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(Bloomberg) — With investors primed for a year-end rally in risk assets — courtesy of a vaccine rollout and the chance of a stimulus breakthrough in Washington — a number of warning signs are flashing that the record-breaking U.S. equity run is overextended.
Here’s a look at five that suggest a so-called Santa Claus stock rally in December may not be so easy to come by:
Pass the Bollinger
A stellar November helped the S&P 500 Index close above its upper monthly Bollinger band, but that may signal a period of consolidation is ahead. Following each of the last three such occurrences, the U.S. stock benchmark posted declines for at least the next two months. The gauge climbed 11% last month and has started December with a more than 1% gain as traders bet on a return to normal for the global economy next year.
“It’s going to be difficult to expect too much near-term upside without some sort of further pause or pullback,” wrote Saut Strategy’s Andrew Adams in a note.
A Cboe gauge measuring the volume of bearish options bets relative to bullish ones for U.S. single stocks is also highlighting investor positivity at extreme levels. The indicator’s five-day moving average has hit its lowest level in 20 years. The gauge can often be a contrarian signal for equity markets.
Video: We are bullish on the markets for the next six months: Strategist (CNBC)
The equity rally has been so broad that almost every stock in the U.S. benchmark is in a technical uptrend. A whopping 93% of stocks in the S&P 500 were trading above their 200-day moving average this week, a level used by technical analysts to determine whether a stock is in an uptrend. That’s the highest in seven years.
Although technology shares have taken a back seat to the recent market narrative looking for gains in cheaper value stocks, the Nasdaq 100 Index still managed to hit a fresh record high Thursday. The tech-heavy gauge — up 43% this year — is now trading about two standard deviations above its 50-day moving average, a signal its rally may have gone too far.
Some investors like a more fundamental approach to judge if a market is overextended, even if the use of Yale professor Robert Shiller’s cyclically adjusted price-to-earnings ratio may reignite old arguments. By this measure, U.S. stock valuations are back above their peak seen in 1929, just before the Great Depression (though still well off dot-com-era highs).
(Updates S&P 500 performance in third paragraph.)
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