Stocks have surged higher following the presidential election, a move that was bound to happen.
Historically, markets perform well after elections, as investors favor the certainty that follows the resolution of political contests. Interestingly, it didn’t matter much which candidate emerged victorious—this rally was baked in.
However, an uncertain outcome could have led to heightened volatility and falling prices.
Now that the post-election rally has propelled stocks to overbought levels, the market is setting the stage for a pullback. These corrections are not just expected but healthy, offering opportunities for investors who know where to look.
The small-cap Russell 2000 Index (IWM) has been a standout performer, gaining an impressive 8% in just four days.
This rapid ascent pushed its Relative Strength Index (RSI) reading above 70 earlier this week - a level that signals overbought conditions.
When the RSI reaches such extremes, it’s a flashing warning sign that stocks are stretched to their upper limits and due for a breather.
We’ve seen this setup before.
Back in July, following a sharp 12% rally in one week, the Russell 2000 pulled back 5% initially and then another 10% just two weeks later.
However, that selloff presented a textbook “buy the dip” opportunity, rewarding patient investors.
Expect a similar playbook this time.
A pullback in the Russell 2000 is not only likely but necessary to reset valuations and sentiment.
The Nasdaq 100 is showing signs of weakness as well.
After a relentless march higher, the tech-heavy index is trading more than 2% lower on Friday, dipping below its 20-day moving average.
This trendline, often referred to as the “trader’s trendline,” is closely monitored by short-term investors. A break below it typically triggers additional selling pressure, as it indicates that momentum is shifting.
The drop below the 20-day moving average signals that further declines may be on the horizon. However, this pullback should not be viewed as alarming. Rather, it’s an essential pause in the market’s upward trajectory.
Corrections from overbought levels are not just normal - they’re healthy.
Investors should brace for further downside next week, but with the understanding that these declines will likely lead to attractive buying opportunities.
Seasonally, we are entering a strong period for the market, which should limit the scope of any selloff.
Looking at historical data, Week 47 - which we are entering - has been one of only two weeks in the last 12 weeks of the year to show average losses over the past 20 years.
Thanksgiving week, or Week 49, is the other. Despite these soft patches, the market tends to rebound strongly heading into the end of the year.
For the Nasdaq 100, keep an eye on the $480 level, which is approximately 3.5% below current prices. That area could serve as a key support level where buyers step in, creating a buy-the-dip opportunity.
Similarly, the Russell 2000 could see dip buyers emerge around $220, roughly 4% lower than its current level. These levels represent potential entry points for investors looking to capitalize on the next leg higher.
While the recent rally has been exhilarating, it’s important to remember that markets don’t move in straight lines. Periodic pullbacks are not only inevitable but are also essential for sustaining longer-term uptrends.
By identifying key support levels like $480 for the Nasdaq 100 and $220 for the Russell 2000, investors can position themselves to take advantage of these corrections.
This is a time for patience and preparation, not panic. The next week is likely to bring some turbulence, but those who stay focused on the long-term opportunities will likely be rewarded.
Remember, buying the dip is not just a strategy - it’s an approach grounded in the history of market behavior.
