After a record-breaking run, the S&P 500 is starting to look overextended. That could be bad news heading into the election cycle. | Image: Colin Zimmer/New York Stock Exchange via AP
- The S&P 500 shows signs of an overextended rally as the Buffett Indicator and options volume near dot-com era levels.
- Strategists say a pullback is not guaranteed, but if the stock market begins to fall, there is a long way down to major support areas.
- The fading U.S. dollar adds additional pressure to the already overvalued stock market.
Two key stocks metrics have soared to levels unseen since the dot-com bubble in the 1990s . It raises the risk of an S&P 500 pullback, coming off a 55.7% rally since March 23.
The Buffett Indicator and the number of option bets predicting an S&P 500 upsurge rose to nearly 20-year highs. The confluence of the two indicators and the fading U.S. dollar puts pressure on the stock market.
Option Bets on the S&P 500 Double, Highest Since the 1990s
According to data from Bespoke Investment Group, retail investors are fueling the S&P 500’s options volume.
The explosive popularity of retail trading platforms like Robinhood led to a “massive boom in options volumes,” BIG analysts explained.
The analysts noted that the noticeable increase in “retail enthusiasm” coincided with a massive volatility spike. It created a perfect storm for individual investors to enter the market.
As CCN.com reported, CNBC’s Jim Cramer echoed a similar sentiment. He said Robinhood traders are nearly outpacing hedge funds, changing the dynamic of the stock market.
Considering the S&P 500’s prolonged uptrend and the options volume, BIG analysts said they see an overextended market :
In any event, the prevalence of call buying is in our view a clear-cut signal that sentiment is extended after a blistering equity market rally since March.
Whether the S&P 500 could continue to surge, despite signs of a crowded market, remains uncertain. But the analysts said the S&P 500 rally’s pace in recent months could intensify the downtrend.
When there are many overleveraged bets in the market, it can cause steep short-term price movements.
A growing number of investors have filed S&P 500 call options throughout the third quarter, fueling the market’s momentum.
The Buffett Indicator Also Hits Dot-Com Levels
A stock market metric dubbed the “Buffett Indicator” reached 1.7 on August 21. That signals that the stock market is overvalued by more than 71%.
The Buffett Indicator divides the value of the entire U.S. stock market by annual U.S. GDP. It evaluates fair value using the most prominent economic indicator.
Before the dot-com bubble burst, the Buffett Indicator rose to 1.71. It is a mere 0.1% away from surpassing the dot-com era in terms of overvaluation.
Similar to BIG analysts, Sevens Report Research founder Tom Essaye said a downtrend is not guaranteed. But if the S&P 500 begins to drop, Essaye noted that “it’s a long, long way down to fundamental support.”
Technical analysis shows the major support levels for the S&P 500 are at 3,393, 3,280, and 3,235 if the index starts to fall.
The Falling Dollar Is a Cherry on Top
Following Federal Reserve Chair Jerome Powell’s much-anticipated inflation speech, the U.S. Dollar Index fell from 93.32 to 92.28.
The dollar has declined sharply since March due to a culmination of factors including soaring virus cases and lagging economic growth. In the second quarter, the U.S. economy saw its biggest-ever decline. Watch the video below.
From the monthly high in March, the DXY has declined by more than 10%.
Historical data shows that a weak dollar tends to slow the stock market’s momentum . Given the S&P 500’s bubble-like rally, the declining dollar might raise the chances of a pullback.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com and should not be considered investment or trading advice from CCN.com.
