After Gaining 9.6% in Three Weeks, S&P 500 Rally May Be at Risk

The recent 9.6% surge in the S&P 500 over a three-week period is raising concerns among certain market observers who question the sustainability of this rapid rally.

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One factor contributing to these apprehensions is the historical tendency for stocks to rally in response to signs of economic softness in the United States. This phenomenon typically occurs because a weaker economy might dissuade the Federal Reserve from continuing to raise interest rates. However, the skeptics argue that weaker economic data, in the end, is simply a manifestation of economic fragility. Additionally, there are growing concerns about stretched technical indicators.

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Market strategists, surveyed by Bloomberg in mid-October, had an average year-end prediction for the S&P 500 at 4,370. However, by the close of Friday's trading session, the index had already surpassed this estimate, reaching 4,514.02.

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Rick Bensignor, a former strategist at Morgan Stanley, has suggested reducing exposure if the S&P 500 approaches the 4,560 level and completes a Setup +9, a technical indicator designed to identify potential trend reversals. Matt Maley of Miller Tabak + Co. expressed caution in a note, stating that while markets are currently reacting positively to weaker economic data, fundamental changes may eventually have a negative impact on equities.

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He emphasized that a decline in inflation does not imply a return to the era of "free money" and noted that the S&P 500 is currently overbought according to its relative strength index, suggesting a possible short-term pullback.

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Bank of America Corp.'s Michael Hartnett has advised investors to sell into what he refers to as the "epic risk rally." Citing technical and macroeconomic factors, he recommended fading gains in areas such as distressed tech and China-exposed assets.

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For investors who believe that the recent market surge resembles an early arrival of "Santa," RBC Capital Markets derivatives strategist Amy Wu Silverman suggested considering put-option spreads through year-end on companies like Expedia Group Inc., Carnival Corp., Nvidia Corp., and Intel Corp.

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Despite the cautious sentiments, some strategists maintain optimism. David Kostin of Goldman Sachs Group Inc. believes that investors are overly concerned about the corporate earnings outlook. Morgan Stanley's Michael Wilson, while bearish for much of the year, predicts that U.S. assets will outperform the rest of the world next year, with American corporate earnings expected to trough in the first quarter.

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However, the rapid ascent in recent weeks has put many investors on edge. Matt Maley warns of a potential drop in the near future, with a crucial support level at 4,400. A breach below this level could signify more than just a temporary pause and raise concerns about the possibility of a more substantial decline in the market.

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