The S&P 500 has largely traded within a range over the past four months, with investors spending heavily to protect against a potential sharp downturn. However, a growing number of strategists view this pervasive pessimism as a reason to anticipate a completely opposite market outcome.
For much of this year, the S&P 500 has hovered below the 7000 mark, defying predictions of an imminent breakout. This stagnation has shifted investor sentiment, particularly among retail participants. The lack of momentum is attributable to several factors: significant sell-offs across multiple sectors driven by AI tools, ongoing trade policy uncertainties, and persistently high geopolitical tensions.
The flow of negative news has prompted a surge in investor demand for derivatives that pay out if the S&P 500 experiences a major decline. The put-call skew, a measure comparing the cost of downside protection to upside bets, jumped to a two-year high last week. The two-month normalized skew for the index is now approaching the upper end of its five-year range.
Typically, when market sentiment becomes excessively skewed in one direction, strategists begin to detect signals for a contrarian move.
Stuart Kaiser, Head of US Equity Trading Strategy at Citi, noted, "We are seeing substantial inflows into very short-term tactical hedging. Over the past 6 to 12 months, the equity market has shown little reaction to most geopolitical events. If the Iran risk subsides, a significant amount of risk premium could be squeezed out of the market, prompting investors who have been waiting on the sidelines to step in and push stocks higher."
Data supports this perspective. A BNP Paribas investor leverage indicator, which tracks metrics like ETF flows and futures-based hedge fund strategies, has fallen to its lowest level since last November. Counterintuitively, such bearish positioning often serves as a buy signal.
Greg Boutle, Head of US Equity and Derivative Strategy at BNP Paribas, suggested, "You could see a large-cap tech-led rally in the coming weeks. This could easily pull the S&P 500 above 7000, a psychological barrier the market has been reluctant to breach. A breakout might force some investors to commit capital."
Boutle titled his latest market report "Be Greedy When Others Are Fearful," pointing out that a post-earnings rally in Nvidia could pave the way for the S&P 500 to challenge the 7000 level. Analysts at Bank of America this week identified buying call spreads on the Invesco QQQ ETF Trust as a straightforward way to trade a potential tech rally.
Nvidia's earnings provided a potential catalyst for the bulls. The chipmaker issued a better-than-expected revenue forecast and reported earnings that surpassed estimates, temporarily alleviating some concerns that AI spending was becoming a burden.
Regardless of Nvidia's performance, US stocks may require further positive signals to confirm that the "all clear" has been sounded. Retail investors, who were consistent buyers during dips in recent years, are showing signs of fatigue. Data compiled by Citi shows that non-professional investors accounted for only 8.3% of total stock trading volume last week, compared to an average of 11.7% last year. Their participation rate had earlier this year fallen to its lowest level of 2024.
"Retail trading volume has plummeted. Those individuals have genuinely pulled back," Kaiser stated.
Geopolitical risks remain elevated as the US assembles military forces near Iran. Any escalation of hostilities in that region could disrupt global energy markets, making investors more concerned about geopolitical risks than they have been recently.
Comments