The S&P 500 index has been trading within a range for nearly four months, leading investors to pay high premiums to hedge against the possibility of a significant downward breakout. However, a growing number of strategists view this pervasive pessimism as a potential signal for an upward market reversal.
This shift in market sentiment, particularly among retail investors, comes as the S&P 500 has repeatedly failed to sustain a breakout above the 7,000 level for much of the year. Several factors are contributing to the market's stagnation: artificial intelligence tools have triggered substantial sell-offs across multiple sectors, trade policies remain uncertain, and geopolitical tensions persist.
Amid these negative influences, investors are increasingly turning to derivatives to establish positions that profit from a sharp decline in the S&P 500. The put/call skew, which measures the cost of put protection relative to call options, surged to a two-year high last week. Currently, the two-month normalized skew for the S&P 500 is near the upper end of its five-year range, while the one-month standardized put skew has reached its highest level in over a year.
Strategists often interpret extreme sentiment in one direction as a contrarian indicator. Stuart Kaiser, Head of US Equity Trading Strategy at Citigroup, noted, "We are seeing significant inflows into very short-term tactical hedging instruments. Over the past 6 to 12 months, equities have not reacted strongly to most geopolitical events. If tensions with Iran ease, a substantial amount of risk premium could be unwound, prompting sidelined investors with cash to re-enter the market."
Supporting this view, a BNP Paribas measure of investor leverage—tracking ETF flows and futures-based hedge fund strategies—has fallen to its lowest level since November of last year. Counterintuitively, such pessimistic positioning often serves as a buy signal.
Greg Boutle, Head of US Equity & Derivatives Strategy at BNP Paribas, suggested, "In the coming weeks, we could see a rally led by large-cap technology stocks. This could easily push the S&P 500 toward 7,000, a psychological barrier the index has struggled to surpass. A decisive breakout might compel investors to allocate more capital to equities."
Boutle titled his latest market commentary "Be Greedy When Others Are Fearful," pointing to a potential post-earnings rally in Nvidia as a catalyst that could help the S&P 500 challenge the 7,000 mark. Bank of America analysts proposed this week that a simple way to trade the tech sector's upside is through call spreads on the Invesco QQQ Trust ETF.
Nvidia’s earnings report, released Wednesday evening, provided potential fuel for the bulls. The chipmaker issued better-than-expected revenue guidance and surpassed earnings estimates, temporarily easing concerns that AI-related spending is becoming a financial burden.
Regardless of Nvidia's performance, broader market recovery may require additional support. Retail investors, who have consistently bought market dips in recent years, are showing signs of fatigue. Data compiled by Citigroup shows that retail traders accounted for only 8.3% of total stock trading volume last week, down from an average of 11.7% in the previous year. Earlier this year, their participation even fell to the lowest level since 2024.
"Retail trading volume has collapsed," Kaiser observed. "These investors have truly stepped back from the market."
Geopolitical risks also remain elevated as the US mobilizes military assets near Iran. Any escalation of hostilities could disrupt global energy markets and heighten investor anxiety over geopolitical instability. For bullish investors, however, the prevailing pessimism may be creating a buying opportunity.
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