The U.S. stock market is highly anticipated for Christmas, how is this year different?

With the three major U.S. stock indexes achieving eight consecutive weekly positives, Wall Street's enthusiasm for Christmas is rising.

While the Fed remains cautious about cutting interest rates, cooling inflation and soft landing expectations still lead to confidence that a policy inflection point will be ushered in in the first half of next year. However, there is no shortage of cautious views in the market, with some institutions worrying that the recent rally is overdrawing the space for the future, and the market is more vulnerable to some uncontrollable factors, such as the panic dive that occurred last week.

The bullish mood in the market is hot

Traditionally, the Santa Claus market usually refers to the movement during the last five trading days of the year and the first two trading days of the new year.

Dow Jones Market data shows that since 1950, the S&P 500 has risen 78% in this faith trading window, with an average gain of 1.3%. And in the past seven years, Santa Claus has never been absent.

This time, U.S. stocks seem to have entered the festive atmosphere ahead of schedule. With Fed Chair Jerome Powell talking about his last policy meeting of the year, markets are starting to become more optimistic that the Federal Open Market Committee (FOMC) will usher in another important policy inflection point as early as March next year. Even subsequent attempts by a number of officials, including the Fed's No. 3 and New York Fed President Williams, have not been able to reverse the trend of Treasury and federal funds rate futures.

By Friday's close, the S&P 500 was less than 1% away from its all-time high and was on track to top again after the Dow two weeks ago. At present, the market sentiment is still in a state of optimism, the proportion of individual stock put options continues to decline, and the breadth of market rally is further expanded, after large-cap stocks take the lead, the small-cap index Russell 2000 has begun to catch up this month, with a cumulative increase of more than 12%. The first financial reporter summarized and found that among the stocks listed on the three major exchanges in the United States, the proportion of stocks above the 50-day moving average of the short-term strength and weakness dividing line has reached 81%, and the proportion of stocks above the 200-day moving average of the medium- and long-term strength and weakness dividing line is also close to 68%.

Money also continues to flow into the market, with BofA Global saying its clients bought a net $6.4 billion in U.S. equities last week, the largest weekly net inflow since October 2022.

Meanwhile, Vanda Research released a report saying that retail investor purchases have "increased dramatically" over the past six weeks. "After aggressively pursuing higher yields over the past few months, the FOMC's pivot and reinforced soft-landing narrative have led individuals to shift their purchases to riskier securities. With US Treasury yields still under pressure, we expect this trend to continue into the new year. ”

The view of the institutions is also generally optimistic. In BofA's latest monthly fund manager survey, respondents' optimism hit a new high since January 2022. The expectation of interest rate cuts has brought its cash holdings to a nearly two-year low.

Whether you need to be vigilant

After the recent continuous rise, the three major stock indexes plunged by more than 1.5% after hours last Wednesday (20th), which has also become part of the reason why some institutions have become cautious about the market outlook.

While there are no clear fundamental triggers for the sell-off, many analysts believe that the surge in zero-day expiration options (0DTE) trading should be the reason for the pullback. Another part of the view is that derivatives, which have been very popular this year, are only part of it, and that overbought technical conditions and low trading volume at the end of the year are also possible factors.

According to Pete Biebel, senior vice president of Benjamin F. Edwards, this is at least an omen or a red flag. "It's a warning that the market is not as rosy as it seems – there is potential trouble beneath the surface. ”

Behind the investor frenzy, traders need to hedge their record upside exposure. According to Cboe Global Markets, an average of 1.44 million S&P 500-linked call options change hands on a trading day.

As the S&P 500 nears all-time highs and options traders continue to chase the rally in U.S. equities, traders' net delta exposure to options hedges has risen to $10.8 billion, the highest on record, Charlie McElligott, a derivatives market expert at Nomura Securities. In options trading, delta indicates the sensitivity of the contract to changes in the underlying asset or index.

At the same time, valuations are drifting off the reasonable range. Albert Edwards, a global strategist at Société Générale, reports that the share of technology stocks in the US market is already about the same as it was at the peak of the dot-com bubble in 1999-2000. "U.S. technology stocks now account for nearly one-third of the total U.S. stock market capitalization. The tech sector will start 2024 with as much of the U.S. broad market index as it did during the crazy months of the summer of 2000. He wrote.

The tech sector is currently trading at 27x forward P/E, compared to 20x average for the rest of the market, a gap not seen since 2000. Edwards believes that this alone poses a huge risk to the market. "If I had to warn about a risk event that will shake investors in 2024, it could be the bursting of the U.S. tech bubble and sending the entire market into a downturn. ”

Bibel believes that judging from the sharp trend before the holiday this year, the space for Santa's market may have been partially realized. "I do think the market is a little too far away, so expectations for the New Year market should be lowered. Adam Turnquist, chief technical strategist at LPL Financial, also advised investors not to bet on seasonal momentum. "The Christmas market may not be absent, but we may see a little after-effects, such as a correction in January or February when the market corrects again after the technical indicators are overbought. ”

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