With the three major stock indexes in the United States achieving eight consecutive weekly gains, Wall Street's enthusiasm for the Christmas market is becoming increasingly high.
Although the Federal Reserve remains cautious about interest rate cuts, the continuously cooling inflation and soft landing expectations still make the outside world believe that the first half of next year will usher in a turning point in policy. However, the market also has cautious views, and some institutions are concerned that the recent rebound is overdrawing future space, making the market more susceptible to uncontrollable factors, such as the panic diving market that occurred last week.
The market is bullish and the atmosphere is lively
According to traditional definition, the Santa Claus market usually refers to the trend between the last five trading days of each year and the two trading days before the New Year.
Dow Jones market data shows that since 1950, the probability of the S&P 500 index rising in this belief trading window has reached 78%, with an average increase of 1.3%. In the past seven years, the Santa Claus market has never been absent.
This time, it seems that the US stock market has entered a festive atmosphere ahead of schedule. As Federal Reserve Chairman Powell discussed at this year's final policy meeting, the market began to become increasingly optimistic, predicting that the Federal Open Market Committee (FOMC) will once again usher in an important policy turning point as early as March next year. Even though several officials, including Federal Reserve number three and New York Fed Chairman Williams, attempted to control external enthusiasm, they were still unable to reverse the trend of US Treasury and federal funds rate futures.
As of last Friday's close, the S&P 500 index is less than 1% below its historical high and is expected to follow the Dow Jones Industrial Average two weeks ago to another peak. At present, the market sentiment is still in an optimistic state, with the proportion of put options in individual stocks continuing to decline, and the breadth of market growth further expanding. After the large cap stocks took the lead, the Russell 2000 index of small cap stocks has started to catch up this month, with a cumulative increase of over 12%. According to a summary by a journalist from First Financial News, among the three major stock exchanges in the United States, the proportion of stocks above the 50 day moving average on the short-term strength boundary has reached 81%, and the proportion of stocks above the 200 day moving average on the medium to long-term strength boundary is also close to 68%.
Funds are also continuously flowing into the market. Bank of America Global stated that its clients bought a net $6.4 billion worth of US stocks last week, the largest weekly net inflow since October 2022.
At the same time, Vanda Research released a report stating that the purchasing volume of retail investors has "sharply increased" in the past six weeks. "After actively pursuing higher yields in the past few months, FOMC's shift and strengthened soft landing narrative have led individuals to shift their purchases towards higher risk securities. As US Treasury yields continue to face pressure, we expect this trend to continue into the new year."
The views of institutions are generally optimistic. In the latest monthly fund manager survey by Bank of America, the optimism of respondents reached a new high since January 2022. The expectation of interest rate cuts has lowered its cash holdings to a low level in nearly two years.
Do we need to remain vigilant
After a recent consecutive rise, the three major stock indexes plunged more than 1.5% after market hours last Wednesday (20th), which has also become part of the reason why some institutions are becoming cautious about the future market.
Although there is no clear fundamental trigger for the sell-off, many analysts believe that the surge in zero day option (0DTE) trading should be the reason for the pullback. Another perspective suggests that this year's popular derivatives are only a part of it, and overbought technical conditions and low year-end trading volume are also possible factors.
Benjamin F. Edwards Senior Vice President Pete Biebel believes that this is at least a warning or danger signal. "This is a warning that the market is not as optimistic as it appears - there are potential troubles beneath the surface."
Behind investor frenzy, traders need to hedge against record breaking upward exposure. According to data from Cboe Global Markets, an average of 1.44 million S&P 500 index linked call options change hands on each trading day.
Charlie McEllicott, a derivatives market expert at Nomura Securities, explained that as the S&P 500 index approaches historic highs, option traders continue to chase the rise of the US stock market, and the net exposure of medium-term option hedging delta in the trader's books has risen to $10.8 billion, the highest level on record. In option trading, delta represents the sensitivity of the contract to changes in the underlying asset or index.
At the same time, valuations are gradually deviating from reasonable ranges. According to the report of Albert Edwards, the global strategist of Societe Generale, the share of technology stocks in the US market is almost the same as that of the peak of the Internet foam in 1999-2000. "US technology stocks currently account for nearly one-third of the total market value of the US stock market. At the beginning of 2024, the technology industry's share in the US market index will be as high as the crazy months of the summer of 2000." he wrote.
At present, the expected P/E ratio of the technology industry is 27 times, while the average expected P/E ratio of other sectors in the market is 20 times, which is a gap that has never appeared since 2000. Edwards believes that this alone poses significant risks to the market. "If I have to warn about the risk event that will shake investors in 2024, it may be the bursting of the foam of American technology stocks, which will bring the whole market into a downturn."
Bibel believes that based on the sharp trend before this year's holiday, the potential for Santa Claus's market may have been partially realized. "I do think the market has gone too far, so expectations for the New Year market should have decreased." Adam Turnquist, Chief Technology Strategist at LPL Financial, also advised investors not to bet on seasonal momentum. "The Christmas market may not be absent, but we may see some aftereffects, such as another adjustment in the market in January or February after technical indicators were overbought."