Stock Market is Rallying Because 'Fear Has Left the Building.’ Here’s the Danger

On Tuesday, U.S. stocks experienced a modest dip, appearing to take a pause from the recent rally that had pushed both the S&P 500 and Dow Jones Industrial Average to new record highs. The market, driven by investor complacency, seemed to be taking a breather after a sustained upward trend.

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Jonathan Krinsky, the chief market technician at BTIG, emphasized in a note to investors that it may be a good time to be cautious of potential short-term downside risks. He noted that while fears of a market decline seemed to have dissipated, the fear of missing out on gains was becoming more prominent. According to Krinsky, this is precisely when investors should tactically assess the risks of a downturn heading into the end of the month.

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Krinsky pointed out that a pullback to the S&P 500’s 50-day moving average, which stood near 5,607 on Tuesday, would amount to a roughly 4% drop. Although a decline of this magnitude might seem mild, it would likely feel more significant given the current complacency among market participants. He highlighted that the S&P 500, which had gained over 22% in 2024 and about 1.6% in October alone, closed above its upper Bollinger band on Monday for the first time since mid-July.

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Bollinger bands are a tool in technical analysis that consists of three lines that move with an asset’s price. The center line represents the stock’s 20-day simple moving average, while the upper and lower bands are set a specific number of standard deviations above and below that average. These bands help traders determine if an asset is overbought or oversold, with a move above the upper band often signaling overvaluation.

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Additionally, the Cboe equity put/call ratio dropped to 0.44 on Monday, marking its lowest level since July 2023. Put options allow investors to sell an asset at a predetermined price within a set timeframe, while call options provide the right to buy. A low put/call ratio, such as the one seen on Monday, can indicate that investors are less concerned about downside risks, as there is a reduced demand for protective put options.

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Krinsky acknowledged that a close above the upper Bollinger band doesn’t automatically signal a selloff. In fact, such occurrences can happen during strong upward trends. However, given the current complacency in the put/call ratios and overall market sentiment, Krinsky cautioned that this recent move could be the final push higher before some downside volatility occurs toward the end of the month.

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Corporate earnings season is now in full swing, with the S&P 500 hovering near its highs and up 14% from its August lows. In July, the S&P 500 had climbed 14% from its April low before experiencing a pullback, dropping 8.5% to reach its lowest point on August 5. The market has since rebounded, but with earnings reports now being released, investors are paying close attention to how companies perform.

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Krinsky also raised concerns about the upcoming November 5 presidential election. He noted that it is unusual for the stock market to go through October in a pre-election year without some kind of market decline. The last time the S&P 500 closed out October with a gain larger than its current month-to-date increase was in 1996, when the index rose 2.61%. However, even then, there was a 2% pullback from October 18 to October 29 that year.

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While the pullback in 1996 was relatively small, Krinsky sees potential for a move back to the 50-day moving average and advises against chasing the current market strength above the 5,800 level.

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By Tuesday afternoon, the S&P 500 had dropped 0.6%, while the Dow Jones Industrial Average lost around 230 points, or 0.5%, after both indexes had finished at record highs on Monday. The Nasdaq Composite, meanwhile, was down 0.9%, with the tech-heavy index weighed down by losses in semiconductor stocks.

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In summary, while the recent rally in U.S. stocks has led to new record highs, some market experts are urging investors to be cautious of potential downside risks. The current environment of investor complacency and the upcoming presidential election could lead to increased volatility. Krinsky’s analysis suggests that a pullback to the S&P 500’s 50-day moving average is possible, and investors should carefully weigh the risks of further upside against the potential for short-term losses.

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