The S&P 500 Index (SPY  ) has been on a ridiculous tear since early October with a nearly 15% gain. Even more impressive has been the lack of meaningful dips, and the widespread participation with even lagging sectors breaking out higher. Some of the major catalysts were an easing in trade tensions between the US and China diffusing, the Fed committing to an even more dovish path, expectations of improving economic data, unwinding of extreme bearish sentiment, and underexposed and underperforming fund managers.

Bearish Dynamics Emerge

Given these potent factors, the bulls' dominance is not surprising. However, it's certainly surprising that the bullish price action is continuing into 2020 despite these bullish catalysts being exhausted. Now, a "phase 1" trade deal has been priced in even though doubts remain as to whether an actual agreement has been made. Recent indications are that the agreement does not seem imminent with Premier Xi Jinping refusing to meet with President Donald Trump for a signing following the APEC summit.

This is the inverse of early October. Another is that sentiment has gone from extreme bearishness to extreme bullishness especially in short-term measures like the put/call ratio, cash balances, and the CNN Fear/Greed Index. Back then positive trade progress kicked off the powerful rally as bearish sentiment normalized. This time, extreme bullish sentiment could lead to a wave of selling if trade tensions reignite.

Another risk is that the market has priced in an acceleration in economic growth that has failed to materialize. Forward-looking indicators are not behaving consistently with this outcome. Despite stock prices being depressed in early October, one bullish development was outperformance in cyclical and small-cap stocks. Currently, these sectors are underperforming. Stock market breadth has also begun diverging from prices.

All in all, this type of action is consistent with a bull market with declining participation. Essentially, money is moving into fewer and fewer stocks. In contrast, gains in the latter months of 2019 were fueled by expanding participation.


This is the time for traders and investors to play defense and protect their profits. It's also a time for patience as it's not prudent to chase stocks given elevated risk at these lofty levels. Even traders who are bullish should wait for a dip for some consolidation. However, bearish traders should also exercise caution in fading this strength. These types of momentum-fueled markets are not governed by rationality. Therefore using stop-losses and sizing positions appropriately to cap risk is necessary.