The stock market rally is reaching a point where it ought to cool off — but will it?

Published Sat, Nov 6 20218:51 AM EDTUpdated Sat, Nov 6 20219:06 AM EDT

The stock market has sped into November on one of its best win streaks of the past couple of years, the S & P 500 up seven straight days and 16 of the past 18, gaining 10% in a month and a day, Nasdaq darlings Tesla and NVIDIA piling on nearly $600 billion in market value between them in just the past three weeks, Wall Street running hot on a potent fuel blend of cheery economic stats and oddly subdued bond yields. Can it possibly last? Sure it can, because sometimes melt-ups happen and seasonal momentum powers right through overbought conditions and punishes the patient by refusing to furnish nice dips to buy. See the year 2017 for the most recent audacious example (a 6% rally from "overbought" conditions in the final two months on tax-cut excitement). Or 1999 — the most vertical bottle rocket blow-off in living memory — for a sense of how this can go at the outer extreme. Major market peaks tend not to present themselves as a moment punctuating a furious upward sprint, with broad participation as we've seen lately during gaudy win streaks. But yes, the market is probably near a point where the only real path aside from a real melt-up is a cooling-off phase — a regenerative pause or proper pullback to forestall overheating and unstable excesses from carrying too far. Are too many investors hoping for such a break in the ripping rally to feel more comfortable about the risk-reward balance? Maybe, but market conditions themselves reflect headlong buyers' urgency. The straight momentum statistics such as the S & P 500's relative strength index is up at official overbought levels, of a kind seen briefly in July, mid-April and before that late August and early June of 2020. Nothing terrible followed any of those times, but additional upside from then on didn't stay in the books long, surrendered in a pullback within weeks before the bull market reasserted itself. They were dips or sharp corrections that proved worth buying, for sure, but they did happen. Friday's 'tells' Friday's market action showed both that economic good news is good news for the market — the S & P added more than a third of a percent following a nice upside surprise in job growth for October and prior months, not to mention encouraging data on Pfizer's Covid treatment. Yet with the indexes and some of the leading risk-appetite "tells" Tesla and Nvidia fading over the course of the day, there were hints that it was one of those culminative payroll-Friday rallies that show the market having fully digested the available fundamental nutrients for the time being. From one angle, the market is singing an upbeat economic tune, cyclical stocks having resumed their outperformance against pure defensive sectors that would likely be doing better if economic vulnerabilities were building up. This is rather reassuring as to the underpinnings of this year's admittedly generous equity performance — as are sturdy credit markets and a Federal Reserve preserving policy flexibility deep into next year on a possible first rate hike until after it winds down its bond buying program and waits for supply-chain clogs to clear before making a call on the true inflation trend. Investors getting aggressive again Yet plenty of what's happening lately in the market is a revival of speculative spirits and a grab for the highest-octane stocks for the universally expected year-end upside flourish. Small-caps, biotech, volatile chain retailers and airline stocks — high-beta groups — soared almost at the same angle the past two weeks. The tactical professional traders of the National Association of Active Investment Managers is back to a leveraged-long position, equity exposure sitting above 100%, as it did during the go-go growth-stock surge of January. Aggressive, though in the past not in itself a reading that stops rallies cold. Bears, as one would imagine have been cowed by the lack of lasting setbacks and the residual pain from the retail-trader short-squeeze ambushes of the first quarter. The total base of outstanding shorts has been hovering near historic lows, though in recent months has stayed steady there even as stocks pushed higher. And the eye-watering volumes of call options being bought in the raciest Nasdaq momentum stocks show a flow of fearless money intent on driving already-elevated stocks up through ever-higher round-number prices. This was the best explanation for Nvidia on Thursday gunning for the $300 mark as it added nearly $100 billion in market value after one analyst cited it as a "metaverse" play. Traders in this way took NVIDIA directly down the tracks laid by Tesla on its way to $1,200 a share and a $1.2 trillion market cap in recent weeks. Goldman Sachs calculated that Thursday the options market saw the most notional value traded (implied value of shares underlying options contracts) in history, and call volume was the most ever except for the Jan. 28-29 crescendo of the speculative growth-stock frenzy. Morgan Stanley breaks down the weekly options tally between Nasdaq 100 stocks and all others, the rush for short-term bets on the marquee growth names reaching new heights. The first-order inference from all this is that things are getting a bit giddy, many stocks being stretched far out on unstable limbs, the bulls having it a bit too easy. Markets don't always cool when they ought to Sure, that's fair. But this action is also what bull markets typically generate after a while, and by its nature the concentrated deployment of "house money" winnings into spring-loaded adjacent bets is a tough dynamic to handicap or declare with confidence when it's about to peak. And if it has felt a bit crazy out there lately, it's worth a reminder of what a truly unhinged melt-up looks like. Here's the Nasdaq Composite this year overlaid with its path during 1999. Some have pointed out that there are resemblances, a rolling/chopping advance into late summer followed by an autumn blast-off. By this date in 1999, the Nasdaq was up about 40% for the year, making its 24% run this year seem meek. Then it ramped 31% into the end of 1999 and 62% by the ultimate March 2000 peak. Here's a fun bit of synchronicity: In the two years ending Friday, Nov. 5, the Nasdaq is up 89%. In the two years ending Nov. 5, 1999, the Nasdaq was up 89%. One could argue that in both years a galloping economy had shaken off the prior year's market panic and was running hard even as a risk-focused Fed kept rates below what conditions might merit, while a new generation of investors laughed at those tethered to traditional fundamental metrics. This is not a prediction for the next few months, or an argument that today is "just like '99." It's not, in crucial ways. The Nasdaq now houses the most profitable companies on the planet, unlike the meager profit contribution of the vastly overvalued Nasdaq of 22 years ago. Back then more than 500 IPOs hit the tape and rose an average of 60% on their first day, not exactly echoed today. But as a touchstone for what the ultimate melt-up looks like in a market that fails to cool down when it ought to and a vision of what truly excruciating "upside risk" can look like, '99 is hard to top and unlikely even to be approached. Probably.