The six months from November to April are historically the best part of the year for US equities because companies and pension plans tend to increase their stock buying starting on Nov. 1, according to the Stock Trader’s Almanac. However, those year-end rallies typically aren’t as robust when the S&P 500 has already risen at least 20%. In that case, since the 1970s the average return from now to Dec. 31 has been roughly 1%, according to data compiled by Bloomberg.

Of course, this bull-market rally has gone far beyond these levels, with the S&P 500 up almost 70% since bottoming in October 2022. That will curb gains into late December, according to Savita Subramanian, head of US equity and quantitative strategy at Bank of America Corp.

“Sentiment and positioning based on at least five indicators have grown dangerously bullish, leaving less room for positive surprises,” she wrote in a note to clients on Nov. 15.

Heavy Hedging

Already, some of the riskiest parts of the market are showing signs of weakness. Small-cap stocks, for instance, have erased most of their post-election rally as concern grows about the Fed’s rate path. And uncertainty over higher borrowing costs is prompting investors to hedge against sharp declines. Demand for far out-of-the-money put options on the S&P 500, technology-heavy Nasdaq 100 Index and small-cap Russell 2000 Index has risen to levels last seen during the heavy volatility ahead of the election, according to Kevin Brocks of 22V Research.

That said, the rally isn’t necessarily in jeopardy simply because there’s growing speculation that the market has run too far. Valuations and investor sentiment can stay frothy for weeks — even months — before stocks suffer a significant drop, said Max Kettner, chief multi-asset strategist at HSBC Bank Plc, adding that there are “very few reasons to suggest a year-end rally has already been front-loaded.”

Indeed, investors keep funneling money into stocks: They put $16.4 billion into US equities in the week through Nov. 20, marking the seventh consecutive weekly inflow, according to a Bank of America note citing EPFR Global data.

The optimism isn’t entirely surprising. Looking at history, the S&P 500’s advance over the past two years isn’t even half of the 143% average gain in the 16 prior bull runs since 1945, according to Birinyi Associates.

What investors most want to see when judging the rally’s strength is the gains broadening beyond the megacap tech that have been powering indexes higher on enthusiasm for artificial intelligence. It’s starting to happen, as the S&P 500 Equal Weight Index is outperforming the regular market-cap weighted version of the benchmark since Election Day, with financials, energy and consumer discretionary shares leading the way.

In the end, however, it may be the bond market that sends the loudest signal for stock prices. If Treasury yields stay high and the Fed stands pat, there are serious risks to betting on significant further gains in equities.

“A broadening rally is crucial but the one thing standing in the way of a strong advance for stocks the rest of the year is the bond market,” said Jamie Cox, managing partner at Harris Financial Group. “That may ultimately put a lid on a hefty year-end rally.”

–With assistance from Natalia Kniazhevich.

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