The year-to-date returns for the major US Market Index ETFs are as follows:

Nasdaq 100 ETF ((QQQ Quick QuoteQQQ - Free Report) ) +44.51%

S&P 500 Index ETF ((SPY Quick QuoteSPY - Free Report) ) +20.27%

Russell 2000 Index ETF ((IWM Quick QuoteIWM - Free Report) ) +12.56%

Dow Jones Industrial Average ((DIA Quick QuoteDIA - Free Report) ) +6.53%

Few investors likely predicted those returns late last year when inflation hit levels not seen in 40-years, geopolitical fears escalated between Russia and Ukraine, and recession fears loomed. However, as is often the case on Wall Street, the stock market is the master manipulator. Whether investors caught the move or not, each is wondering what happens next. Below are five reasons stocks need to digest:

Fitch Downgrade

US debt was downgraded for the first (and only) time since 2011. Tuesday night, Fitch Rating Agency downgraded US debt from the highest possible rating of AAA+ to AA.

While investors only have one data point to go off, in early August of 2011, S&P announced the company’s decision to downgrade US sovereign debt for the first time ever. Over the next few weeks, the S&P 500 corrected nearly 20%

Image Source: Zacks Investment Research

Wednesday’s 2% Nasdaq decline was the worst hit since February. Though such a rapid decline as 2011 is unlikely, investors should view Wednesday’s action as a warning shot in the short term.

Gravity

Driven by big-tech and Artificial Intelligence oriented stocks like Microsoft ((MSFT Quick QuoteMSFT - Free Report) ), Nvidia ((NVDA Quick QuoteNVDA - Free Report) ), and Alphabet ((GOOGL Quick QuoteGOOGL - Free Report) ), The Nasdaq 100 has gone five months without touching the 50-day moving average.

Image Source: TradingView

Remember, even during the strongest bull markets, valuations begin to matter, profit taking occurs, and markets must recalibrate by correcting through time or price. Furthermore, technicians realize that the 50-day moving average tends to act like a bungy cord – when equity indexes get stretched too far away, a mean-reversion is on the horizon.

Overheated Sentiment

Whether you use the AAII (American Association of Individual Investors) Sentiment Survey, NAAIM Exposure Index (National Association of Active Investment Managers), or the CNN Fear & Greed Index, sentiment is running hot. For example, until Wednesday, the CNN Fear/Greed Index was at “Extreme Greed” levels for over a month.

Image Source: CNN

As General George S. Patton once stated, “If everyone is thinking alike, then someone isn’t thinking”.

Seasonality

Seasonality refers to the tendency for equities to exhibit recurring patterns and behaviors at specific times of the year. Over the past ten years, August and September have been amongst the worst performing months. The magnificent run that equities have had, couples with weaker seasonality trends, should lead us to a broader pullback sooner rather than later.

Punishing Stocks Post Earnings

Several stocks got punished by double-digits after releasing earnings this week including SolarEdge Technologies ((SEDG Quick QuoteSEDG - Free Report) ), Scotts Miracle-Gro ((SMG Quick QuoteSMG - Free Report) ), and Generac ((GNRC Quick QuoteGNRC - Free Report) ). The poor action in these stocks indicates a character change in the market from previous weeks.

What Should Investors Do?

·      Build a watchlist using relative strength.In other words, in a sea of red, look for green. As the S&P 500 notched new lows in late 2022, stocks like e.l.f Beauty (ELF) and Rambus ((RMBS Quick QuoteRMBS - Free Report) ) were notching 52-week highs.

·      Don’t overtrade. In choppy, light summer trading, it can be easy to suffer from “death by a thousand cuts.”

·      Wait for the dust to settle.You don’t need to be the first to buy the dip. Wait for proof and interpret, don’t predict. Look for winning stocks like Apple ((AAPL Quick QuoteAAPL - Free Report) ) and Microsoft ((MSFT Quick QuoteMSFT - Free Report) ) to have a higher-time frame rotation (take out a previous weekly high).