Is the Santa rally set to stall?

Wall Street’s bulls ran out of gusto on Friday, failing to push the Dow Jones industrials index over the 20,000 level -- a threshold that was teased all week long.

It was a relatively mild end to a “quadruple witching day,” with December market index futures, market index options, stock options, and stock futures all expiring on the same day. Investors continued to digest big rallies in the dollar and a rise in interest rates following Wednesday’s Federal Reserve interest rate hike.

But fresh hurdles are appearing for a market that has seemed to want to only rise over the last two months. Here’s why.

Stocks are looking increasingly vulnerable to a correction as expectations for Dow 20,000 are off the charts amid overbought technical measures and narrow market breadth readings (the ratio of stocks that are rising versus falling). According to the latest Bank of America Merrill Lynch global fund manager survey:

  • Growth and inflation expectations are at five-year highs.
  • Global profit expectations are at six-year highs.
  • 58 percent of asset allocators are underweight bonds, up from 48 percent in November.
  • Stock allocations have gone from net 8 percent overweight in November to 31 percent overweight now.

Yet the Dow industrials are nearly 1,000 points above the index’s 50-day moving average, fewer stocks are participating to the upside (last Wednesday was the largest sell-off since October) and the ratio of new highs to new lows is rolling over again.

The market’s behavior over the past week should give investors pause, according to Jason Goepfert at SentimenTrader. A day after closing at news highs on Tuesday, stocks fell hard in the broadest selling in two months. 

Of the 15 other times such a thing has happened since 1962, stocks continued to lose ground over the next 30 days nearly 70 percent of the time. Over the next three months, it lost at least 5 percent at its worst point seven times.

Even seasonality is set to fade: According to Goepfert, between December options expiration and the end of the year, the Nasdaq 100 rallied only seven out of 17 times, averaging a small decline.

The risk of a January sell-off is rising fast.

Emerging market stocks look like they’ll be the epicenter of any fresh weakness in the weeks to come, a consequence of the combination of the surging U.S. dollar, vulnerable economies, fears of trade spats with the incoming Trump administration and concerns about the massive buildup of dollar-denominated debts.

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In fact, the iShares Emerging Markets ETF (EEM) -- which provides easy exposure to a basket of emerging market stocks in countries like China and Brazil -- fell to test its 200-day moving average on Friday for the first time since the middle of November (chart above). That threatens to break the uptrend out of the January lows that saw prices return to levels not seen since 2009.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.