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U.S. stocks are sitting on hefty gains at the end of a volatile year, but market strategists warn the rally that led three major indexes to notch five straight winning weeks could mean equities are getting overbought and flashing a warning signal for the market in 2024, according to Oppenheimer Asset Management.
“In our view, the current year-end rally from the lows in October is constructive while nonetheless raises some concern that gains hastily achieved in just five weeks may have taken stocks near term to what will be seen as ‘overbought levels’ requiring some pay back early next year,” said a team of Oppenheimer strategists led by John Stoltzfus, chief investment strategist and managing director.
A November “everything rally” had raised the Dow Jones Industrial Average
DJIA,
the S&P 500
SPX,
the Nasdaq Composite
COMP
and the small-cap Russell 2000
RUT
respectively higher from the end of October through the first day of December by 9.7%, 9.6%, 11.3% and 12.1%, according to FactSet data.
See: Stellar stock-market rally builds on ‘soft landing’ hopes. Why the economy isn’t out of the woods.
The across-the-board rally on U.S. stock market, which was driven in part by Wall Street’s expectation that the economy will pull off a “soft landing” after a run of aggressive interest-rate hikes by the Federal Reserve, also suggests a broadening of this year’s rally across market capitalizations as mid- and small-cap indexes outperform some of the large-cap indexes in the latest period, said Stoltzfus and his team.
However, since the 2007-2008 financial crisis and the Covid-19 pandemic, financial markets have shown a tendency to get overbought and oversold pretty quickly, particularly when sentiment has leaned heavily to either bearish or bullish persuasion, the strategists said in a Monday note.
SOURCE: AAII, BLOOMBERG, OAM RESEARCH
The American Association of Individual Investors survey of investor sentiment showed optimism among investors about the short-term outlook for stocks continuing to rise in the week ending Nov. 30. Bullish sentiment, expectations that stock prices will rise over the next six months, increased three and a half points to 48.8% last week, which was “unusually high” and reached the highest level since August, said a recent AAII survey released on Thursday.
Conversely, bearish sentiment in the stock market, expectations that share prices will fall over the next six months, decreased 4.1 percentage points to 19.6% over the same period. That was the lowest level since January 2018 and was below its historical average of 31% for the fourth time in 11 weeks, the survey said.
To be sure, traders and money managers often use the market’s sentiment as a contrarian indicator. After all, an extreme bullish reading raises questions about who is left to buy, while extreme bearish readings raise the same question about sellers.
“We [Oppenheimer strategists] are not getting bearish but can remember a tendency for powerful rallies from year-end to be met with some questioning on any catalyst for profit-taking without fear-of-missing-out [FOMO] in the first quarter or second quarter of the new year,” Stoltzfus and his team said.
Stoltzfus in late October projected the S&P 500 would end 2023 at 4,400, implying a 3.5% drop from Monday’s level of 4,559, according to FactSet data. Earlier this year, he said the large-cap index would rise above 4,900 by the end of this year. That was the highest price target for the benchmark index among 20 Wall Street firms surveyed by MarketWatch in August.
See: Stock market will struggle to rise by more than 2% by mid-2024, says Stifel’s Bannister
Jason Draho, head of asset allocation Americas at UBS Global Wealth Management, said despite the increase in bullish sentiment, stock-market investors are not really bullish about the macro or markets — “they just see little near-term downside risk,” Draho said in a note on Monday.
That also explains why the Cboe Volatility Index, known by its ticker symbol VIX
VIX
and sometimes referred to as Wall Street’s “fear gauge,” fell to one of its lowest levels since January 2020 last week, meaning few investors see the need to pay up for downside protection right now, Draho said.
“The biggest near-term risk for the markets could simply be that after a phenomenal one-month rally, a period of consolidation may be a necessary breather,” he said. “A lot of good news is priced in, and investors seeing little imminent downside risk does make the markets vulnerable to even small disappointments.”
U.S. stocks were trading lower on Monday afternoon with the Nasdaq Composite off 1.1%, while the S&P 500 was falling 0.7% and the Dow industrials was down 0.3%, according to FactSet data.
