(Bloomberg) -- Worries around overheating stocks took over the narrative on Tuesday, underscoring the sense of froth in risky parts of the market that had surged after President-elect Donald Trump’s decisive election victory.
A number of trades that took flight since last week faltered before key US inflation data to be released Wednesday. Small-cap stocks — which tend to be more sensitive to economic conditions than their larger peers — fell from near an all-time high. Equities with a large concentration of bearish bets also sank, as did unprofitable technology shares. Bitcoin briefly dropped from a record before resuming gains, and the stock of Elon Musk-led Tesla Inc. slumped from the highest in more than two years.
Even before the latest reversal, the euphoria around risky assets was starting to push up against worrying signals.
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Smaller stocks, given their relatively higher debt loads, are particularly at risk when bond yields rise, which happened Tuesday on concern the flesh inflation data could dash bets on Federal Reserve interest-rate cuts next year. What’s more, an index of unprofitable tech stocks was bumping up against a level it has found hard to eclipse over the past couple years. On top of that, a measure of highly shorted shares was close to a trading zone that augurs a potential reversal.
“The post-election moves in Bitcoin and Tesla illustrate the remarkable level of froth in the markets,” said Mike O’Rourke, chief market strategist at Jonestrading. “The market is behaving as if each individual trade is occurring in a vacuum, which is not how markets work. They are interconnected.”
Even after Tuesday’s slide, Tesla’s gains since Election Day have added about $250 billion to the electric-vehicle maker’s market value. That makes it a standout example of the frenzy that followed the election, as investors wagered that Trump’s return to the White House will benefit Musk’s company, given the CEO’s support for the Republican.
All is not lost for the bulls. Market watchers also pointed to signs that the rally may not be done. A sharp pullback this month in Wall Street’s fear gauge — the Chicago Board Options Exchange Volatility Index — has given traders hope that stocks can extend their run of strength.
“We are heading into the part of the year where volatility should decline, an important market signal for whether the current rally is sustainable into 2025,” said Nicholas Colas, co-founder at DataTrek Research.
Here are five charts that show the euphoria that gripped parts of the equity market before Tuesday’s risk-off move, even as signs of bullish sentiment persist.
Short-Sellers Punished
Before faltering Tuesday, risk appetite was on display in some of the more speculative parts of the stock market. A Goldman Sachs Group Inc. basket of the 50 companies with the highest short interest advanced 9.5% in the five days through Monday to trade at the highest level since September 2022. The gauge declined 3.4% on Tuesday, but is still near that level.
Small-Cap Sensation
Small-caps were one of the big winners of the so-called Trump trades since the election, as investors bet that the president-elect’s pledge of protectionist policies will boost the group, which is typically more domestic-oriented than larger companies. The trouble is, Trump’s other proposals, such as tough immigration laws, can drive up labor costs and squeeze smaller businesses.
Call-Option Surge
The options market was also sending a bullish signal that suggested euphoria was building. Demand for options contracts that wager on more gains in the S&P 500 Index had been rising. Almost 36 million call contracts traded hands on US exchanges on Monday, compared with less than 21 million puts. Before sliding Tuesday, the ratio of the two, at 1.7, was the highest since Jan. 4, 2022. That was the day the S&P 500 started its descent into a bear market.
Tesla Gap
Tesla’s rally cooled off on Tuesday, but the stock is close to the levels it was trading at in late 2021 and early 2022, when a rush to own anything related to electric vehicles triggered an investor mania in the shares of the industry leader.
ARKK Fervor
Other anecdotal evidence also points to a buying frenzy: Call volumes on the ARK Innovation ETF (ARKK), the flagship fund of Cathie Wood, jumped to a level not seen in over a year. The fund counts Tesla as its largest holding.
--With assistance from Elena Popina.
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