Wall Street hits reset after market 'froth' but Fed Reserve fears loom

Investors who used the stock market’s recent swoon to scoop up shares are hoping the last weeks of the year bring renewed strength to equity prices, even as worries over the Omicron variant and a more aggressive Federal Reserve continue to loom.

A two-day surge has put the S&P 500 back near record highs and nearly erased the more than 4 per cent loss the index suffered after the emergence of the new Omicron variant of the Coronavirus and a potential hawkish pivot from the Federal Reserve.

Uncertainties remain over Omicron even as optimism it may cause milder illness has helped boost markets, while next week’s Fed meeting could bring unwelcome news for investors worried that the central bank may begin to normalise monetary policy at a faster-than-expected pace to fight surging inflation.

Some investors, however, believe the recent pullback may have tempered a market that had grown frothy after weeks of steady upward movement, potentially setting the stage for more gains going into the end of December — typically a strong month for stocks.

“As a result of the pullback, we saw a healthy reset of investor sentiment. And this suggests still some room for positive surprises into year-end,” said Keith Lerner, co-chief investment officer at Truist Advisory Services, told Reuters.

Extremes in investor sentiment are sometimes viewed as potential turning points in markets, and therefore opportunities to buy or sell stocks.

After a period of placid trading, some indicators of investor sentiment and positioning had swung towards caution during last week’s selloff.

Among those was the Cboe Volatility Index, known as Wall Street’s “fear gauge”, which hit 35.32 last week, its highest level since January. The index has eased in recent days and stood near 22 late on Tuesday.

Several other options market measures, including put-call ratios, volatility futures prices and skew, showed that a lot of “froth/downside” had left the market during the recent pullback, Susquehanna International Group’s Chris Murphy said in a note.

Meanwhile, investor bearishness on the market’s direction hit its highest level of the year in last week’s survey from the American Association of Individual Investors. Deutsche Bank’s measure of investor equity positioning saw its largest decline since March 2020.

Buying interest

At the same time, the Omicron-fulled pullback attracted its share of buyers. As stocks fell last week, BofA Securities clients were “big buyers of the dip,” buying $6.7 billion worth of equities on a net basis, the largest weekly amount since 2017, according to BofA Global Research.

Among recent buyers was Baker Avenue Asset Management, which added shares of Airbnb and Apple Inc as markets tumbled, said King Lip, Baker Avenue’s chief strategist.

“We actually think this Omicron situation is likely going to be more modest than ... the market was expecting,” Lip said.

Deltec Bank and Trust, a private bank and multi-asset portfolio manager in the Bahamas, also “selectively” added to equity positions during the pullback, including in Devon Energy and Levi Strauss, said Deltec’s chief investment officer Hugo Rogers.

“We do think that the demand remains very good in terms of economic activity in the (United States),” Rogers said.

Still, plenty of investors believe there could be more volatility to come, especially if it appears a more aggressive Fed will speed up the taper of its monthly government bond buying program and eventually raise rates sooner, denting the allure of stocks and other comparatively risky investments.

As of late on Tuesday, investors saw a roughly 60 per cent probability that the Fed will raise its benchmark overnight lending rate from current levels by May 2022, according to CME Group’s FedWatch program. That compares with a roughly 24 per cent chance a month ago.

“Given the major change in policy by the Federal Reserve, we believe the suckers will be the ones who do not take advantage of this bounce to raise some cash,” wrote Matt Maley, chief market strategist at Miller Tabak.