The stage is set for a volatile end to the year in the U.S. stock market after bullish and bearish signals both hit extreme levels in recent days.
Bulls are being encouraged by the strengthening breadth of the current rally. A gauge of momentum -- the five-day moving average of new 52-week highs on the New York Stock Exchange relative to lows -- is just off its highest in 10 years. Bears are pointing to measures of extreme positive sentiment -- such as record call option volumes -- to bolster their case for a pullback.
“There is really no way to perfectly square the conflict that’s happening right now between high optimistic sentiment versus high momentum,” wrote Sundial Capital Research Inc. founder Jason Goepfert in a note to clients. “Buying breakouts with leveraged positions in this kind of environment is highly risky. Shorting isn’t much better, since momentum conditions like this can continue for weeks or months.”
The S&P 500 Index halted a four-day losing streak Tuesday, as Congress moved toward a spending package that would boost the economy. The U.S. benchmark is trading a fraction below its all-time high and has surged 65% from its March low.
Investors are the most bullish on stocks and commodities since February 2011, according to the latest Bank of America fund manager survey. Yet a plunge in cash exposure has triggered a sell signal for equities, BofA strategists said.
“Objectively, the most likely scenario is limited, choppy upside at best, with a high probability of a 3% to 8% minimum pullback over the next 1 to 2 months,” wrote Goepfert. “That leaves both sides with a poor setup.”
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