has averaged about a 14% annualized decline, even when posting annual gains. So a selloff could still be on the horizon and investors should be prepared for it.

According to Fundstrat, these are the eight warning signs investors should watch to gauge if a stock market correction is imminent.

1. Evidence of speculation and complacency

“While some investor sentiment surveys have become more optimistic, they have not yet reached the level of complacency/speculation that has led to previous market downturns,” Newton said. Investors can look at CNN's Fear and Greed Index or the weekly AAII investor sentiment survey to gauge the level of investor complacency.

2. Defense strength

“When utilities, consumer staples and REITs rise sharply in value on an absolute and relative basis, it can typically precede market corrections,” he said.

3. Negative dynamics and latitude divergence

“As fewer and fewer stocks participate in rallies, that has served as a warning – see early 2020 and 2021 as examples,” Newton said. So far this year, mega-cap tech stocks have accounted for much of the stock market's gains.

4. Concerns about seasonality

“US stocks are now exiting the best two quarters of the entire four-year cycle. While the pre-election years as a whole tend to be bullish, the second half of 2023 could see greater volatility.”

5. DeMark exhaustion

“When the TD Combo, TD Sequential 13 countdown signals appear on weekly and/or monthly charts, the markets can indicate potential trend reversals,” Newton said, referring to Tom Demark's indicators.

They help technical analysts gauge supply and demand for a particular security and are known for highlighting key turning points in price action. The indicators are commonly used by various strategists on Wall Street.

6. Trend deterioration in key market sectors

“If/when these sectors [financials and technology] “Markets may face headwinds as we begin to break existing uptrends.”

7. Overbought market conditions on a weekly and monthly basis

“While some investors have noted that US stocks are overbought, this is primarily seen only on $QQQ and not on the DJIA or the weekly or monthly charts of the equally weighted SPX.”

8. Divergence within the market

“Markets are at their healthiest when indices are rising in tandem. If this changes and various indices are left behind, that can be problematic and a warning.”

Read the original article on Business Insider

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